Why Every Founder Should Be Thinking About Forecasting Differently
I learned first hand how difficult it is to get forecasting right—especially at a startup.
At my first company, we were guided by a steadfast belief in an awesome idea. Every move we made was in line with the grand vision for our product and the need we were trying to meet. And it was true: we did have a great idea—one that grew over the years into an incredible company which was eagerly acquired.
But not before we learned some major lessons about forecasting along the way.
I had always made an effort to model and predict cash flows in order to keep the business in a healthy position. But working from a series of massive Excel sheets is not only difficult and time-consuming, it’s error-prone and you find yourself constantly questioning your numbers.
I remember one day, we found ourselves in need of several hundred thousand dollars in order to make payroll—and we didn’t have it. Something in our model was clearly broken. Thankfully, we were well-backed and got the cash. But not without a tense conversation with our investors where we had to answer to, “How the heck weren’t you prepared for this?”
This was a hard-earned lesson in the value of accurate forecasts, and it really made me stop and question the way I was doing things.
Startups are constantly growing and changing. Proper forecasting lets you move forward confidently and make more informed decisions.
Creating financial models and making projections puts you in touch with the actual status of your business. It helps you foresee potential problems, make better decisions, and measure the impact of those decisions.
Forecasting also forces you to figure out what your metrics really mean. For example, we were fully aware of our gross margin, but before we began forecasting, modeling and comparing ourselves to our peers, we didn’t know if that was actually good or bad.
Especially as a first-year company, this is incredibly important. For example, you might know that your industry experiences a slow-down in the summer, but you may not understand the full effect it will have on your business without accurate models. And, vice versa, you need to plan for busier times to make sure you’re staffed and configured to operate properly.
Most founders are focused on attempting to forecast revenue, but there’s so much more you should be trying to track and predict.
I could write pages of examples, but here are four:
- Cash. At every step, you need to know how much cash you have and how much you’ll need. This is probably the most important thing to forecast. Running out of cash unexpectedly can immediately jeopardize your business. This is why it’s so important to regularly go through your income statements and track both expenses and revenue for every line item.
- Hiring. In hiring, forecasting can help you determine if it’s a good time to bring in a new marketing director or two new salespeople. Of course, two new salespeople will surely equate to added sales revenue. But will that increased revenue outweigh their salaries, plus their actual costs? How do you even determine what their true cost is? Forecasting has the answer.
- Pricing models. There is an ideal price point for your product—one at which you’ll see an optimal sales stream—and forecasting can help reveal it. If you have a finely tuned forecast, you can even determine the impact to revenue, income and cash flow if you were to increase or decrease the price of your product by just one dollar or even change your payment terms from monthly to quarterly
- Customer acquisition. It’s important to know how much it costs to bring on a new customer, the lifetime value of the business they bring you, and how long it will take them to pay back what you paid to bring them aboard. We did a terrible job at this initially at Talent Rover and it cost us a fortune. Once we figured out how to forecast this we changed who we were actually trying to sell to.
Forecasting these things is, of course, easier said than done.
It’s not easy to create an accurate forecasting model. It requires tedious data collection, complex formulas, and intimate knowledge of how your business and industry work.
As I said, I’ve been down this road. ‘The Beast‘, a powerful series of Excel spreadsheets that took a former colleague and I a decade to build, allowed us to create financial forecasts for every aspect of our business. But I was spending 30 to 40 hours a month updating it and our accounting team was spending hundreds more.
Most founders just don’t have the skills or resources necessary to create something like this, and it’s far from efficient. Many founders hire a consultant to do their forecasting, but this is tremendously costly and, in order for the collaboration to work, you have to establish constant communication. You also run the risk of the consultant not truly understanding your business, which will have a dramatic impact on how accurate that future forecast is. That’s exactly why we’re building PlaceCPM, a forecasting and planning software built specifically for growing businesses.
If you want to begin forecasting on your own, you don’t have to boil the whole ocean at once. You just have to start collecting data and creating financial models, and you’ll be in a much better position six months down the line.
Understand, though, that while forecasting is a science, it’s also an art. There are always assumptions involved. And the better informed your assumptions, the more accurate your forecasts.
Forecasting has always been difficult, expensive and time-consuming, so I can sympathize with why so many founders don’t do it. However, without an accurate picture of their company’s future, it’s just not possible to consistently make good decisions. And while many things in business are out of a founder’s control, having an accurate model of what lies ahead certainly makes one better equipped to be successful.