Charta is on Google Play: practise on the go. Get the app
Charta

Set out what makes up a business model

CFA® Level I · Corporate Issuers · Business Models · CI.6.a

The idea

A business model states who the customer is, what is sold to them, how it reaches them and how the company is paid. The elements that matter analytically are the target market, the value proposition, the channel, the pricing approach and the cost structure that supports them. Two companies in the same industry with different models can have entirely different economics: one selling through distributors at low margin and high volume, another selling direct at high margin and low volume. Reading the model first tells an analyst which financial ratios will be informative and which will mislead.

A practice question

From the question bank, with the reason each wrong option is wrong.

Which element is part of a company's business model?

  1. How the product reaches the customer — correct
  2. The prevailing risk-free interest rateWhy not: A market-wide input that applies to every company alike and describes none of them.
  3. The auditor's opinion on the accountsWhy not: A statement about the reliability of the accounts, not about how the business earns its money.

A business model describes the customer, the offering, the channel and the pricing. External market rates and audit findings sit outside it.

A harder one

Why does understanding the business model change how financial ratios are read?

  1. Because ratios are calculated differently under different modelsWhy not: The arithmetic is the same everywhere; what differs is what a given value means.
  2. Because the model determines which ratios are informative and what normal looks like — correct
  3. Because accounting standards vary by business modelWhy not: Standards vary by jurisdiction and transaction type rather than by business model.

A high-volume, low-margin distributor and a direct high-margin seller can be equally healthy with very different margin and turnover figures. The model sets the benchmark the ratios should be read against.

The hardest tier

Two competitors sell the same product, one through distributors and one direct to consumers. What should an analyst expect?

  1. Identical gross margins but different net marginsWhy not: The channel takes its cut above the gross line, so the gross margins are the first thing to diverge.
  2. Identical cost structures since the product is the sameWhy not: The product cost may match while distribution, marketing and working capital differ substantially.
  3. Different gross margins and different working capital needs, reflecting the channel — correct

Selling direct captures the distributor's margin but brings its costs and its receivables and inventory in-house. The channel decision reshapes both the income statement and the balance sheet, so like-for-like comparison requires adjustment.

In the app: 9 practice questions on this outcome, a narrated walkthrough with diagrams, spaced review that brings it back before you forget it.

Take the free diagnostic →

More in Business Models