How much funding will you need to build your company? How much revenue will you generate over the next 5 years? How much cash will you need to hire your next employee?
These are important questions. And the only way to get meaningful estimates of both cash requirements and revenue potential is to develop a bottoms-up financial forecast.
Projections do more than tell you how much cash you need. You’ll need a forecast to raise money – either from investors or from a banker. The investor wants to see how much you’ll grow (and whether your financial projections make sense). The banker will want to be convinced that you can pay back the loan. In either case – how do you create a forecast for a business that may not even have any revenue yet?
But aren’t Five Year Projections Total Fantasy?
Yes and no. Your projections will be wrong. But without creating projections, you have no basis for planning. If your projections are wrong you can learn from that and make adjustments to that your projections get better. Meanwhile, if you have no projections, you have no idea how much money you’ll need to fund your company.
To keep your projections to be total fantasy, you need to develop projections using a “bottoms up” approach – or what I call “behavior based projections”. (More on that in the following Road Map steps.)
How Investors View your Projections
Smart investors realize your projections are wrong – but you need to convince them that “these numbers could happen”. You convince them of that by doing your homework, building a bott0m-up forecast, recording your assumptions at each step, and testing those assumptions so you can defend them. The discussion with an investor should come down to defending the critical assumptions you’ve made. You defend assumptions by finding examples from comparable companies.
If your projections show higher growth or higher margins or lower spending on R&D than any other startup in your market – then you’ll have a tough time defending your projections. But if you can point to similar companies that have experienced the growth you’ve projected, and that have the margins you’ve projected, and have R&D and Marketing spending at the same levels you’ve projected – then you’ve gone a long way toward showing that the numbers are realistic and “this could happen”.