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Projections: How to Predict the Future

Be concrete: Start with Year 1, Month 1

I think of this as the “behavioral approach” or “activity approach” to projections.   Start by focusing on the first month.  In month 1, what exactly will you do?  What “activities”?  What costs will you have to pay to do that?  What orders will you receive as a result?

Cash Out

For each Month, starting with Month 1: what will you actually do:

What will you actually do  to create demand?

What will you actually do to move that created demand down the sales funnel to result in an order?

What other activities will you do?  Product development?  Customer support?  Recruiting?

What will you spend to deliver product for the orders you expect to receive (or received in previous months)?

For each month, what expenses will you have to pay to accomplish the activities you’ve documented?  Pay rent?  Salaries?  Commissions?  Utilities? Marketing services?  Cost of Goods sold?  Online services?   R&D? What are your total expenses in month 1?  Then month 2? …

What assets will you have to purchase starting in month 1, month2, …?  Computers?  Furniture?  How much will you pay in month 1 for all that?

For each month, what is the total out-of-pocket cash that you’ll spend on all the above?

Typical assumptions you’ll make:

  • Average compensation cost per employee (salary, benefits)
  • How number of employees will grow over time (in marketing, sales, R&D, admin, operations, IT, etc.)
  • Capital cost per employee (desks, computers, etc.)
  • Monthly rent, utilities, and how those will increase over time
  • Number of units sold each month
  • Cost of goods sold

 

Cash In

For each month, starting with Month 1, based on all your marketing and sales work, how many orders will you receive?  (Yes, that takes an assumption!)  Once you receive an order, when will you get paid?  Remember – getting an order and receiving payment are often two different things that happen at different times.   In some businesses, payment comes 60 or 90 days (or even more) after the customer gives you an order.  On the other hand, if you charge via credit card, payment can be almost immediate.

So yes, this involves some assumptions.  But it also involves hard-headed thinking: what will I do and month by month, as my marketing builds up, what orders will I receive each month.  If you think it through, you can make somewhat educated guesses!

That’s the idea of a bottom-up forecast of revenue.  It’s not purely a guess.  It is based on assumptions, but it’s also based on clear, defensible actions.  Something like:

  • We’ll hire two sales people in Q2 with experience in the market and an extensive list of contacts in our target market.
  • Based on our experience in this market, the sales cycle requires 6 months, and each sales person can work 6 prospects at any one time
  • Based on our experience in this market, we expect that 20% of the prospects our sales people engage with ultimately buy.
  • The average order will be $2,000

You test those assumptions based on the experience of other companies.  Before long, you’ll have your own validation of key assumptions (like how many leads each month do your marketing investments yield, how long is the sales cycle, etc.)  With those kind of concrete, defensible assumptions, you can put together a defensible revenue forecast.

 Repeat for each Month for the next 2 Years

Keep on going for months 2, 3, 4, 5…   Month by month, build a projection for the first two years.  Then shift to a quarterly focus for years 3-5.

Once you have the cash-in and cash-out projection, you have the basic info you’ll need for your financial projections.

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