How do you create a realistic financial forecast for a start-up?

Let's look at a specific case: If the startup is an e-commerce platform, revenue drivers might include the number of active users, the conversion rate of visitors into customers, the average order value and the frequency of purchase. Understanding these drivers allows you to make more accurate projections about future revenue and make informed strategic decisions.

Understand what customers pay for - products, services, software, transaction fees. For SaaS, focus on licensing and add-ons. Use per user, usage-based, or per module pricing. For marketplaces, we prioritize gross merchandise value and take rates. Employ freemium models for adoption, charge for premium tiers. Multi-year prepaid deals boost cash flow. Identify go-to-market channels - direct, online, partners. Understand customer use cases and ROI drivers when pricing - don't just use cost-plus. Different tiers should align with where customers derive value. Be flexible - monthly, annual, multi-year commitments. View pricing through customer lens, what outcomes justify pricing. Simplicity trumps complexity.

This is for SaaS: Identify your primary revenue streams, including license subscriptions to software, professional services, and training. Then develop your pricing model based on the number of seats, modules, devices, or usage buckets. Consider tiered pricing for different levels of service or functionality. Multi-Year Deals: Highlight the importance of multi-year deals that are paid up front (great for cashflow). Analyze your target market size and growth, customer base, and market penetration rate. Examine the competitive dynamics. Sales Channels: Identify the channels through which you will sell your products, such as direct sales, online platforms, and channel partners. As a startup you want to stand the shoulder of giants.

It’s so easy to spend money. For us, 80% of cash use is related to people and commissions. Salaries, benefits, taxes+ commissions. Overhead like rent, utilities, insurance are significant fixed costs. Variables for us are cloud cloud services (do the math to see if you should bring inhouse). Account for customer acquisition costs across channels – software, digital spend, ad buys. When doing the marketing budget work backwards from the target "magic number" for ROI. Account for operations like supplies, software, admin. Overseas engineers dont always save money so weigh the pros/cons.

To calculate the cost of running a startup, identify all expenses associated with operations. This includes fixed costs like rent, utilities, salaries, and equipment, as well as variable costs such as marketing, materials, and inventory. Additionally, factor in one-time expenses like initial investments or legal fees. Projecting future costs involves estimating growth-related expenses as the business scales. By meticulously analyzing each expense category and forecasting future expenditures, startups can develop a comprehensive budget that accurately reflects the financial requirements of running the business, aiding in financial planning and decision-making.

My approach is to estimate as best all the expenses but in a conservative manner. For instance, if you company is eligible to tax reductions (R&D etc.), research grants etc., know it but do not take them into account. This will force you to consider your runway in the worst case scenario, likely giving you valuable extra months when the time comes.

Money in and Money Out. Add all recurring subscriptions, services fees, upfront multi-year payments. Offer incentives for upfront multi-year to improve cash position and reduce late payment risk. Project outflows: operating expenses, capital expenditures, tax obligations. Try to push for 90 days. Focus on cash conversion cycle - time between outlay and receipt. Create detailed monthly/quarterly cash flow statements to identify potential shortages/surpluses in advance. Private equity firms do it on a weekly basis.

When doing cash flow planning, I suggest to especially focus on learning about size, timing and risk of CF items. Size: Try to identify the items with the largest positive (= inflows) and negative (= outflows) impacts on cash. Inflows are probably coming mainly from different revenue buckets whereas outflow might come from people cost or CAPEX. Timing: Based on the P&L model, you will be able to identify in which months or quarters certain sizeable in- and outflows will happen. Especially businesses with high seasonality will need to think about CF timing. Risk: Each CF item will have risk associated to it. Deviations can lead to way more positive (such as more revenue) or negative (unexpectedly higher CAPEX) flows vs. expectations.

Most companies underachieve in ARR and overachieve in expenses (ouch). Use data to validate your model. Look at attainment data, expense patterns, and cash flow trends (is it really net 30 days?) Ramp-Up Time for Salespeople: Recognize that most salespeople take longer to ramp up and hit their numbers. Consider providing six-month quotas to help account executives (AEs) ramp faster and become productive sooner. Employee Churn: Factor in employee churn particularly among salespeople, when planning for sales capacity. Consider the associated resources attached to AEs, such as business development representatives (BDRs) and sales engineers (SEs). Conduct scenario analysis by creating best-case, worst-case, and most-likely scenarios.

Adjust assumptions: A start-up creating a financial forecast for a new app may need to adjust assumptions about user acquisition costs based on initial marketing tests. Review scenarios: A food delivery start-up might create scenarios for different growth rates in order to anticipate how changes in market conditions could impact revenue projections. Test assumptions: A tech start-up developing a new product may need to test assumptions about production costs by getting quotes from manufacturers. Use sensitivity analysis: A clothing start-up could use sensitivity analysis to see how changes in material costs affect profit margins.

One major technique for creating a realistic financial forecast for a newly started startup is to employ a bottom-up approach. Instead of relying solely on top-down estimates, break down your forecast into specific components such as customer acquisition costs, product development expenses, and operational overhead. By analyzing each aspect individually and building your forecast from the ground up, you can ensure that your projections are based on concrete data and realistic assumptions, leading to a more accurate financial outlook.

Show how you get to the sharp ARR YoY growth rates. TCV, ACV growth, logo growth and overall deal sizes can explain your assumptions. If your salespeople regularly achieve their targets, be realistic about their quota growth. Build in price increases in your customer contracts to protect yourself in inflationary environments. Also factor: Break-Even Analysis, Funding Requirements (6 months cushion) I also like to show sequential improvements in GMs and narrowing operating loss. Cohort analysis goes a long way and you want to show net dollar retention metrics and how existing customer expand. Economic Conditions: No one wants to blame the macro for missing the quarter but do be aware of changes in the overall environment.