Accurate Financial Forecasts - Do they exist?

What is a Forecast, and Why Does Accuracy Matter

At its core, a financial forecast is a roadmap that projects your company's expected financial performance over a specific period, typically ranging from one to five years. It serves as a valuable tool for understanding how your startup's finances are expected to evolve and provide insights into future revenue, expenses, and cash flow. For the companies we work with, we recommend building a three-year financial model centred around the premise that the model becomes exponentially more fictional over time. 

This isn't to say a five-year model is wrong by year five—only that a sharper lens needs to be held to its accuracy. Accurate financial projections are the lifeblood of startups, boosting credibility, showcasing potential profitability, and empowering strategic decision-making, investor attraction, funding acquisition, and effective resource allocation. But financial models are also largely driven by assumptions, including assumptions that revenue targets are hit, employees are hired, cost of goods sold (COGS) remain steady, pricing stabilizes ...the list goes on. 

As you move further ahead with a forecast, the assumptions of a given year are driven by the assumptions of the previous one, decreasing confidence in the accuracy as you move further away from actual data; this will always be the case until we master telling the future. (Which, if you have a lead on this, please contact our tech team)

Until then, we have one category of drivers to shine up ahead of your fundraising pursuits.

And get this; investors love when founders have a deep understanding of them—your assumptions.

Revenue Projections

Revenue projections provide insight into your startup's future income and sales. These projections should go beyond guesswork by incorporating market analysis, industry trends, and evaluation of customer acquisition rates. Without heaps of customer data, this isn’t easy. We recommend starting with your first year of actual revenue data and applying a "double, double, triple, triple, double" rule to year-over-year revenue growth.

Looking at your first "doubled" year of projected revenue, here is where assumptions need to be challenged. But rather than ask yourself, "Is it reasonable I hit this number next year" try asking, "What would we need to do as a company to hit this revenue goal?"

Do key employees need to be hired? Do your marketing and ad spending need to increase? Do you need to make changes to your pricing structure? All of these represent assumptions that now drive your model and potentially support the need to fundraise. 

Expense Projections

Expense projections involve estimating the costs and expenses your business will likely incur, including overhead costs like rent and utilities. By accurately projecting your expenses, you gain the power to allocate resources effectively, ensuring financial stability and making informed decisions about budgeting and cost control. 

When we work with companies, we recommend projecting annual incremental increases in overhead costs like banking fees, communication costs, and office equipment. The assumption here is that many costs are bound to increase with increased business activity. Projecting expenses is about more than just getting it accurate to the dollar but instead using assumptions to estimate a reasonable cost and refining that skill over time.

Cash Flow Projections

Cash flow projections map the movement of money in and out of your business over a specific period of time. Understanding when and how much money will be available is essential for covering expenses, fueling growth, and ensuring financial stability, particularly for companies without consistent monthly recurring revenue. Where revenue projections show sales and expenses predicted over time, effective cash flow projections show cash events as they happen. This is incredibly important for companies that might not collect payment on a strict 30-day schedule or have outstanding payables (bills) beyond 30 days. 

An assumption that drives most cash flow projections is that all bills are paid on time, and all revenue is collected on time (founders, I hear you laughing). By reviewing your actual cash flow on a monthly basis, you'll learn to gauge the accuracy of this assumption and be able to carry that level of confidence when analyzing your runway (number of months before running out of cash). 

By highlighting the impact of timing on cash flow, you gain insights into when your business will have cash on hand to meet obligations, invest in new opportunities, and weather unexpected challenges. This awareness emphasizes the need for contingency planning, allowing you to prepare for unforeseen events and maintain a steady operation.

Best Practices for Financial Forecasting Success

Implementing the best financial forecasting practices can significantly enhance your projections' value and accuracy. Here are three key tips:

1. Start with realistic assumptions and data: Ensure that your forecast assumptions are based on solid research and analysis. Use relevant data (your own actuals are the best) and industry benchmarks to support your projections, enhancing the accuracy of your forecast.
2. Utilize a variety of forecasting methods: Gain insights into different scenarios by using various forecasting techniques. Consider employing both top-down and bottom-up approaches to capture a comprehensive view of potential outcomes and mitigate risks.‍
3. Regularly review and update your forecast: Financial forecasts are not set in stone. Business conditions can change, and market dynamics can shift. It is crucial to review and update your forecast regularly to reflect changes in your business or market conditions. This helps you maintain accuracy and adapt to evolving circumstances.