Dear Daughter (VII), Sunk cost, Podcasts you should listen to, and the P&L

Wow, congratulations on also getting into ESCP in Paris! I know you didn't expect it, and with two great university choices, you are in a great position but have a tough decision to make.

Should the non-refundable deposit of 7.000 Euro (which I covered 50% of) to the other school be part of your decision-making process? No. You will make great, good, bad, and horrible decisions in business, investing, and life. This is unavoidable. When making a decision, your focus should be only on future outcomes. I'm not saying you should not learn from the past. You should. I am saying that past decisions should not influence your future decisions. Let me give you an example. You have invested 5 million in a project. It now shows little progress and hope, but it only needs 500,000 to keep going. Many think of the 5 million already invested in the project and are tempted to just put in a little more. This is a trap, the right way to think about it is to forget about the 5 million and just evaluate if the project, on its own, going forward, is attractive for a 500,000 investment. Let's take a personal example. You have a good friend you have spent a lot of time with while growing up (your investment). You are now very different, and you wonder whether to continue the relationship. Think of the future and not all your time invested in the relationship.

Back to the school money. Since ESCP is a few thousand Euros less expensive per year than the school we have paid deposits to, you should not consider the deposit. The deposit cannot be reversed, and in business and investment, this is called a?sunk cost?and should not impact your future decisions. The money has just sunk outside of Nice in France, and you should not worry about it. Think about your two great choices, and evaluate all their Pros and Cons, including, of course, the cost of attending. No matter where you decide to go, I know it will be great and that you will have a good time.

Since you still have some time before school starts, you should listen to more Podcasts. There are so many great podcasts, but so little time. I subscribe to about 50, but if I could only listen to 10, it would be these in prioritized order:

1. The All-In Podcast – Weekly podcast with 4 rich, but smart dudes discussing the economy, business, science, and politics.
2. Dan Carlin Hard Core History – 2-4 episodes per year – but they are worth waiting for.
3. BG2Pod – Twice a month, these investor legends talk business.
4. My First Million – Two entrepreneurs jam business ideas and share amazing stories. You will love it, and it is perfect to listen to when you train, despite its cringe title.
5. Acquired – The best in-depth study of the most interesting companies in the world. It will teach you a lot if you want to rule the business world.
6. Lex Friedman - is a legend who interviews amazing people for many hours.
7. The Ben and Marc show – Two venture capital legends discuss business.
8. Founders - A strange but very knowledgeable host will take you through the history of the world′s most amazing founders.
9. Marketing against the grain – Two heads of marketing in tech companies discuss the latest Do′s and Don′ts in marketing.
10. Tetragrammaton – You will not be able to pronounce the name of the Pod, but you will find it very interesting.

Now, back to business. The remaining parts of the rough plan include a budget for the first 24 months and a cash budget. Are you ready?

The P&L

Of course, making a budget for 24 months at this stage is very difficult and will be wrong, but we need some idea of what we are dealing with, so there is no way around making a budget estimate. We have now arrived at the budget most people are familiar with. The P&L, the profit and loss statement. When you read about a company′s performance and results, they are referring to this. To get to a profit or a loss, you need to start with revenues and then subtract the cost for the period you are working on. It may be a month, a quarter, or a full year.

Revenues – We always start with revenues, and I can see four sources of revenue for the Night Booster: 1) revenues from D2C (what we sell through our own website and Amazon), 2) what we sell through retailers 3) sales to distributors, 4) some subscription revenues from customers needing more scented material.

The reason for splitting the revenue streams into four is to account for the different price points and volumes (We can charge less to retailers than to end consumers since they need to make a margin). It is always very difficult to estimate volume for a new product with no history, but my best guess is that we will sell 12,000 units in year 1 and then 35,000 in year 2 when the product is more established with better distribution. In the beginning, D2C will be the largest revenue stream, but when the product succeeds, it will be easier to get distribution in retail and through distributors. “June, what do you think of this initial budget? Is it too ambitious or too passive?”

When I ran my stores and distributed with other retailers, a commercial hit was 50,000 units in Q4 alone, so I would not say that these numbers are impossible.

I wish we could just quit now, and this would be our profit. Unfortunately, we cannot, and we need to subtract our costs.

Costs – While revenues are difficult to predict, costs are not. They are either a function of revenues (costs linked to each unit that is sold) or something you can control (hiring of people, office rent, etc.). With full control of your costs, you can reduce or increase them depending on how much you sell. In other words, if we sell less than expected, we try to reduce costs correspondingly. Here are the cost elements I have included:

• Product cost - This is directly linked to the number of units sold, and the calculation is the cost we pay to the factory + the cost of shipping it to our warehouse, multiplied by units sold. You could argue that the cost per unit in year 2 would decrease due to higher volume or go up due to inflation. I have assumed the cost stays the same and have not allocated costs for returned or malfunctioning products. In real life, the product cost varies due to variations in exchange rates and if you sometimes need to fly the products to the warehouse, compared to containers on a ship.
• Subscription cost—I imagine we will sell scent refills when they run out. The end consumer could possibly buy one for 299 NOK, including sales tax. With a combination of D2C and sales to retailers/distributors, I assume an average sales price of 150, excluding sales tax, at a cost of 50 NOK.
• Transaction costs—This is the cost of accepting credit cards when selling directly to end consumers (D2C). I have assumed this to be 40 NOK (about 2%) per transaction multiplied by D2C sales.
• Outgoing logistics - The cost of getting the product to our warehouse is included in the product cost, but the cost of sending the products to our customers is not and has a separate line in the budget. I have assumed 100 NOK per unit to the end consumer and 10 NOK per unit when sending to retailers and distributors (we will send in bulk on pallets).
• Marketing costs - In the unit calculation, we assumed we would spend 600 NOK per unit on advertising for everything we sell D2C. For this calculation, we multiply the number of units sold through D2C by the marketing cost per unit. I have not assumed spending any marketing to support the retailers or distributors. We might have to do this, but it would then be linked to larger retail orders.
• Staff - We need people to make this a success. In the good old days, you had to hire and put people on your payroll. Now, you can hire many good freelancers part-time for some key roles when scaling up. Here are the roles I see that we need in year 1: 600,000 NOK - Marketing Manager, 600,000 NOK – Content Producer, 300,000 NOK – Amazon Expert, 600,000 NOK - Customer Service, 400,000 NOK – then your dad fills the rest of the roles. For year 2, I assume that each of these roles will be expanded and moved in-house, and we will add 1-2 resources in R&D/Product Development and someone for logistics.
• Miscellaneous (etc.)—At this stage, you don′t know all the costs and cannot go into too much detail, so you need a bucket for all other costs. Examples of these costs are office rent, insurance, travel, influencers, quality control, etc.
• Amortization — “June, this is a difficult word, right?” I have included it in the budget to make a point on investments. When you invest, it is not considered a normal cost to subtract from your revenues all at once. You make an investment to make money in the future. Therefore, the investment cost is subtracted from your future earnings. Often, it is done over 3 years. We plan for 700,000 NOK in investment, and the cost is split evenly over 3 years, resulting in 233,333 NOK per year. Does this make sense to you?

We are done! The only remaining step is subtracting the cost from your revenues to see if we end up with a profit or loss. The budget shows a small profit in year 1 and a significant profit in year 2. The large uptick in year 2 and over future years is called a "hockey stick" in business jargon and the norm when entrepreneurs make their budgets. Entrepreneurs are always optimistic, and they should be, but seasoned investors know that costs will be higher, revenues will be lower, and will take longer to materialize. But at least we now have a budget to reason around. No one would take me seriously If I just said that this business will make 2 MNOK in year 1 and 10 MNOK in year 2. People may criticize a budget, but you will force them to argue about different elements, not just the final profit number. People might say, "I don’t believe that 600 NOK in marketing cost per unit is enough to sell a unit. It should be 750 NOK." You can then say, “Ok, let’s put that into the model and see what happens.”

Cash is Queen

Now, on to the last budget – the cash flow budget. It has to be last since it incorporates all the others but with a twist and a different focus: CASH. Before we dig in, let me show you something that took me a long time to understand, but you will get in a blink.

Let’s say we initially buy 3,000 units with a cost of 400 NOK per unit for a total of 1.2 million. “June, is this a cost in your accounting system and budgets? It obviously is something we need to pay, right?” The answer is… it is not a cost. Imagine everything a company owns is recorded in a balance. In that balance, you have the cash it owns, the machines, the claims it has on customers, the products it owns, etc. Also, in that balance, you have what you owe others: loans, suppliers you owe money to, etc. When you buy products, you convert your cash to products, and from the company’s perspective, you are not richer or poorer. You just moved 1.2 million NOK from cash into products. But cash is not unlimited (at least not for your dad), and we need to understand how much cash the Night Booster will eat before products are transferred back into cash.

• 400,000 NOK—Investments: We start with the investments we need before the product starts selling, but we?can remove the sum allocated to me, which we don’t have to pay out in cash.
• 800,000 NOK - Opening Order: I assume we must order at least 2,000 units when we place the first order. With a unit cost of 400 NOK per unit, the total cost is 800,000 NOK. We will get better payment terms when we have worked with suppliers over a long period, but initially, we have to pay for the products before they are shipped. In other words, we have to pay for all the products before we sell a single unit.
• 500,000 NOK - Initial Losses: If you look at the P&L, you see that I expect a slight profit for year 1. What I should have done is break the budget down month by month. It would most likely show a loss initially as we get everything started. Since we don′t have this breakdown, I have assumed that we spend 500.000 NOK before we get a positive cashflow month by month.

That brings the total cash we need to 1,700,000 NOK to get the Night Booster off the ground. “June, what do you think? Should we go all in or try to find another investor to help us finance this?”

With all my love and support,

Dad

PS It now looks like you will be going to France. You need to be very careful. Please rewatch the movie Taken a few times and remember that it is no coincidence that it takes place in Paris/France.

P.P.S You need to learn to hold and drink from a wineglass. Here′s how to do it. Never place your hand and fingers on the bulb, but always at the stem close to the base. It makes you look sophisticated, with no fingerprints on the glass itself, and you are not heating the wine by your hand. When it comes to drinking from a wine glass, remember this. You can only pick up 5 different tastes with your tongue, but your nose can do much more, and 80% of the flavor comes from your ability to smell. So, you need to involve your nose in the drinking. Swirl the wine to release as much aroma as possible, and use your nose to take in the wine. Take small sips and no big gulps.