How do I put together a financial forecast that makes sense to investors?

QUESTION:

If I don’t expect substantial revenue anytime soon (we’re focused on growing our user base), how do I put together a financial forecast that makes sense to investors?

ANSWER:

Nathan Beckord

by Nathan Beckord at VentureArchetypes

Financial forecasts for startups are rarely accurate; but what investors DO care about is how you are thinking about your business, and the logic and diligence that you put into your assumptions. In that sense, building a financial forecast is a great way to organize your thoughts, put numbers around your (future) business model, and run various “what-if” scenarios.

I like to get started by organizing everything along a timeline– generally, on a monthly basis, and generally in an Excel spreadsheet. I begin by mapping out the user or customer growth curve, and then by applying one (or more) business models at some future date. As a very simple example, we would estimate the rate at which our unique website visitors grows– 10k in July, 15k in August, etc.– and at some future point, let’s say in December when we have 100k monthly uniques, we introduce a business model by serving up ads. We know that each visitor visits on average twice a month, and they click through three pages. From this,we can generate the number of total monthly impressions, and by looking at ad rates (CPMs) from similar sites, we can estimate how much revenue we’ll make. A good practice is to place all the variables in a “dashboard” format that can easily be adjusted; this way, we can run various scenarios, like “what happens if CPMs are actually $0.10 vs. $0.25” and see what that does to the bottom line.

The other key part of the the modeling process is mapping out expenses on this same timeline. Indeed, for most startups, expenses precede revenue, so this can be very telling in showing your your “burn rate”, or how much money you’re losing each month. The exercise is essentially the same– plug in the costs, such as marketing spend, salaries, IT costs, etc. in the month they are likely to be incurred.

Finally, once you’ve got this model built, go in and run a couple baseline, lower case, and worst case scenarios– e.g. by haircutting revenue, while pumping up expenses– see what happens to your business, and how much you’ll need to raise. By doing this, you’ll start to get an intuitive feel for where the real sensitivities are in your business, and you’ll be able to fluently discuss and present the forecast to investors.