Forecasting Startup Growth
Use this easy-to-follow guide to forecasting revenues and expenses during the startup stage of your biz.
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Forecasting business revenue and expenses during the startupstage is really more art than science. Many entrepreneurs complainthat building forecasts with any degree of accuracy takes a lot oftime--time that could be spent selling rather than planning. Butfew investors will put money in your business if you're unableto provide a set of thoughtful forecasts. More important, properfinancial forecasts will help you develop operational and staffingplans that will help make your business a success.
My column this month provides some detail on how to go aboutbuilding financial forecasts when you're just getting yourbusiness off the ground and don't have the luxury ofexperience.
1. Start with expenses, not revenues. When you're inthe startup stage, it's much easier to forecast expenses thanrevenues. So start with estimates for the most common categories ofexpenses as follows:
- Utility bills
- Phone bills/communication costs
- Legal/insurance/licensing fees
- Advertising & marketing
- Cost of Goods Sold
- Materials and supplies
- Direct Labor Costs
- Customer service
- Direct sales
- Direct marketing
Here are some rules of thumb you should follow when forecastingexpenses:
- Double your estimates for advertising and marketing costs sincethey always escalate beyond expectations.
- Triple your estimates for legal, insurance and licensing feessince they're very hard to predict without experience andalmost always exceed expectations.
- Keep track of direct sales and customer service time as adirect labor expense even if you're doing these activitiesyourself during the startup stage because you'll want toforecast this expense when you have more clients.
2. Forecast revenues using both a conservative case and anaggressive case. If you're like most entrepreneurs,you'll constantly fluctuate between conservative reality and anaggressive dream state which keeps you motivated and helps youinspire others. I call this dream state "audaciousoptimism."
Rather than ignoring the audacious optimism and creatingforecasts based purely on conservative thinking, I recommend thatyou embrace your dreams and build at least one set of projectionswith aggressive assumptions. You won't become big unless youthink big! By building two sets of revenue projections (oneaggressive, one conservative), you'll force yourself to makeconservative assumptions and then relax some of these assumptionsfor your aggressive case.
For example, your conservative revenue projections might havethe following assumptions:
- low price point
- two marketing channels
- no sales staff
- one new product or service introduced each year for the firstthree years
Your aggressive case might have the following assumptions
- low price point for base product, higher price for premiumproduct
- three to four marketing channels managed by you and a marketingmanager
- two salespeople paid on commission
- one new product or service introduced in the first year, fivemore products or services introduced for each segment of the marketin years two and three
By unleashing the power of thinking big and creating a set ofambitious forecasts, you're more likely to generate thebreakthrough ideas that will grow your business.
3. Check the key ratios to make sure your projections aresound. After making aggressive revenue forecasts, it's easyto forget about expenses. Many entrepreneurs will optimisticallyfocus on reaching revenue goals and assume the expenses can beadjusted to accommodate reality if revenue doesn't materialize.The power of positive thinking might help you grow sales, butit's not enough to pay your bills!
The best way to reconcile revenue and expense projections is bya series of reality checks for key ratios. Here are a few ratiosthat should help guide your thinking:
Gross margin. What's the ratio of total direct coststo total revenue during a given quarter or given year? This is oneof the areas in which aggressive assumptions typically become toounrealistic. Beware of assumptions that make your gross marginincrease from 10 to 50 percent! If customer service and directsales expenses are high now, they'll likely be high in thefuture.
Operating profit margin. What's the ratio of totaloperating costs--direct costs and overheard, excluding financingcosts--to total revenue during a given quarter or given year? Youshould expect positive movement with this ratio. As revenues grow,overhead costs should represent a small proportion of total costsand your operating profit margin should improve. The mistake thatmany entrepreneurs make is they forecast this break-even point tooearly and assume they won't need much financing to reach thispoint.
Total headcount per client. If you're a one-man-armyentrepreneur who plans to grow the business on your own, payspecial attention to this ratio. Divide the number of employees atyour company--just one if you're a jack-of-all-trades--by thetotal number of clients you have. Ask yourself if you'll wantto be managing that many accounts in five years when the businesshas grown. If not, you'll need to revisit your assumptionsabout revenue or payroll expenses or both.
Building an accurate set of growth projections for your startupwill take time. When I first started my company, I avoided buildinga detailed set of projections because I knew the business modelwould evolve and change. But I regret not spending more time onbusiness planning since I would have avoided several expenses alongthe way. The company's board of directors now requires me toprepare quarterly updates to our financial projections. Now when Ilapse into fits of audacious optimism, the projections force me toforecast what these dreams mean for the company's bottomline.