Forecasting future revenue and growth is one of the toughest exercise for any entrepreneur. In fact, almost anyone in entrepreneurial ecosystem knows and acknowledges that revenue forecasts for startups are hardly ever met…
However, building a revenue & growth forecast remains a key step to success for any entrepreneur !
Yes, indeed. So, let’s have a look about why it’s so important.
Why building a forecast of revenues and growth is so important for a startup ?
First of all, remember that you don’t forecast “real future”… Instead, you forecast your revenue and growth model.
It’s a way of understanding how your startup will behave and look like in a possible future. It will give you the opportunity to test and improve your business model and strategy.
Forecasting revenue and growth with financial modeling is thus greatly complementary to business modeling with a Business Model Canvas. It’s a more “dynamic” approach of business modeling, as you model a whole “engine” that represent you startup model with an excel spreadsheet template (or any other great financial plan tool for startup).
As part of business modeling, revenue forecasts are also great to estimate ressources needed to grow your business. Forecasting revenues implies to build a consistent ressources forecast (HR, investments, financials, …).
It will also give you metrics to compare your forecast credibility to your competition and to market size.
Last but not least, building a forecast of your future revenue and growth model will give you a great insight of your startup business potential.
Now, let’s have a look on how to build a great forecast !
How to forecast startup revenue and growth ?
Basically, a revenue forecast is based on the obvious couple between “revenue per unit sold” x “quantity sold“.
Then, a growth forecast is simply the evolution over time of the “quantity sold”.
It’s seems quite straightforward, isn’t it? However, behind this simplicity, it’s much more complicated to build a great & relevant revenue and growth forecast. Let’s get deeper into it!
First you need to work on your “revenue per unit” model. It’s not really a “forecast work”. Instead, it’s deeply related to your business model design. This means that it’s the core of your “revenue engine” that will generate your revenue forecast. To build your “revenue per unit” model, you need to work on this two main variables :
- Type of business model : “one shot sell” or “recurrent subscription” ?
- Price : low, average or high ?
Most startups, whatever they sell, will have to deal with these questions. Business modeling usually greatly helps to get clues to find the best model. Financial forecasting is also a powerfull way to test & iterate the building of any business model.
Choosing a “one shot sell” or “recurrent subscription” model may have a huge impact on your future business and cash management. A “recurrent subscription” model give a great financial visibility, but it’s doesn’t fit to all businesses. Still, a lot of “one shot sell” businesses can also be considered as “recurring businesses” because they sell products/services that customers will need to buy again and again. In any case, you will have to deal with customers acquisition and retention issues. Don’t hesitate to test one or another model with alternative forecasts, if it fits to your business, to undersand financial impacts of these different models.
Then, defining a business model pricing is usually a great concern for most startup. Low-cost pricing will usually imply the need of high-volume of sales to reach profitability, while a high pricing may implies a lower volume to reach break-even. Once again, if your are hesitant about your pricing, don’t hesitate 😉 to build alternative financial forecasts to help you build the best pricing strategy. Remember that you can also start with a pricing and forecast to evolve it over time. However, beware of setting a too low pricing that could prevent you from beeing profitable on the long run : it’s always easier to lower a price than to raise it… Customers usually don’t appreciate any raise of price while they are always happy about any lower price!
You now have to figure out how to forecast the “quantity sold” over time. It’s getting harder!
As we already wrote about, they are mainly 2 complementary ways to build a forecast : bottom-up and top-down.
The “bottom-up” approach is the best method to build a credible growth forecast. Basically, this bottom-up approach relies on building a revenue and growth “engine” based on tangible ressources that the startup can afford.
The first step to build this bottom-up growth engine, is to build the “customer acquisition engine“. This is the model that would describe best how you will gain / retain customers and how much it will cost you. This is what will generate the “growth” of your “quantity sold” over time. For any business they are mainly 3 way to “stimulate” your growth engine : Paid, Viral and Sticky.
- Paid : Most customer acquisition will cost you. You will need to invest in marketing to get customers. It’s important for any entrepreneur to know main channels that will grow the customer acquisition. Channels should be choosen preferably by customer cost acquisition (the price to acquire one new customer ; less is better of course) and potential volume of customers acquisition (the volume of acquisition a channel can provide ; a channel, even if it’s the cheaper, may not be interesting if it generates a too small volume of customers ; it may be preferable to choose a high volume channel, event if it cost a bit more.). Finding the right mix between channels, between cost and volume, is really important. You need to take into account these “paid” channels to build your growth engine. It means you also need to fix an amount of investment of marketing to acquire customers. Usually most startups don’t have much money and knowledge about “how much each channels cost”. You should really consider to test most channels with little budget to understand well each of these channels. Then, you will have better clues to define your “paid engine” and to convince financiers to give you some money to invest in marketing. Keep in mind to forecast a reasonable marketing budget at the beggining, because it’s hard to get much money. You need to grow step by step. You have to learn with iteration to expect to get progressively more and more money from financiers. It’s a chicken and egg issue! Last but not least, remember to take into account the average “customer acquisition cost” in addition to your “variable cost per unit sold” to calculate your gross margin. Indeed, this acquisition cost can sometime be really important. It has a direct impact on gross margin… For instance, e-businesses have usually high acquisition costs with little margins due to high competition…
- Viral : This is the acquisition of new customers thanks to the activity of existing customers. Almost any business can have viral customer acquisition. An existing customer can generate new customers either by using your product/service or because he talks about it around him. The “viral engine” can be terrific for growth ! Don’t overlook this. Don’t expect “viral engine” to be a “magic engine”. You have to think deeply on how to generate the best “viral engine” for your business. It’s usually super cost effective : it can either cost you little or cost you a variable cost (referral program, …). To estimate your “viral engine” efficiency for your “growth forecast”, try to get as many inputs as possible from the real world (from your starting business, from competition, …).
- Sticky (or Retention) : Most bussinesses can resell to an existing customer. It’s key to understand that is way cheaper to sell to a satisfied customer than to a new one. The “sticky engine” is thus great to grow a business ! Try to design your business model to maximise your customer retention. However, remember that a 100% retention rate is illusory… So build your “growth engine” with a reasonable retention rate. Again, try to get inputs from real world to quantify your “sticky engine”.
When you are done tuning your “customer acquisition engine“, you will have to double check your growth forecast with your “production engine“. Indeed, you can’t just do business with marketing! It’s good to sell stuff… but only if you are able to produce and deliver on time ! This is why you need to keep in mind to build your “growth engine” taking into account your internal/external ressources (HR, financial, machines, …) that make your “production engine” works. Remember that you don’t always need to get all your ressources internally. It’s usually really powerfull and effective to build business models with external ressources of “key partners” to help you focuse on your “key activities”. It’s a great leverage to growth your business. Understanding that, can save you time and money!
Finally, the “top-down” approach is a way to forecast potential revenue by comparison with competition and market size. This approach should mostly be used after building a growth forecast with the “bottom-up” approach to validate “long term” potential and revenue forecast. Remember that you have competitors. Try to estimate a reasonable market share within 3 to 5 years. Then, compare this market share with your revenue and growth forecast built with the bottom-up approach. Check that your bottom-up forecast is close or below this top-down forecast.
Test and iterate methodology to improve your forecast with multiple hypotheses and scenarios
You can see that forecasting revenue and growth is not as easy as it seems. And it’s not a random exercise. It can be designed as a whole engine, by decomposing the business workflow and challenging all hypotheses. It’s an iterative process relying on time and inputs.
You should consider to test and iterate this methodology until you are satisfied with the credibility of your main hypotheses.
Here are some other tips to consider while working on your revenue and growth forecast :
- Test business ratios VS competition (prices, gross revenues, margins, profitability, revenue / employee, investments, growth …)
- Test a base volume to test profitability with fixed ressources
- Focuse on few business revenues streams (less than 5), because it’s really hard to forecast revenue with to many variables. Moreover, it’s not an efficient way to test and improve a revenue model because it’s hard to understand underlying issues. If you have too many revenues streams, try at least to aggregate them by consistent group with an average price and sales forecast.
- Use the 80/20 rule to remain your forecast simple. It’s more effective to work with a simple model. You will be much more able to understand and improve your revenue and growth engine.
- Remember to keep in mind seasonality and holidays …
- Lower your revenue and growth forecast in a “worst case scenario” to build a steady cash management (revenues are usually not as easy/fast to reach as entrepreneurs expected while costs remain mostly fixed …).
- Compare “margin per unit sold” with your “acquisition cost per unit”. Usually it should be higger … If you expect a strong customer retention, your “acquisition cost per unit” will be more easily supported over time.
Want to build your revenue and growth forecast ?
Try our free and easy financial forecast tool, Business Model Forecast : It’s totally free to download