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Run » finance, how to create a financial forecast for a startup business plan.

Financial forecasting allows you to measure the progress of your new business by benchmarking performance against anticipated sales and costs.

When starting a new business, a financial forecast is an important tool for recruiting investors as well as for budgeting for your first months of operating. A financial forecast is used to predict the cash flow necessary to operate the company day-to-day and cover financial liabilities.

Many lenders and investors ask for a financial forecast as part of a business plan; however, with no sales under your belt, it can be tricky to estimate how much money you will need to cover your expenses. Here’s how to begin creating a financial forecast for a new business.

[Read more: Startup 2021: Business Plan Financials ]

Start with a sales forecast

A sales forecast attempts to predict what your monthly sales will be for up to 18 months after launching your business. Creating a sales forecast without any past results is a little difficult. In this case, many entrepreneurs make their predictions using industry trends, market analysis demonstrating the population of potential customers and consumer trends. A sales forecast shows investors and lenders that you have a solid understanding of your target market and a clear vision of who will buy your product or service.

A sales forecast typically breaks down monthly sales by unit and price point. Beyond year two of being in business, the sales forecast can be shown quarterly, instead of monthly. Most financial lenders and investors like to see a three-year sales forecast as part of your startup business plan.

Lower fixed costs mean less risk, which might be theoretical in business schools but are very concrete when you have rent and payroll checks to sign.

Tim Berry, president and founder of Palo Alto Software

Create an expenses budget

An expenses budget forecasts how much you anticipate spending during the first years of operating. This includes both your overhead costs and operating expenses — any financial spending that you anticipate during the course of running your business.

Most experts recommend breaking down your expenses forecast by fixed and variable costs. Fixed costs are things such as rent and payroll, while variable costs change depending on demand and sales — advertising and promotional expenses, for instance. Breaking down costs into these two categories can help you better budget and improve your profitability.

"Lower fixed costs mean less risk, which might be theoretical in business schools but are very concrete when you have rent and payroll checks to sign," Tim Berry, president and founder of Palo Alto Software, told Inc . "Most of your variable costs are in those direct costs that belong in your sales forecast, but there are also some variable expenses, like ads and rebates and such."

Project your break-even point

Together, your expenses budget and sales forecast paints a picture of your profitability. Your break-even projection is the date at which you believe your business will become profitable — when more money is earned than spent. Very few businesses are profitable overnight or even in their first year. Most businesses take two to three years to be profitable, but others take far longer: Tesla , for instance, took 18 years to see its first full-year profit.

Lenders and investors will be interested in your break-even point as a projection of when they can begin to recoup their investment. Likewise, your CFO or operations manager can make better decisions after measuring the company’s results against its forecasts.

[Read more: ​​ Startup 2021: Writing a Business Plan? Here’s How to Do It, Step by Step ]

Develop a cash flow projection

A cash flow statement (or projection, for a new business) shows the flow of dollars moving in and out of the business. This is based on the sales forecast, your balance sheet and other assumptions you’ve used to create your expenses projection.

“If you are starting a new business and do not have these historical financial statements, you start by projecting a cash-flow statement broken down into 12 months,” wrote Inc . The cash flow statement will include projected cash flows from operating, investing and financing your business activities.

Keep in mind that most business plans involve developing specific financial documents: income statements, pro formas and a balance sheet, for instance. These documents may be required by investors or lenders; financial projections can help inform the development of those statements and guide your business as it grows.

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How to Prepare a Financial Plan for Startup Business (w/ example)

Free Financial Statements Template

Ajay Jagtap

• December 7, 2023

13 Min Read

If someone were to ask you about your business financials, could you give them a detailed answer?

Let’s say they ask—how do you allocate your operating expenses? What is your cash flow situation like? What is your exit strategy? And a series of similar other questions.

Instead of mumbling what to answer or shooting in the dark, as a founder, you must prepare yourself to answer this line of questioning—and creating a financial plan for your startup is the best way to do it.

A business plan’s financial plan section is no easy task—we get that.

But, you know what—this in-depth guide and financial plan example can make forecasting as simple as counting on your fingertips.

Ready to get started? Let’s begin by discussing startup financial planning.

What is Startup Financial Planning?

Startup financial planning, in simple terms, is a process of planning the financial aspects of a new business. It’s an integral part of a business plan and comprises its three major components: balance sheet, income statement, and cash-flow statement.

Apart from these statements, your financial section may also include revenue and sales forecasts, assets & liabilities, break-even analysis , and more. Your first financial plan may not be very detailed, but you can tweak and update it as your company grows.

Key Takeaways

• Realistic assumptions, thorough research, and a clear understanding of the market are the key to reliable financial projections.
• Cash flow projection, balance sheet, and income statement are three major components of a financial plan.
• Preparing a financial plan is easier and faster when you use a financial planning tool.
• Exploring “what-if” scenarios is an ideal method to understand the potential risks and opportunities involved in the business operations.

Why is Financial Planning Important to Your Startup?

Poor financial planning is one of the biggest reasons why most startups fail. In fact, a recent CNBC study reported that running out of cash was the reason behind 44% of startup failures in 2022.

A well-prepared financial plan provides a clear financial direction for your business, helps you set realistic financial objectives, create accurate forecasts, and shows your business is committed to its financial objectives.

It’s a key element of your business plan for winning potential investors. In fact, YC considered recent financial statements and projections to be critical elements of their Series A due diligence checklist .

Your financial plan demonstrates how your business manages expenses and generates revenue and helps them understand where your business stands today and in 5 years.

Makes sense why financial planning is important to your startup, doesn’t it? Let’s cut to the chase and discuss the key components of a startup’s financial plan.

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Key Components of a Startup Financial Plan

Whether creating a financial plan from scratch for a business venture or just modifying it for an existing one, here are the key components to consider including in your startup’s financial planning process.

Income Statement

An Income statement , also known as a profit-and-loss statement(P&L), shows your company’s income and expenditures. It also demonstrates how your business experienced any profit or loss over a given time.

Consider it as a snapshot of your business that shows the feasibility of your business idea. An income statement can be generated considering three scenarios: worst, expected, and best.

Your income or P&L statement must list the following:

• Cost of goods or cost of sale
• Gross margin
• Operating expenses
• Revenue streams
• EBITDA (Earnings before interest, tax, depreciation , & amortization )

Established businesses can prepare annual income statements, whereas new businesses and startups should consider preparing monthly statements.

Cash flow Statement

A cash flow statement is one of the most critical financial statements for startups that summarize your business’s cash in-and-out flows over a given time.

This section provides details on the cash position of your business and its ability to meet monetary commitments on a timely basis.

Your cash flow projection consists of the following three components:

✅ Cash revenue projection: Here, you must enter each month’s estimated or expected sales figures.

✅ Cash disbursements: List expenditures that you expect to pay in cash for each month over one year.

✅ Cash flow reconciliation: Cash flow reconciliation is a process used to ensure the accuracy of cash flow projections. The adjusted amount is the cash flow balance carried over to the next month.

Furthermore, a company’s cash flow projections can be crucial while assessing liquidity, its ability to generate positive cash flows and pay off debts, and invest in growth initiatives.

Balance Sheet

Your balance sheet is a financial statement that reports your company’s assets, liabilities, and shareholder equity at a given time.

Consider it as a snapshot of what your business owns and owes, as well as the amount invested by the shareholders.

This statement consists of three parts: assets , liabilities, and the balance calculated by the difference between the first two. The final numbers on this sheet reflect the business owner’s equity or value.

Balance sheets follow the following accounting equation with assets on one side and liabilities plus Owner’s equity on the other:

Here is what’s the core purpose of having a balance-sheet:

• Indicates the capital need of the business
• It helps to identify the allocation of resources
• It calculates the requirement of seed money you put up, and
• How much finance is required?

Since it helps investors understand the condition of your business on a given date, it’s a financial statement you can’t miss out on.

Break-even Analysis

Break-even analysis is a startup or small business accounting practice used to determine when a company, product, or service will become profitable.

For instance, a break-even analysis could help you understand how many candles you need to sell to cover your warehousing and manufacturing costs and start making profits.

Remember, anything you sell beyond the break-even point will result in profit.

You must be aware of your fixed and variable costs to accurately determine your startup’s break-even point.

• Fixed costs: fixed expenses that stay the same no matter what.
• Variable costs: expenses that fluctuate over time depending on production or sales.

A break-even point helps you smartly price your goods or services, cover fixed costs, catch missing expenses, and set sales targets while helping investors gain confidence in your business. No brainer—why it’s a key component of your startup’s financial plan.

Having covered all the key elements of a financial plan, let’s discuss how you can create a financial plan for your startup.

How to Create a Financial Section of a Startup Business Plan?

1. determine your financial needs.

You can’t start financial planning without understanding your financial requirements, can you? Get your notepad or simply open a notion doc; it’s time for some critical thinking.

Start by assessing your current situation by—calculating your income, expenses , assets, and liabilities, what the startup costs are, how much you have against them, and how much financing you need.

Assessing your current financial situation and health will help determine how much capital you need for your startup and help plan fundraising activities and outreach.

Furthermore, determining financial needs helps prioritize operational activities and expenses, effectively allocate resources, and increase the viability and sustainability of a business in the long run.

Having learned to determine financial needs, let’s head straight to setting financial goals.

2. Define Your Financial Goals

Setting realistic financial goals is fundamental in preparing an effective financial plan. So, it would help to outline your long-term strategies and goals at the beginning of your financial planning process.

Let’s understand it this way—if you are a SaaS startup pursuing VC financing rounds, you may ask investors about what matters to them the most and prepare your financial plan accordingly.

However, a coffee shop owner seeking a business loan may need to create a plan that appeals to banks, not investors. At the same time, an internal financial plan designed to offer financial direction and resource allocation may not be the same as previous examples, seeing its different use case.

Feeling overwhelmed? Just define your financial goals—you’ll be fine.

You can start by identifying your business KPIs (key performance indicators); it would be an ideal starting point.

3. Choose the Right Financial Planning Tool

Let’s face it—preparing a financial plan using Excel is no joke. One would only use this method if they had all the time in the world.

Having the right financial planning software will simplify and speed up the process and guide you through creating accurate financial forecasts.

Many financial planning software and tools claim to be the ideal solution, but it’s you who will identify and choose a tool that is best for your financial planning needs.

Create a Financial Plan with Upmetrics in no time

Enter your Financial Assumptions, and we’ll calculate your monthly/quarterly and yearly financial projections.

Start Forecasting

4. Make Assumptions Before Projecting Financials

Once you have a financial planning tool, you can move forward to the next step— making financial assumptions for your plan based on your company’s current performance and past financial records.

You’re just making predictions about your company’s financial future, so there’s no need to overthink or complicate the process.

You can gather your business’ historical financial data, market trends, and other relevant documents to help create a base for accurate financial projections.

After you have developed rough assumptions and a good understanding of your business finances, you can move forward to the next step—projecting financials.

5. Prepare Realistic Financial Projections

It’s a no-brainer—financial forecasting is the most critical yet challenging aspect of financial planning. However, it’s effortless if you’re using a financial planning software.

Upmetrics’ forecasting feature can help you project financials for up to 7 years. However, new startups usually consider planning for the next five years. Although it can be contradictory considering your financial goals and investor specifications.

Following are the two key aspects of your financial projections:

Revenue Projections

In simple terms, revenue projections help investors determine how much revenue your business plans to generate in years to come.

It generally involves conducting market research, determining pricing strategy , and cash flow analysis—which we’ve already discussed in the previous steps.

The following are the key components of an accurate revenue projection report:

• Market analysis
• Sales forecast
• Pricing strategy
• Growth assumptions
• Seasonal variations

This is a critical section for pre-revenue startups, so ensure your projections accurately align with your startup’s financial model and revenue goals.

Expense Projections

Both revenue and expense projections are correlated to each other. As revenue forecasts projected revenue assumptions, expense projections will estimate expenses associated with operating your business.

Accurately estimating your expenses will help in effective cash flow analysis and proper resource allocation.

These are the most common costs to consider while projecting expenses:

• Fixed costs
• Variable costs
• Employee costs or payroll expenses
• Operational expenses
• Marketing and advertising expenses
• Emergency fund

Remember, realistic assumptions, thorough research, and a clear understanding of your market are the key to reliable financial projections.

6. Consider “What if” Scenarios

After you project your financials, it’s time to test your assumptions with what-if analysis, also known as sensitivity analysis.

Using what-if analysis with different scenarios while projecting your financials will increase transparency and help investors better understand your startup’s future with its best, expected, and worst-case scenarios.

Exploring “what-if” scenarios is the best way to better understand the potential risks and opportunities involved in business operations. This proactive exercise will help you make strategic decisions and necessary adjustments to your financial plan.

7. Build a Visual Report

If you’ve closely followed the steps leading to this, you know how to research for financial projections, create a financial plan, and test assumptions using “what-if” scenarios.

Now, we’ll prepare visual reports to present your numbers in a visually appealing and easily digestible format.

Don’t worry—it’s no extra effort. You’ve already made a visual report while creating your financial plan and forecasting financials.

Check the dashboard to see the visual presentation of your projections and reports, and use the necessary financial data, diagrams, and graphs in the final draft of your financial plan.

Here’s what Upmetrics’ dashboard looks like:

8. Monitor and Adjust Your Financial Plan

Even though it’s not a primary step in creating a good financial plan, it’s quite essential to regularly monitor and adjust your financial plan to ensure the assumptions you made are still relevant, and you are heading in the right direction.

There are multiple ways to monitor your financial plan.

For instance, you can compare your assumptions with actual results to ensure accurate projections based on metrics like new customers acquired and acquisition costs, net profit, and gross margin.

Consider making necessary adjustments if your assumptions are not resonating with actual numbers.

Also, keep an eye on whether the changes you’ve identified are having the desired effect by monitoring their implementation.

And that was the last step in our financial planning guide. However, it’s not the end. Have a look at this financial plan example.

Startup Financial Plan Example

Having learned about financial planning, let’s quickly discuss a coffee shop startup financial plan example prepared using Upmetrics.

Important Assumptions

• The sales forecast is conservative and assumes a 5% increase in Year 2 and a 10% in Year 3.
• The analysis accounts for economic seasonality – wherein some months revenues peak (such as holidays ) and wanes in slower months.
• The analysis assumes the owner will not withdraw any salary till the 3rd year; at any time it is assumed that the owner’s withdrawal is available at his discretion.
• Sales are cash basis – nonaccrual accounting
• Moderate ramp- up in staff over the 5 years forecast
• Barista salary in the forecast is $36,000 in 2023.
• In general, most cafes have an 85% gross profit margin
• In general, most cafes have a 3% net profit margin

Projected Balance Sheet

Projected Cash-Flow Statement

Projected Profit & Loss Statement

Break Even Analysis

Start Preparing Your Financial Plan

We covered everything about financial planning in this guide, didn’t we? Although it doesn’t fulfill our objective to the fullest—we want you to finish your financial plan.

Sounds like a tough job? We have an easy way out for you—Upmetrics’ financial forecasting feature. Simply enter your financial assumptions, and let it do the rest.

So what are you waiting for? Try Upmetrics and create your financial plan in a snap.

Build your Business Plan Faster

with step-by-step Guidance & AI Assistance.

Frequently Asked Questions

How often should i update my financial projections.

Well, there is no particular rule about it. However, reviewing and updating your financial plan once a year is considered an ideal practice as it ensures that the financial aspirations you started and the projections you made are still relevant.

How do I estimate startup costs accurately?

You can estimate your startup costs by identifying and factoring various one-time, recurring, and hidden expenses. However, using a financial forecasting tool like Upmetrics will ensure accurate costs while speeding up the process.

What financial ratios should startups pay attention to?

Here’s a list of financial ratios every startup owner should keep an eye on:

• Net profit margin
• Current ratio
• Quick ratio
• Working capital
• Return on equity
• Debt-to-equity ratio
• Return on assets
• Debt-to-asset ratio

What are the 3 different scenarios in scenario analysis?

As discussed earlier, Scenario analysis is the process of ascertaining and analyzing possible events that can occur in the future. Startups or businesses often consider analyzing these three scenarios:

• base-case (expected) scenario
• Worst-case scenario
• best case scenario.

About the Author

Ajay is a SaaS writer and personal finance blogger who has been active in the space for over three years, writing about startups, business planning, budgeting, credit cards, and other topics related to personal finance. If not writing, he’s probably having a power nap. Read more

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Financial Projections for Startups [Template + Course Included]

January 11, 2022

Adam Hoeksema

Financial projections are an important part of any business plan or startup pitch deck. They allow a company to estimate future revenues, expenses, and profits, and to identify potential risks and opportunities.  We have been helping founders create financial projections through our templates, tools, and custom financial modeling services since 2012.  I thought it was finally time to write a comprehensive article that should answer the key questions that we get from founders again and again.  So here is what I plan to cover:

What are financial projections? 

Why should a startup create financial projections, how to create a financial forecast , creating sales projections based on data, forecasting operating expenses, salary projections.

• Startup cost forecasting

Pro forma financial statements

Existing business vs. startup vs acquisition forecasting, how to know whether my projections are realistic, what will investors and lenders be looking for in my projections, tools used for financial forecasting.

But first, who am I, and do I know anything about financial projections? 

My name is Adam Hoeksema and I am the Co-Founder of ProjectionHub.  Since 2012 we have helped over 50,000 entrepreneurs create financial projections between our software tool and our business projection spreadsheet templates . 

I didn’t spend a decade on Wall Street or make a killing in private equity, and I haven’t even raised VC funding myself.  

But I did spend over a decade launching a growing an SBA (Small Business Administration) lender in the Indianapolis, IN area.  During that time we made over 1,800 small business loans and we often asked our clients for financial projections along with their loan applications.  That is why I started ProjectionHub.  

So 10 years ago my experience was with helping small, main street businesses create projections and secure loan funding to start their dream.  Along the way, I learned a ton about startup projections for tech-based businesses as well.  Today about 50% of our work is with small businesses looking for an SBA loan and 50% is with tech-based businesses looking to raise capital from investors.  

With that background in mind, I want to share with you what I have learned along the way to try to make your financial forecasting process just a little bit easier.  Let’s dive in!

Financial projections are estimates of the future financial performance of a company. These projections are typically based on a set of assumptions and are used to help businesses plan for the future and make informed decisions about investments, financing, and other strategic matters. Most ProjectionHub customers use pro forma financials to help external stakeholders, such as investors and lenders understand a company's financial position and future prospects. Financial projections typically include projections of income, expenses, cash flow, and balance sheet items.  

There are many opinions on whether a startup needs to create a forecasted balance sheet and how many years a set of projections should be.  At ProjectionHub, all of our financial projection templates have an integrated pro forma income statement, cash flow and balance sheet in annual and monthly format for 5 years.  This seems to meet the needs of 99% of our customers, so I think it is pretty safe to say that your investor or lender might not require all of that level of information, but they probably won’t require more than a 5-year forecast of your 3 statement financials. 

So it sounds like a lot of work to create a financial forecast, so why do we create projections?  No one can know the future.  Isn’t it just a pointless exercise?  

Well, I think it is smart for an entrepreneur to create a set of projections before they start a business to understand what they are getting themselves into and what it will take to break even and generate a profit.  

I could beat that drum all day, and you know what it doesn’t really matter.  Even if we know it is a good idea to create projections before throwing our life savings into a new venture, most entrepreneurs will not create projections before starting their business.  I have just come to accept this!  

So the real reason to create projections is because the people with the money, the investors and lenders ask for them.  

• Investors will ask for a financial model because they want to see how you plan to use their money, how long you think it will last, and what the potential return could be. 
• Lenders will ask to see financial projections for startups or new projects or divisions in a business because they want to be able to see whether you think you can pay them back or not.  How does your debt service coverage ratio look? How many cups of coffee are you going to have to sell to make your monthly loan payment? 

Now that we know why we are creating projections and who the audience is, let’s get into the “how.”

So the plan now is to walk through how to create a set of financial projections, how to do good research to take a data-driven approach when modeling, what tools you can use to help you with research, and then how to know whether your forecast is realistic once you are done.   We are going to look at:

• Creating revenue projections
• Operating Expenses
• Salaries Forecasting
• How to get investor and lender-ready projections

Revenue Projections

This is where we will camp out for a while.  I want to show you a few examples of different types of revenue models to show you how I approach creating revenue projections.  

If you have a stable, existing business, then it is possible that the best approach to creating sales projections is simply to take last year’s numbers and apply a growth rate based on your expectations of growth.  Since that approach is quite straightforward I am not going to spend any time on that today. Our Existing Business Forecast Template will be perfect for you in this scenario.  

We are going to focus on more of a first principles approach.  I am going to outline two different approaches that I often take when building a financial model.  First a capacity approach and then a customer funnel approach.  

Capacity-Based Revenue Projections

I use a capacity-based approach to revenue projections when a company is pretty certain to have demand for their products or services and their revenue is more of a function of your price x capacity.  

Here are some examples of businesses where I would take a capacity-based approach. 

Farming Projections

For a farm, your revenue forecast is going to be based on how many acres you are farming x the yield per acre x the price per unit for your crop.  You don’t really need to worry about whether you have a customer or not.  Since most crops are commodities you won’t need to find a customer, you simply sell into the ready made market at the market price. 

Trucking Projections

Trucking is similar in the sense that as long as you have a valid license and a working truck, you will be able to find loads to deliver.  The question is more about how many trucks do you have, how many miles per day can each truck drive and what price will you be able to earn per mile.  Again this is about capacity and price, not whether or not you can find a customer.  This is the approach we take to show how a trucking business with one truck can generate $400k in annual revenue . 

Daycare Facility

A daycare facility will also be able to calculate a capacity based on the size of the facility and the teacher-to-student ratio requirements.  Once you have your capacity it is mostly a function of pricing to determine your revenue forecast.  You can see a screenshot from our daycare financial forecast tool to see how we think about modeling this type of business. 

I would say most tech businesses do not fall into a capacity-based projection approach. 

For tech companies, I typically use a customer funnel-based approach to forecasting revenue. 

Customer Funnel-Based Revenue Projection Approach

These are companies where your customer might not even know your product or service exists and might not know that they want it or need it so you are going to have to really go out and market and sell.  You will likely have a customer funnel that will have leads that convert into customers over time.  

Here are some examples of business models where I would use a customer funnel approach to financial modeling. 

B2B SaaS Projections

For a B2B SaaS product you will probably have an advertising budget and a sales team that will drive leads that your team will work to qualify.  Then some percentage of those sales qualified leads will turn into customers.  You will need assumptions for things like:

• A monthly ad budget 
• Cost per click to attract a website visitor
• Percentage of website visitors that become sales qualified leads
• Percentage of sales qualified leads that the sales team converts into customers
• Average monthly spend per customer

DTC Product Forecasting

For direct to consumer product companies you will have a similar customer funnel.  Once you get to a customer, then you might have assumptions like:

• Average order value
• % of customers that become repeat customers
• How often do repeat customers repurchase

Consumer Apps 

For a consumer mobile app you will need assumptions for things like:

• Monthly ad budget
• Cost per download
• Organic / word of mouth downloads
• % of customers that download the app that convert into active users
• % of active users that churn each year
• Average monthly spend per active user per month

So this should give you an idea of the structure of assumptions that you will need in order to approach creating projections, but I just left you with a bunch of assumptions that you have no idea how to fill in with realistic data.  

Next I want to show you what I would do in order to research and find good data for your sales projections. 

So how do you know how many people are searching on Google for terms that are relevant to your product or service?  How do you know how much it would cost to advertise and get a click for that term?  How do you know what a reasonable conversion rate is from a website visitor to a customer?  How do you know what the average order value is for an ecommerce business like yours, etc? 

I recorded an entire course on this , but I have listed some tools and some slides below to show you my typical research process. 

As you will notice in the slides, I start out be simply doing Google research to try to find reasonable assumptions for as many of the key assumptions as I can.  

From there, I like to use the following tools:

• Ahrefs - I use this tool for competitor research to determine how much organic traffic my competitors are getting and thereby how much organic traffic my website might get over time. 
• Google Trends - I use Google Trends to see seasonality trends in a business. 
• Google Adwords Keyword Tool - I use this tool to forecast how much it will cost per click to attract a website visitor, and to see search volume for certain keywords.
• Bizminer - You can use Bizminer industry reports to get an idea of key industry ratios to get an idea of whether your projections are realistic for your industry. 

When forecasting expenses I like a couple of different resources to help me forecast my expenses and ensure that my expense projections are within industry standards. 

Expenses for Small Businesses

Bizminer - You can use Bizminer industry reports to get an idea of key industry ratios.  For example, you can determine if the average company in your industry spends 10% on rent or 12% on rent. 

Expenses for Tech Startups

SaaS Capital - You can use this report from SaaS Capital to get an idea of the spending categories as a % of revenue for tech companies.  This is specifically focused on SaaS, so if you are in ecommerce or a hardware startup you will need to find a similar source for your industry.  You can see an example of the expense ratios from SaaS Capital below:

When forecasting salaries I actually take two different approaches.  I typically start out by projecting specific salaries and positions for the first 24 months of the projection.  Then after that, I simply include salaries in larger buckets of operating expenses like General & Admin, R&D, and Sales & Marketing.  When you are raising investment the investors will likely want to know your specific use of funds for the first 18 to 24 months, but after that they will understand that it is impossible to predict exact positions, timing and salaries, so transitioning to an expense as a % of revenue makes sense.  You can see how this looks in one of our financial models for a B2B SaaS company : 

Detailed Salary Projections for the First 24 Months:

Salaries included in operating expense categories as a percentage of sales for year 3 and beyond:

Startup Cost Forecasting

When forecasting your startup costs, your specific location, concept, size and scale of business will make a dramatic difference in what it costs to launch your business.  I don’t recommend that you just take the first “average startup cost” number that you find in a Google search because your specific situation matters.  You will need to do your own research for each startup cost, but I have actually found it helpful to use ChatGPT to ask for a list of common startup expenses for business XYZ so that I don’t forget any common expenses. 

I have already mentioned this before, but I commonly take a different approach to creating projections for an existing business compared to a startup compared to modeling a business acquisition.  

Existing Business Projections

When modeling a projection for an existing business I like to use our existing business budgeting template that allows me to enter in historical revenue and expenses and use that as a baseline to build a forecast by increasing or decreasing expenses and revenue based on my plans. 

Startup Projections

For a startup, I would use one of our 70+ industry specific financial projection templates and start from the ground up.  You would use the research process outlined in this article to create your projections. 

Forecasting a Business Acquisition

For creating projections for a business that you are looking to acquire I would use our acquisition financial model which will allow you to enter in historical financials from the target business, but it will also allow you to make adjustments to the balance sheet and revenue and expenses for a post acquisition pro forma. You can’t simply use the existing balance sheet and income statement because both will likely change quite a bit after the sale of the business.

Finally, I wanted to show you some example pro forma statements so that you can see what the end product should look like.  

Pro forma P&L Example

Here is an example of our 5 year pro forma income statement. 

Pro forma Balance Sheet Example

Here is an example of our 5 year pro forma balance sheet. 

Once you have a complete set of projections (if you are using a ProjectionHub template) I would suggest taking a look at the profit and loss at a glance table as seen below: 

In this example, I am looking at projections for a technology company that is looking to raise investment.  So a couple of things that I would look at for a tech company pro forma.  

• The first year should probably be a loss because that is why you are looking to raise investment right?  I would just make sure you are assuming that you will raise enough investment to cover that first year loss.  
• Next I would look at how fast revenue is growing.  For an investable company there is a rule of thumb “triple, triple, double, double” which means after investment an investor will be hoping that you triple sales the first 2 years and then double sales the following two years.  This is really hard to do, so if you are forecasting that you will do 10x every year you are probably off base! 
• For tech startups you can look at this study with our partner Story Pitch Decks where we looked at what is a reasonable projection for a tech startup .  This study will show you what other similar companies are projecting, so that you can ensure that whatever you project will fall within the norms that investors see. 

Investors and lenders will likely be looking at the following numbers and ratios to make sure your projections seem to be reasonable:

• Gross Profit Margin
• Profit Margin
• Debt Service Coverage Ratio
• Comparing to industry averages
• Do revenue projections, units sold make sense?
• Does your balance sheet balance?
• When do you reach breakeven?
• Do you have room for error?

I suggest that you simply Google these things and make sure your numbers seem “normal.”  For example, if you are opening a coffee shop you could Google “average profit margin for a coffee shop” and you would probably find our article on coffee shop profit margins .  Confirm that your forecasted profit margins are in line and reasonable. Do this same exercise with each of these key ratios and numbers.  

As a thank you for reading this behemoth of an article, you can download our free financial projection template .  Other tools that I utilized or mentioned in the article include:

• Ahrefs - For competitor research
• Google Trends - For seasonality trends
• Google Adwords Keyword Tool - For search volume and cost per click
• Bizminer - For industry expense ratios
• ProjectionHub Pro Forma Templates - You can use our library of templates built specifically for over 70 unique industries and business models. 

If you would like to learn more about my process for creating financial projections, you can watch this course that I put on for tech startups looking to create investor-ready financial projections. 

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Well I hope this has been helpful to you.  If you have specific questions please feel free to reach out directly to us at [email protected]  

About the Author

Adam is the Co-founder of ProjectionHub which helps entrepreneurs create financial projections for potential investors, lenders and internal business planning. Since 2012, over 50,000 entrepreneurs from around the world have used ProjectionHub to help create financial projections.

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Guide to Mastering Startup Financial Planning and Management

The world of startups is exciting, dynamic, and often fraught with challenges. One of these challenges is the management and planning of finances.

Startup Financial Planning is a crucial aspect of running a successful business and should not be overlooked. This guide will delve into vital aspects of startup financial management , including budgeting, cash flow management, financial forecasting, expense management, vendor management, and financial security and risk management.

The Essence of Budgeting and Financial Planning in Startups

Financial planning and budgeting form the backbone of any startup. These crucial processes help startups allocate resources efficiently, prevent overspending, and ensure optimal fund distribution. A comprehensive budget identifies both fixed and variable costs, aligning with the startup’s financial landscape.

The Startup Budget

A startup budget serves as a roadmap that guides your financial decisions and shapes your business operations. It details your startup’s current revenue, deducts the fixed and variable costs, and sets aside funds for emergencies. A well-planned budget ensures the efficient use of resources, prevents overspending, and contributes to the startup’s financial stability.

Financial Planning

Financial planning in startups involves setting realistic financial goals based on a comprehensive understanding of the business’s financial landscape. It includes forecasting revenue and expenses, conducting a market analysis to project sales and revenue streams, and estimating both operating and non-operating expenses.

Cash Flow Management: The Lifeline of Your Startup

Cash flow management is a critical aspect of startup financial management. It involves monitoring the inflows and outflows of cash within a defined timeframe, ensuring the availability of funds for day-to-day operations, and planning for contingencies.

Establishing a Cash Flow Statement

A cash flow statement serves as a financial report that provides aggregated data about all the cash inflows a company receives from its ongoing operations and external investment sources. It also includes all cash outflows that pay for business activities and investments during a given period.

Analysing and Forecasting Cash Flow

Conducting a thorough analysis of your cash flow statement helps identify trends and potential problems. It involves focusing on operating, investing, and financing activities and using the insights to prepare monthly forecasts . Regular forecasting helps maintain a healthy cash flow and ensures your business remains solvent.

Optimising Cash Flow

To optimise cash inflow, consider strategies such as offering discounts for early payments, tightening credit requirements, and issuing invoices promptly. For cash outflow, negotiate extended payment terms with suppliers, prioritize payments to vendors, and control discretionary spending.

Financial Forecasting: Navigating the Future

Financial forecasting is a vital part of startup financial planning. It involves predicting future revenue, costs, and financial outcomes based on historical data, market research, and financial trends.

Revenue Forecasting

Revenue forecasting is an essential component of financial forecasting. It includes projecting future sales and income based on present data and market trends. The forecast’s accuracy directly impacts the budget, financial planning, and overall business strategy.

Expense Forecasting

Predicting future expenses allows startups to plan for resource allocation effectively. Expense forecasting considers factors like inflation, cost of labor, and market conditions. It helps startups prepare for upcoming costs, and aids in decision-making regarding investments and growth opportunities.

Understanding Financial Modeling

Financial modeling is a process that allows businesses to forecast a financial picture for the company. It involves creating a model that represents financial asset performance, investment return outlook, future operating performance, or other financial projections. A well-crafted financial model serves as a decision-making tool, helping startups evaluate potential investments or financial decisions.

Expense Management: Optimising Costs

Expense management involves organizing and controlling the costs incurred in running a business. This process is crucial for maintaining financial stability, maximising profitability, and ensuring the efficient use of resources.

Prioritising Expenses

Startups should prioritise expenses to avoid cash flow issues. Differentiating between essential and optional business expenses is crucial for effective financial management. Regularly comparing actual spend against your budget helps identify areas of overspending and necessitates adjustments.

Reducing Unnecessary Spend

Identifying and eliminating unnecessary expenses can significantly improve a startup’s financial health. Scrutinizing your cash flow statement helps locate areas of excessive spending, enabling cost reductions and improved cash reserves.

Maximising Tax Returns

Startups should take advantage of tax breaks and deductions. These can include deductions for setup costs, marketing expenses, equipment purchases, and contributions to retirement accounts. Utilizing these benefits can significantly reduce a startup’s tax liability, improving its bottom line.

Vendor Management: Fostering Strong Partnerships

Effective vendor management is essential for smooth business operations, cost-effectiveness, and fostering strong partnerships. It involves selecting the right vendors, establishing clear communication and expectations, regularly reviewing performance, and diversifying vendor relationships.

Vendor Selection

Choosing the right vendors is a critical first step in vendor management. Consider factors such as reputation, reliability, and pricing. A thorough evaluation ensures that you partner with vendors who can consistently meet your business needs.

Vendor Performance Reviews

Regularly reviewing vendor performance helps identify any issues early and allows for timely resolution. Using agreed-upon metrics or key performance indicators (KPIs), you can objectively evaluate how well a vendor is meeting your expectations.

Diversifying Vendor Relationships

Relying on a single vendor can pose significant risks. Diversifying vendor relationships provides flexibility and reduces potential disruptions to your supply chain.

Financial Security and Risk Management: Safeguarding Your Future

Financial security and risk management are vital for a startup’s sustainability and long-term success. It involves maintaining healthy cash flow, budgeting effectively, diversifying revenue streams, and planning for contingencies.

Ensuring Financial Security

Financial security for startups involves having enough resources to cover both current and future expenses. It requires effective cash flow management, building emergency reserves, diversifying revenue streams, and accurate budgeting and forecasting.

Risk Assessment and Management

Risk management involves identifying potential risks and implementing strategies to mitigate their impact. This includes internal risks, such as operational issues, and external risks, like market fluctuations or regulatory changes.

Contingency Planning

Contingency plans outline how the startup will navigate unexpected financial challenges or disruptive events. It includes backup plans for suppliers, alternative production methods, and crisis communication strategies.

Successful Startup Financial Planning involves a multifaceted approach covering various aspects, from budgeting to vendor management. By understanding and implementing these strategies effectively, startups can enhance their financial stability, optimize their resources, and set a solid foundation for success.

At Growwth Partners, we understand the importance of financial management for start-ups. Our services include automated financial management systems, bookkeeping, payroll automation, and more. We help start-ups streamline their financial operations, improve efficiency, and make informed decisions. Contact us today to learn more about how we can support your start-up’s financial management needs.

The material / information contained above or other parts of this website is for general information purposes only and should not be relied upon for tax, legal or accounting advice. You should consult an expert in the relevant field before engaging in any transaction since applicability of the above may be different on the facts and circumstances of your situation. While we have made every attempt to ensure that the information contained on this website has been obtained from reliable sources, we are not responsible for any errors, omission or the results obtained by using the above information. We are not responsible for updating the above for changes in law, practices, or interpretation.

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How to Set Up a Financial Forecasting Model  For Your Startup

The ultimate guide to financial modeling for startups.

Setting up a robust financial forecasting model is the cornerstone for any successful startup. Navigating the intricacies of finances can be daunting, but a well-structured financial forecast not only serves as a roadmap but also empowers entrepreneurs to make informed decisions critical to their business’s growth and sustainability. In this blog post, we’ll explain why financial forecasting is important, give you a step-by-step guide for creating a strong plan, and call out what is significant to consider to achieve an accurate and reliable model. We aim to equip you with the knowledge and tools necessary to develop a solid financial roadmap that propels your startup toward success.

Why is Financial Forecasting Important?

Financial forecasting serves as a guide to businesses during times of uncertainty. They offer a strategic plan, help with decision-making, and ultimately help achieve long-term success.

For startups specifically, financial forecasting is a must. During the early stages of these businesses, a financial plan helps predict the potential challenges that may arise. The plan gives insight into how resources should be allocated and what funds should be saved.

Startups, typically operating in an environment of high risk and rapid change, rely on accurate financial projections to attract investors, chart sustainable growth trajectories, and steer away from potential pitfalls that could derail their ambitious endeavors. The ability to forecast financial outcomes empowers startups to make informed decisions, adapt swiftly to market fluctuations, and maintain a healthy financial standing in the face of uncertainty, positioning them for resilience and success in the competitive business landscape.

A Step by Step Guide

• Define your Goals and Objectives

Clearly outline the short-term and long-term goals of your business. Understand what you aim to achieve through financial forecasting – whether it’s securing funding, managing cash flow, or planning for growth.

• Do the Research

Collect and analyze historical financial data from your startup. This includes income statements, balance sheets, cash flow statements, and any other relevant financial records. Understanding past performance is crucial for making accurate projections. It’s also important to understand the different models that are available and how they can fit your needs.

• Gather the Data

Collect relevant financial information from external sources such as banks, credit agencies, and other public records and understand how they will impact your business. 

• Input the Data into a Model

Use the data collected and import it into a spreadsheet or other software program 

for analysis.

• Analyze the Results

Analyze the results to determine the best types of investments and strategies for reaching your goals.

• Visualize the Data

Utilize visuals such as charts and graphs to help understand the information

• Test and Evaluate the Outcomes

Test different scenarios within your model to make sure it is working accurately and evaluate the results accordingly. 

•  Update Your Forecasts Regularly

Regularly update your forecasting model with new data as it becomes available in order to ensure accuracy over time.

By following these steps and continuously refining your financial forecasting plan, you’ll equip your startup with a powerful tool to make informed decisions, manage risks, and drive sustainable growth.

Things to Consider

When conducting financial forecasting as a startup business, several crucial considerations can significantly impact the accuracy and relevance of your projections:

By considering these factors while financial forecasting, startups can develop more accurate, reliable, and adaptable financial models, empowering them to make informed decisions and navigate the challenges inherent in the early stages of business development.

In Conclusion

In essence, financial forecasting serves as a guiding light for startups, lighting the path toward sustainable growth and success. By meticulously analyzing past performance, making informed assumptions about the future, and projecting key financial metrics, startups gain a profound understanding of their business landscape. This foresight arms entrepreneurs with the insights needed to steer their ventures through uncertain terrain, make strategic decisions, secure funding, and remain agile in a rapidly evolving market. 

Ultimately, financial forecasting isn’t just about numbers on a spreadsheet; it’s a dynamic tool empowering startups to navigate challenges, capitalize on opportunities, and pave the way toward a future where their innovative ideas thrive and flourish. Embracing the power of financial forecasting equips startups with the resilience and foresight necessary to transform visions into tangible, long-lasting success stories.

*This blog does not constitute solicitation or provision of legal advice and does not establish an attorney-client relationship. This blog should not be used as a substitute for obtaining legal advice from an attorney licensed or authorized to practice in your jurisdiction.*

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• December 21, 2023

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A Guide to Financial Projections for Startups

Financial projections and financial forecasting provide a view into the future financial health of your startup. The terms are sometimes used interchangeably, but there are key distinctions that make one a better tool for guiding internal decision-making and the other the best way to show investors and lenders that your business deserves their confidence.

Both disciplines use current and historical transactional data, coupled with information on market conditions and industry trends, to predict what a startup’s journey may look like and whether it’s on track to meet its intended targets.

But while financial forecasting predicts events that are likely to happen, financial projections are used to present and examine hypothetical scenarios. According to the American Institute of Certified Public Accountants Standards Section 301, forecasts present the assumptions that reflect conditions the business expects to exist and the course of action it expects to take. Financial projections, on the other hand, allow financial professionals to model hypothetical “what if” scenarios.

Market analysts and financers often want to see “what if” scenarios so they can ground their decisions in data when evaluating whether to invest in or lend to the startup.

To complete financial projections, startups can use current and historical financial statements and external market information such as reports from government agencies such as the Department of Labor or market and industry projections from consulting firms. Revenue projections give investors and lenders a sense of how much you will sell by modeling out how it impacts operating expenses, for instance, on the income statement. Cash flow projections show where you will get that money—from receivables, loans, a line of credit, etc. Profit and loss projections help investors assess the growth potential of your business , while a balance sheet projection can suggest the rate of return on an investment in your company.

Taken together, financial forecasts and financial projections provide a toolset for a startup to not only react to imminent potential scenarios but also anticipate more far-fetched ones. With clear, data-based definitions around targets, a startup will know when, for instance, its selling expenses are outpacing revenue growth, and make adjustments.

Why Do I Need a Financial Model?

To get financial projections for a startup, you must use a financial model—often an Excel-based tool that brings in data from current financial statements and market trends to project how those statements may look in the future. Financial modeling produces financial projections by taking financial forecasts and playing them out.

In order to make financial projections, you will first need to gather your financial statements, decide on the scenarios you’d like to play out and, most importantly, build a financial model to do the work. You can build these basic financial models in Excel with the help of a finance expert.

The spreadsheet-based formulas allow you to play out different assumptions and see how different variables will impact line items and ultimately business plans. Financial projections can be completed across all three financial statements: your income statement/P&L, your balance sheet and cash flow statement. With projected financial statements, you can complete scenario planning.

Financial projections provide specific targets to drive performance and help a company achieve its goals. They also give lenders and investors a sense of the company’s long-term financial prospects, increasing their confidence in the business. Above all, these projections give the startup a much better idea of the impact of external factors on its financials and the investments it needs to make to achieve its business plan.

When Do I Use Projections?

Financial projections are used internally to show the effects of internal business decisions and external market conditions. For instance, what would happen if you added a new line of hand sanitizers in the fall? How would it affect the production of other products? How would that affect revenue and profit? And what external conditions need to be considered?

Executives within the company use financial projections to make decisions about raising capital, pursuing an acquisition or divestiture, opening new stores or entering new markets. They also use them to prioritize projects, establish budgets and plan for the future. Financial projections help a startup see the big picture and zero in on moves that best align with the company’s business plan, helping define its strategy moving forward.

Outside the company’s proverbial four walls, financial statements demonstrate business performance to shareholders, investors and lenders while financial models and projections help estimate and justify performance targets. For this reason, financial projections are crucial for startups. When investors and lenders can see how certain business plans play out in terms of your startup’s future financial health, they have more information with which to make financing and investing decisions.

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What Is Included in a Financial Projection?

Financial projections can be short-term, which cover one year and each month thereafter, or mid-term, which cover three years and are broken down year by year. A financial projection generally takes into account your startup’s business model, goals and objectives, along with income tax planning, business insurance and investment vehicles.

To project financial statements—projected financial statements are also called “pro forma” financial statements—you’ll need past and current statements. These include the income statement/profit and loss statement (P&L), the balance sheet and the cash flow statement. These financial statements provide a sort of common language among companies, banks, investors, regulators and anyone who needs to understand the company’s financial performance, according to Ernst and Young.

• The P&L shows: Performance metrics such as gross revenue and net profit. A P&L statement also provides important details that can be used to calculate key metrics like EBITDA (earnings before interest, taxes, depreciation and amortization), which gives investors insight into operational performance of a company so they can compare its efficiency with that of other companies. The P&L can be used to compare time periods, budget vs. actual performance and performance against other companies. It can indicate overall weak or strong performance.
• The balance sheet shows: Tangible assets a company owns (the computers, the building, etc.) and everything it owes (its debt or liabilities) over a specific time period, as well as receivables, which aren’t technically “owned” until they have been converted into cash. The difference between the value of the assets and liabilities on the books represents shareholder equity, which can consist of stocks, retained earnings or other forms of income.
• The cash flow statement shows: All cash going in and out of a company over a specific time period. The cash flow statement includes the three types of cash flow: operating activities, investing activities and financing activities. Operating cash flow measures the amount of cash generated by normal business operations. Investing cash flow measures cash coming in or out of the business from its long-term or capital investments. Financing cash flow measures cash coming in from financing transactions such as debt, equity and dividends.

Negative or positive cash flow gives investors a better sense of your overall cash position. They are looking for indicators that point toward the sustainability, solvency and growth potential of the business. Projected profit and loss statements give them an indication of whether you’ll bring in enough money to cover anticipated expenses. The projected balance sheet estimates your future financial position, which helps them determine the worth of your startup.

Investors use actual financials to assess the current value of shares and projections to estimate the future value of those shares. This helps in determining a potential return should they decide to invest in the company.

How Do I Build a Financial Projection?

To build a financial projection, you need to have accurate, easily accessible information on your past and current finances. Start with the income statement. You’ll need a strong and reliable picture of your revenue, your cost of goods sold, how much you’re spending on R&D, the cost of operations or SG&A (selling, general and administrative expenses), operating income or operating loss and the value of current assets, such as cash, receivables, inventory, investment income, etc.

Building a financial projection is challenging. Oftentimes, the hardest part for startups is getting the numbers themselves.

According to Ernst and Young, there are two ways to get those numbers: based on the market share you want to capture (top-down) or based on the resources at hand and the current data (bottom-up). EY recommends using bottom-up forecasts in the shorter term of one to two years and top-down in the longer term of three to five years. Used together, the two offer a healthy balance between ambition and realistic chances to capture market share.

To build a financial model, you will need at least three years of historical data, and The Journal of Accountancy provides a comprehensive list of financial data and metrics to include.

Complete this process for every financial statement. Model “what if” scenarios to keep independent variables constant, while looking at the metrics that would be affected if, say, you added a new product line and needed more people to sell it, more equipment to manufacture it and more supplies with which to make it.

8 Tips for Valid Startup Financial Projections

Startups should complete financial forecasting and financial projections with a few tips in mind.

• Know your audience. Remember the difference between a financial forecast and a financial projection, with the latter being particularly useful for investors and lenders who will be looking at your company from the outside.
• Get your house in order. Getting easy access to accurate historical and current financial data with which to model is often the most challenging part. Bad data won’t produce an accurate forecast and weakens the confidence of investors and lenders. Start with a reliable source of transactional data.
• Start with spend. In general, it’s much easier to predict your expenses than your revenues . Start building your forecast model by outlining your burn rate and fixed operating expenses: things like rent, utilities and insurance.
• Don’t be too conservative (nor too aggressive). Investors like to see both aggressive and conservative scenarios. Model both optimistic and cautious scenarios in financial projections, especially if the business environment is uncertain.
• Don’t let financial projections become static. Constantly reassess your financial projections and add new assumptions for modeling your growth rate. Projections without constant care become static and irrelevant.
• Be honest. Be absolutely clear about cash flow, and make sure it’s consistent across your financial statements.
• Look outside. Researching industry trends is essential to producing credible financial projections. Constantly compare your projections with those of other businesses in your industry.
• Get help. Producing regular financial statements can be difficult for startups, which means projecting financial statements can be very challenging. A CPA or a financial leader like a CFO is critical, as is software that automates the process.

Keeping accurate and easily accessible information on the current financial health of your startup is the first step to making good business decisions. But seeing the possible impact of business plans—and allowing key stakeholders to do so too—empowers you to execute sustainable and profitable plans.

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Financial Forecast vs. Financial Projection: Key Differences

Financial terms are easily confused and often used interchangeably. But phrases like "financial forecast" and "financial projection" that sound similar are quite…

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Effective financial projections for a startup

Get a business started with meaningful financial projections..

• Management Accounting
• Business Planning

Today's business world is bursting with startups, particularly in the technology industry. One of the biggest contributors to a startup's success is a sound business plan that includes meaningful financial projections.

Accountants have the skills to help entrepreneurs build logical financial assumptions to increase the probability of attracting investments. Refining these projections can also help startups develop a growth strategy by keeping information simple and hitting on the key metrics, such as market size.

This list of practical considerations for startups and the accountants who support them is by no means exhaustive, and for many readers the concepts may be familiar. It's meant to serve as a handy guide to key conversations that can keep a startup on the right track.

An Excel workbook providing a more detailed look at the three-year projections in this example is available here .

Revenue will influence the rest of the profit and loss (P&L) assumptions. So if revenue estimates are materially misstated, the company risks overstaffing or understaffing and/or purchasing assets incorrectly. Revenue is also a key metric for potential investors. Estimates do not need to be precise, but they do need to be realistic and supported by a viable story.

Step 1: Collect critical inputs

Four crucial inputs are used to calculate revenue for a new business: revenue levers, revenue drivers, activity assumptions, and pricing.

Revenue levers: Revenue levers are the various opportunities to earn revenue. Levers can include products and/or services, software maintenance agreements, channel partner sales, etc. Start with a list of all the revenue levers that will produce income over the period of the financial projections.

Revenue drivers: Revenue drivers are the activities that influence how revenue levers produce income. Each revenue lever could potentially have a different driver. Think about what activity will increase or decrease revenue for each lever.

Revenue driver activity assumptions: Activity assumptions are the inputs that will indicate how the revenue driver will act. To determine assumptions, work with marketing, sales, or the CEO, depending on the company organization.

Pricing: Pricing is a necessary input to calculate total revenue. This article does not go into detail on pricing methodology. If prices have not yet been determined, read pricing guides and/or articles to ensure effective pricing methods are being implemented.

Step 2: Convert inputs into the revenue estimate

Now that the revenue inputs have been determined, it's as straightforward as inputting the data into a model that calculates total revenue. In its simplest form, the calculation is revenue driver assumption multiplied by price for each revenue lever . If the driver is marketing spend, there will be an additional step to convert dollars spent to revenue earned.

Create revenue calculations for three to five years by year, quarter, or month. A monthly calculation is helpful if your revenue driver is new clients, as clients will be attained throughout the year and will not provide a full year's revenue in year 1. The monthly or quarterly detail should be summarized by year to report the total annual impact.

Be sure to include an estimate for churn. Revenue can be easily overstated or understated without a reasonable estimate on the business that will be lost over the period of the pro forma.

Step 3: Review the final revenue outcome

Take a step back from the detail and reflect on the total revenue result.

On the SEC's website, check the public Forms 10K of competitors or companies in the same industry and compare net revenue. If there are no publicly listed companies to provide financial comparisons, perhaps check with the potential investment banker or capital provider. It may be able to provide a range of financials that are typical in a similar industry. If forecasted revenue in year 2 is higher than the industry leader, then review the calculations for accuracy and activity assumptions for reasonableness.

Consider the growth year over year. The business should show steady growth over the years at a realistic rate. Then calculate the compound annual growth rate (CAGR) to easily identify growth over a period of time. CAGR is an easy comparison tool for investors to use.

Revenue do's

• Use a range of activity assumptions to determine a worst - case scenario and an optimistic scenario. Determine what makes the most sense within this range.
• Build the revenue estimates using calculations of inputs so you can easily pivot and create new scenarios.
• Show revenue increasing over time at an attractive yet realistic rate.

Revenue don'ts

• Don't create revenue assumptions without having a calculation or story to support the total.
• Don't overcomplicate the calculations with additional details that do not materially change the result.
• Don't forget to reflect on the result.

COSTS OF SALES

Costs of sales (COS) are the costs directly related to a product or service, and they represent the cost of producing revenue. Product costs will include raw materials, labor, production equipment depreciation, etc. Service industry companies' COS include salaries of professional service providers; software - as - a - service companies' COS include hosting fees. Measuring the gross profit (revenue minus COS) and gross margin (gross profit as a percentage of revenue) assists in determining profitability and long - term viability.

Compare margins to industry benchmarks or similar companies. COS may be higher at the start, but it is important to show higher margins over time as efficiencies are gained.

SG&A EXPENSES

Selling, general, and administrative (SG&A) expenses include all other expenses outside of product costs and capital purchases. Consider the following major categories:

Salaries and benefits

Build a headcount plan by role for the pro forma period by month. This approach creates a hiring plan based on revenue timing to properly support the business. It also allows for quick adjustments when modeling revenue changes.

Sales staff hire dates should correspond with the sales cycle. If a full sales cycle is three months, then the headcount plan should include sales salaries at least three months before the first month of planned revenue. Ensure other variable sales expenses relate directly to the revenue estimates, including sales commissions, bonuses, and other selling expenses.

Include benefits and payroll taxes in addition to the base salary.

Marketing expenses

Business - to - business relationship building and business - to - consumer advertisement and promotions drive revenue. Marketing expenses as a percentage of revenue vary depending on the industry and the company's size, but they will typically fall somewhere between 5% and 20% of revenue. Years 1 and 2 require higher marketing spend as the company is promoting awareness; however, projections should show increased efficiencies over time.

Several one - time and recurring legal - related costs are associated with incorporating a new business. Consider the following to avoid expensive surprises:

• Negotiation of customer contracts.
• Business license fees.
• Industry - specific state licensing.
• Incorporation fees.
• Other legal fees relating to copyrights and/or trademarks.

IT-related costs

Most new businesses require a website and have some technology needs, even if the industry is not technology specific. Technology ignorance is dangerous for any new business owner and can create unplanned expenses. Consider the following:

• Data storage.
• Website hosting fees.
• Software and software maintenance.
• Data security efforts.

Consider all other potential business expenses such as credit card fees, office rent, office supplies, etc. It is safe to create high - level estimates in this area based on revenue, location, industry, etc.

SG&A do's

• Stay familiar and current with technical terminology and cost structures to avoid expensive surprises.
• Ensure the staffing plan and marketing plan align with revenue assertions.
• Compare expenses as a percentage of revenue to industry averages and benchmarks.

SG&A don'ts

• Don't underestimate accounting and legal needs during inception.
• Don't forget business necessities like call centers and credit card fees.

CAPITAL INVESTMENTS

Estimate capital investment dollars needed by year and by category between hardware, software, equipment, inventory, etc. The capital plan should:

• Correspond with the revenue growth and demonstrate a return on assets.
• Show that the business can scale and that the capital investments can set the business up for continual growth.
• Create a purchasing plan for the business and describe to investors how funds will be allocated.

In the simplest form, cash flow equates to projected EBITDA (earnings before interest, taxes, depreciation, and amortization) less capital investments. There are many other balance sheet implications for cash flow (accounts receivable, payables, inventory, etc.). Depending on the industry and round of investing, that level of detail may be unnecessary. If the industry has an exceptionally long cash cycle or includes a large upfront inventory investment, then an annual cash implication estimate should be made on those pieces. Otherwise, EBITDA and capital investments will be sufficient for the seed round. After the seed round, working capital impact will be beneficial to get a full cash flow look.

THE PRESENTATION

Now that the estimates are complete, it is time to transform the work into a collection of facts that potential investors and business owners can use to drive decisions. The initial information and discussions should focus on high - level assumptions and give confidence that the business can scale and grow as the example outlines. (See the sidebar, "Example for High - Level Projections," below.)

Item 1: Condensed profit and loss statement

Present the following sections in a P&L format for each year over the three - to five - year period:

Revenue: Include a row for different revenue levers with a total net revenue.

COS: Show total dollar amount, cost as a percentage of revenue, gross profit (revenue less COS), and gross margin (gross profit as percentage of revenue). If possible, show COS at the individual revenue lever.

SG&A: (1) Categorize the expenses into salaries, marketing, and all other. Present the category subtotals in dollars and as a percentage of revenue as well as the SG&A expense grand total; (2) consider categorizing any other major expense that may be specific to the business; and (3) do not show any expense assumption detail here.

EBITDA: Include EBITDA in total and as a percentage of net revenue.

Item 2: Cash flow

Add two rows underneath EBITDA for each year: one for total cash flow for that particular year and one for cumulative cash flow.

Item 3: Capital investments

Include the capital plan by project and year.

Item 4: Bullet points on key revenue and cost assumptions

Add key assumption points to give the reader an idea of how the revenue and costs were estimated without going into too much detail. These can be points on the same page as the P&L or on a separate page.

Revenue: Revenue drivers, churn, revenue assumptions, and how the assumptions change year over year.

COS: Significant expense drivers. This could be product - specific labor expenses or materials.

SG&A: Total marketing, selling, and administrative headcount year over year with key roles, total one - time startup expenses, and any other material expense that may be specific to the business.

Item 5: Metrics and graphs

Break - even point: The break - even point can be calculated in dollars or units and will indicate at what level of sales the company will cover all fixed costs. This metric is beneficial internally for pricing and production purposes. For external readers, it indicates roughly how long it will take before the company starts generating a profit.

Payback period: The payback period is the length of time it will take to pay back the original investment. Investments with a long payback period are undesirable; however, the required period will range by investor and business industry. Technology projects typically have a desired payback period of one to two years.

Graphs: Graphs are a great way to visually communicate financial results and tell the story of the business. Consider including the following information in a colorful graph format:

• Revenue over time with a trend line.
• EBITDA over time with a trend line.
• Cash flow over time with a break - even point and a payback period point.
• Revenue drivers and assumptions over time.

Size of the market: Give the reader an idea of the full market potential and what piece of the market the business is trying to attain.

Item 6: Presentation of do's and don'ts

• Keep it simple.
• Round numbers to thousands or millions.
• Highlight the key assumptions.
• Don't use decimals.
• Don't confuse the overall story by giving too many details.
• Don't request less or significantly more cash than required to bridge the business to profitability as outlined on the P&L.

Example for high-level projections

This made-up example outlines high-level projections investors like to see:

Stuff Faux Less is a new thrift store that buys and sells used home goods and clothing items. Stuff Faux Less has an online presence and recently developed software to assist in thrifty shopping. This software allows thrift stores to easily inventory new items using specific keywords and alert a shopper when a desired item becomes available. Lastly, Stuff Faux Less has a personal shopper tool. Using the tool, a customer pays a small fee to have a personal shopper select and retrieve outfits based on the customer’s style.

There are three revenue opportunities associated with Stuff Faux Less’s business model:

REVENUE LEVERS

1. Product sales

Revenue driver: Foot traffic and conversion rates.

Revenue assumptions: 70,000 visitors in year 1 at a 30% conversion rate and a $30 average order; 140,000 visitors in year 2 at a 32% conversion rate and a $30 average order; and 150,000 visitors in year 3 at a 34% conversion rate and a $30 average order.

2. Personal shopper fees

Revenue driver: Advertising spend and advertising return.

Revenue assumptions: One personal shopping order will occur for every $1.50 in advertising dollars spent in year 1, $1 in year 2, and $0.95 in year 3.

3. Software license revenue

Revenue driver: Sales staff and number of licenses each sales team member is able to sell per year.

Revenue assumptions: 10 new licenses in year 1; 11 additional licenses in year 2 net of churn; and 13 additional licenses in year 3 net of churn.

ASSESSING PROJECTIONS

On the P&L, the sales staff’s projection supports the estimated software licenses sold, and the advertising projected spend supports the shopper fee income.

About the author

Tiffany Hovland, CPA , is the owner of Hovland Consulting LLC.

To comment on this article or to suggest an idea for another article, contact Sabine Vollmer, a  JofA  senior editor, at  [email protected]   or 919-402-2304.

AICPA resources

• " Don't Fall for These Presentation Myths ," CPA Insider , Oct. 1, 2018
• " What Investors Want to See ," JofA , Oct. 25, 2017
• " Crowdfunding Brings New Opportunities for CPAs ," JofA , Oct. 2015

CPE self-study

• Financial Forecasting and Decision Making (#733970, text; #163153, online access)
• Financial Performance Management Program (#165364, online access)
• Planning and Budgeting (#165383, online access)
• Pricing Strategy (#165379, online access)

For more information or to make a purchase, go to  aicpastore.com or call the Institute at 888-777-7077.

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7 Financial Forecasting Methods to Predict Business Performance

• 21 Jun 2022

Much of accounting involves evaluating past performance. Financial results demonstrate business success to both shareholders and the public. Planning and preparing for the future, however, is just as important.

Shareholders must be reassured that a business has been, and will continue to be, successful. This requires financial forecasting.

Here's an overview of how to use pro forma statements to conduct financial forecasting, along with seven methods you can leverage to predict a business's future performance.

What Is Financial Forecasting?

Financial forecasting is predicting a company’s financial future by examining historical performance data, such as revenue, cash flow, expenses, or sales. This involves guesswork and assumptions, as many unforeseen factors can influence business performance.

Financial forecasting is important because it informs business decision-making regarding hiring, budgeting, predicting revenue, and strategic planning . It also helps you maintain a forward-focused mindset.

Each financial forecast plays a major role in determining how much attention is given to individual expense items. For example, if you forecast high-level trends for general planning purposes, you can rely more on broad assumptions than specific details. However, if your forecast is concerned with a business’s future, such as a pending merger or acquisition, it's important to be thorough and detailed.

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Forecasting with Pro Forma Statements

A common type of forecasting in financial accounting involves using pro forma statements . Pro forma statements focus on a business's future reports, which are highly dependent on assumptions made during preparation⁠, such as expected market conditions.

Because the term "pro forma" refers to projections or forecasts, pro forma statements apply to any financial document, including:

• Income statements
• Balance sheets
• Cash flow statements

These statements serve both internal and external purposes. Internally, you can use them for strategic planning. Identifying future revenues and expenses can greatly impact business decisions related to hiring and budgeting. Pro forma statements can also inform endeavors by creating multiple statements and interchanging variables to conduct side-by-side comparisons of potential outcomes.

Externally, pro forma statements can demonstrate the risk of investing in a business. While this is an effective form of forecasting, investors should know that pro forma statements don't typically comply with generally accepted accounting principles (GAAP) . This is because pro forma statements don't include one-time expenses—such as equipment purchases or company relocations—which allows for greater accuracy because those expenses don't reflect a company’s ongoing operations.

7 Financial Forecasting Methods

Pro forma statements are incredibly valuable when forecasting revenue, expenses, and sales. These findings are often further supported by one of seven financial forecasting methods that determine future income and growth rates.

There are two primary categories of forecasting: quantitative and qualitative.

Quantitative Methods

When producing accurate forecasts, business leaders typically turn to quantitative forecasts , or assumptions about the future based on historical data.

1. Percent of Sales

Internal pro forma statements are often created using percent of sales forecasting . This method calculates future metrics of financial line items as a percentage of sales. For example, the cost of goods sold is likely to increase proportionally with sales; therefore, it’s logical to apply the same growth rate estimate to each.

To forecast the percent of sales, examine the percentage of each account’s historical profits related to sales. To calculate this, divide each account by its sales, assuming the numbers will remain steady. For example, if the cost of goods sold has historically been 30 percent of sales, assume that trend will continue.

2. Straight Line

The straight-line method assumes a company's historical growth rate will remain constant. Forecasting future revenue involves multiplying a company’s previous year's revenue by its growth rate. For example, if the previous year's growth rate was 12 percent, straight-line forecasting assumes it'll continue to grow by 12 percent next year.

Although straight-line forecasting is an excellent starting point, it doesn't account for market fluctuations or supply chain issues.

3. Moving Average

Moving average involves taking the average—or weighted average—of previous periods⁠ to forecast the future. This method involves more closely examining a business’s high or low demands, so it’s often beneficial for short-term forecasting. For example, you can use it to forecast next month’s sales by averaging the previous quarter.

Moving average forecasting can help estimate several metrics. While it’s most commonly applied to future stock prices, it’s also used to estimate future revenue.

To calculate a moving average, use the following formula:

A1 + A2 + A3 … / N

Formula breakdown:

A = Average for a period

N = Total number of periods

Using weighted averages to emphasize recent periods can increase the accuracy of moving average forecasts.

4. Simple Linear Regression

Simple linear regression forecasts metrics based on a relationship between two variables⁠: dependent and independent. The dependent variable represents the forecasted amount, while the independent variable is the factor that influences the dependent variable.

The equation for simple linear regression is:

Y ⁠ = Dependent variable⁠ (the forecasted number)

B = Regression line's slope

X = Independent variable

A = Y-intercept

5. Multiple Linear Regression

If two or more variables directly impact a company's performance, business leaders might turn to multiple linear regression . This allows for a more accurate forecast, as it accounts for several variables that ultimately influence performance.

To forecast using multiple linear regression, a linear relationship must exist between the dependent and independent variables. Additionally, the independent variables can’t be so closely correlated that it’s impossible to tell which impacts the dependent variable.

Qualitative Methods

When it comes to forecasting, numbers don't always tell the whole story. There are additional factors that influence performance and can't be quantified. Qualitative forecasting relies on experts’ knowledge and experience to predict performance rather than historical numerical data.

These forecasting methods are often called into question, as they're more subjective than quantitative methods. Yet, they can provide valuable insight into forecasts and account for factors that can’t be predicted using historical data.

6. Delphi Method

The Delphi method of forecasting involves consulting experts who analyze market conditions to predict a company's performance.

A facilitator reaches out to those experts with questionnaires, requesting forecasts of business performance based on their experience and knowledge. The facilitator then compiles their analyses and sends them to other experts for comments. The goal is to continue circulating them until a consensus is reached.

7. Market Research

Market research is essential for organizational planning. It helps business leaders obtain a holistic market view based on competition, fluctuating conditions, and consumer patterns. It’s also critical for startups when historical data isn’t available. New businesses can benefit from financial forecasting because it’s essential for recruiting investors and budgeting during the first few months of operation.

When conducting market research, begin with a hypothesis and determine what methods are needed. Sending out consumer surveys is an excellent way to better understand consumer behavior when you don’t have numerical data to inform decisions.

Improve Your Forecasting Skills

Financial forecasting is never a guarantee, but it’s critical for decision-making. Regardless of your business’s industry or stage, it’s important to maintain a forward-thinking mindset—learning from past patterns is an excellent way to plan for the future.

If you’re interested in further exploring financial forecasting and its role in business, consider taking an online course, such as Financial Accounting , to discover how to use it alongside other financial tools to shape your business.

Do you want to take your financial accounting skills to the next level? Consider enrolling in Financial Accounting —one of three courses comprising our Credential of Readiness (CORe) program —to learn how to use financial principles to inform business decisions. Not sure which course is right for you? Download our free flowchart .

About the Author

Small business budgeting and forecasting

It’s time to run some numbers on your business idea. Budgeting and forecasting help with that.

What is a budget?

A budget predicts how much money will come and go from your business over a period of time (usually a year). Budgeting and forecasting help startups see if they can afford to start a business – and if it will repay all their hard work with a return on their effort.

The purpose of a budget

Budgets predict the money-making potential of a business, but they also tell you things like:

• how much it will cost to start up
• whether you’ll need to borrow money
• your breakeven point
• what you need to charge customers
• if you can afford staff

How to make a budget

Start off by listing your costs and note roughly when they’ll hit. The timing is important to small business budgeting because it affects your cash flow. Do the same for income.

Budgeting is so nice, you ought to do it twice

Make a budget that assumes a solid first year, and another that assumes a slow start. That second budget won’t be so much fun to create, but you’ll be glad to have it up your sleeve if things don’t take off. Bank managers and investors will also want to see two budgets.

Small business budgeting mistakes to avoid

• Don’t forget to deduct sales and income tax from sales revenue
• Some jobs go wrong, and some inventory gets broken so build in contingencies
• Remember to calculate how much interest you’ll pay on loans
• Factor in costs to insure your business against liabilities and disasters
• Put money aside to cover depreciation of assets like work tools (because you’ll have to replace them eventually)

Reduce financial risk by validating your business idea first. For example, you could open a pop-up store first, instead of paying for the fit-out of a retail store.

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Creating a financial plan for your business

Try not to freak out about this red part of the graph.

That’s just part of being a startup and will appear in most small business budgets. It will take time for customers to find and trust you, so sales will be slow in the beginning. Meanwhile you’ll have a lot of set-up costs to contend with.

Include a section in your business plan on how you’ll make up the difference. Will you dip into personal savings? pitch investors? go to the bank? or turn to family and friends?

Learn more in our guide to finance.

The difference between a budget and a forecast

Budgeting and forecasting are often treated the same, but there are important differences. Small business budgeting shows how you expect the business to perform over a given period. Forecasts use real-life sales and cost data to show where things are actually headed.

For obvious reasons, you want to know if the two are seriously out of whack. So check your budget against actual business numbers regularly. That way you can fix problems before they get too big, and spot opportunities before they’re missed. Plus the exercise will help you get better at estimating costs and income for the years ahead. Small business budgeting and forecasting go hand in hand.

It’s important to not only budget for costs that occur monthly, but also the costs that happen once or twice a year. Don't get surprised by a big lump sum insurance payment, for example.

Accountingprose

Get help from an accountant or bookkeeper

Accountants and bookkeepers work with small businesses all day, every day. They can help get your numbers right. Find one in the Xero advisor directory .

Xero does not provide accounting, tax, business or legal advice. This guide has been provided for information purposes only. You should consult your own professional advisors for advice directly relating to your business or before taking action in relation to any of the content provided.

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Creating a Financial Plan for Startups: The Ultimate Guide

The top reason startups fail is because they run out of money, according to a 2020 survey by Wilbur Labs . And one of the main reasons they run out of money is because their financial planning consists of rosy projections of the best-case scenario, based on bad data — or no financial planning at all.

Creating a financial plan is essential to a startup’s success. For one thing, most investors need to see a startup’s financial plan before they even consider funding it. More importantly, a financial plan allows you to quantify your business assumptions, define specific benchmarks, plan for worst- and best-case scenarios, and measure your company’s success (even before you start making a profit).

The bottom line is: if you have expenses, you should have a financial plan. But you don’t need an accounting degree (or even an accountant) to get started.

What is startup financial planning?

Your startup’s financial plan is the roadmap that lays out the path for your company’s future financial success. In it, you make predictions and plans based on historical performance and industry research. Start with your company’s current financial situation, add in future goals and predictions, and strategize how to get there. Financial plans include details about:

• Fixed/variable expenses
• Gross/operating margins
• Profit potential and durability
• Break-even point
• Cash balance
• Cash flow changes

Don’t have all that information close at hand? That’s okay. The first financial plan you create may not be very detailed. You’ll keep building and tweaking it as your company iterates.

A financial plan is NOT the same as a business plan

A business plan is written in paragraphs. A financial plan is (traditionally) a giant Excel spreadsheet. It’s synonymous with Pro Forma financial, which is the finance industry term for three detailed reports: cash flow statement, profit and loss (P&L) , and balance sheet . Financial planning is part of the due diligence process , which you’ll need to provide to investors prior to signing a Series A term sheet.

Financial planning is made up of several smaller activities:

These activities include:

• Creating a hiring plan
• Making projections about sales, expenses, cash flow, income statement, and balance sheet
• Analyzing projections
• Producing profit and loss statements
• Financial projections and modeling
• Analyzing internal controls
• Creating annual growth strategies

Before you start: collect data and tools

You can’t create a financial plan in a vacuum. First, you’ll need to assemble some critical things:

Before you can accurately create a financial plan, identify and assemble all your existing financial data. What financial accounts (bank accounts, credit cards) are you using for your business income and expenses? Where/how are you doing your bookkeeping (e.g., QuickBooks, Xero, NetSuite), and is that information up to date?

You’ll need to import the above information into your financial plan. Updates can be done manually with a spreadsheet or automatically using software (more on that below). Generally, it’s better if updates can be automated so you know you’re looking at the latest data and can be more nimble with decision-making.

Now you need to decide what tools you’ll use to create a financial plan. Options include a spreadsheet, dedicated software, or outsourcing to a CPA.

If you opt for a spreadsheet, you can download an Excel or Google Sheet template from an online resource, or you can create it yourself. If you create it yourself, a finance analyst, HR manager, or office manager can maintain it, and then later, a CFO can run point on the whole process.

The problem with a spreadsheet is that it’s often too fragile for everyone to use collaboratively — it’s not automatically version controlled, and it’s too manual. That’s why you might choose software like Pry, Finmark, Brixx, or Causal. Obviously, we think Pry is the best choice for financial planning. But whatever you choose, the main reason to use software is it will scale as you grow.

Finally, you can hire a CPA to build a financial plan for you. This option can afford you some peace of mind. However, it costs a lot more than a DIY spreadsheet or software approach. Additionally, you’ll understand your business better if you create your financial plan internally.

Steps to create a financial plan

Startup financial planning can seem daunting at first, especially if you’re an early-stage founder and this is your first time. We’ll break it down below.

1. Visualize the end result

At the beginning of the financial planning process, you should sketch out long-term strategies and goals. If you’re pursuing a financing round, ask your investors about what metrics matter the most to them. That way you can bring those details to the forefront instead of burying them in a series of complex tabs.

A good starting point is to determine your company’s KPIs. What are the things you want to track and forecast? Remember that different metrics are important to different business models . For example, SaaS companies should include metrics like MRR (monthly recurring revenue) , as well as bank balance and budget vs. actuals.

Thinking back to your best lever of growth, what will be your key milestones? This could include acquiring a certain number of customers, raising a round of fundraising, or making an acquisition.

This sounds like, “To reach X, we need to hit A, B, C, and D milestones. Here’s how we think we’ll get from A to B, then B to C, then C to D.” – Underscore VC

2. Pick the right template or software

It’s hard to create a generic template for all sorts of businesses, so find a template that matches your business model. Sometimes you can access these templates for free, like the one in this LinkedIn thread . Or you can download a template in exchange for your contact info, like this one for SaaS startups.

Of course, you can also choose software that creates this template for you instead of trying to retrofit some random online spreadsheet template. At Pry, we can customize reports and dashboards to your specific business model for $500 with our custom onboarding.

3. Import existing data

Now you’ll need to import your existing information from different financial accounts like QuickBooks or Xero (depending on which you use), bank account(s), and/or credit card(s). This is sometimes referred to as the “ Chart of Accounts .” Your bank data could be a statement, or it could just be today’s balance. Ideally, you should pull as much as possible, so you have the clearest, most detailed picture.

The information you should import can be broken down as follows:

• Assets (e.g., checking, savings, amounts owed to the company from customers, inventory, prepaid expenses)
• Liabilities (e.g., line of credit, credit card payable, the amount owed to vendors, payroll taxes payable)
• Equity (assets minus liabilities)
• Income (e.g., product sales, interest)
• Expenses (e.g., cost of goods sold, marketing, travel, rent, office supplies)

If your financial plan is a spreadsheet, you’ll need to manually export your existing data and then import it into your spreadsheet. This process looks slightly different for each different financial account. QuickBooks and Xero both outline how to do this on their websites.

If you’re using a financial planning tool like Pry, you can connect these accounts so they sync automatically via an API integration .

4. Project expenses

Once you have an accurate picture of current accounts, you should start projecting future expenses. These can be broken into two broad categories: direct expenses (aka, costs of sales) and indirect expenses (aka, selling, general, and administrative expenses). Direct expenses include any raw materials, production equipment depreciation, hosting fees, etc. Everything else (other than product costs and capital purchases) is considered an indirect expense.

Salaries and benefits (an indirect expense) are usually the biggest expense at this point, so we recommend starting with this one. You should add existing employees and forecast future hires to predict the additional cost of roles and salaries over time. Be sure to include benefits and payroll taxes. Also, don’t project people out by dollars spent on them — do it by name/role/salary, then convert salary into a monthly cost. For example, 4 Software Engineers, $100k each, Start Dates: July 2021, September 2021, November 2021, January 2022 .

Build a headcount plan by role for the pro forma period by month. This approach creates a hiring plan based on revenue timing to properly support the business. It also allows for quick adjustments when modeling revenue changes. – Tiffany Hovland, CPA, Journal of Accountancy

• Legal and professional services (e.g., the costs of incorporating a new business, like business license fees)
• IT (e.g., data storage, software, data security)
• Office rent
• Office supplies

As you make projections about future expenses, remember to focus on high-level estimates based on industry standards, location, and company size.A lot of things can change, and you shouldn’t waste time perfecting predictions — they may not come true, anyway.

5. Project revenue

Now you’ll describe how your company will produce income. If your company is pre-revenue, you can start with industry standards. Realistic revenue projections are important to investors, and they influence all other assumptions about profit and loss (P&L) . If revenue projections are drastically wrong, you may over- or understaff your company or make big purchases you can’t afford.

To make accurate projections, define the revenue levers, drivers, and assumptions. Revenue levers could be products and/or services, software maintenance agreements, or channel partner sales. You also need to identify which activities increase or decrease revenue, as well as pricing and activity assumptions.

One important revenue projection for SaaS businesses is MRR. Here’s an example of this type of revenue projection:

• Revenue lever: monthly subscription revenue
• Revenue driver: marketing spend and conversion rates
• Revenue assumptions: $200 subscription price, 100 initial customers, 25 new signups per month, two churned customers per month

To project MRR using software like Pry, use this formula: MRR = total customers * average subscription price.

6. Build a report

After you have collected all your current financial information and built out some projections, it’s time to present it in an easily digestible format to drive decision-making. A dashboard is a visual way to summarize and report on the data. It makes it easy for business owners, board members, and investors to look at and know the status of the company.

Now that the estimates are complete, it is time to transform the work into a collection of facts that potential investors and business owners can use to drive decisions. The initial information and discussions should focus on high-level assumptions and give confidence that the business can scale and grow as the example outlines. – Tiffany Hovland, CPA, Journal of Accountancy

If you’re using Excel for your financial plan, you can build these reports as pivot tables. Or, if you find pivot tables too cumbersome, you can create a dashboard easily using software. Here’s what Pry’s dashboard looks like:

7. Test assumptions

The final step of financial planning is often called a what-if analysis or sensitivity analysis. Now that you’ve built some assumptions about the future, try playing with some different ones — some aggressive and some conservative. Change some inputs and review the reports in different scenarios. This will help you see how the assumptions relate and ensure that the end model makes sense.

Another way to test your assumptions is to compare your company’s metrics to those of other companies. Larger companies might check the SEC’s website for public competitors or companies in a similar space with similar net revenue. If you can’t find a good comparison, though, you can check with investors to see which assumptions you should tweak. Then revise accordingly.

We picked a list of IPO comparables—enterprise-class SaaS companies that had gone public. We look at up to three years of their financial data, and based on our growth rate, revenue, and expenses as a percentage of revenue, we compare ourselves against their metrics. These comparables are a way to validate our progress against our three-year plan. – Jason Purcell, CEO of Salsify

Now it’s your turn (we can help)

The bottom line is that if your startup has expenses, you should also have a financial plan. And now that you know how to create one, it’s time to get started.If the prospect of making pivot tables in Excel intimidates you, try creating a financial plan with an out-of-box tool like Pry. It does everything the expensive firms do but without the hefty price tag.

View Pry’s pricing ->

Keep reading...

Revenue forecasting for founders: how to make projections early.

Revenue forecasting is looking at existing data and predicting how much money your company will bring in from sales in future months, quarters, or years. Even early-stage startups need to track these metrics because accurate and realistic revenue forecasts are the only way you can avoid a big cash flow shortage and complete company meltdown.

September 06, 2023

A Guide To Financial Forecasting For Startups

The only constant in the global market is uncertainty. While larger organizations can more easily weather fluctuations in market conditions, less established businesses are more vulnerable. Fortunately, they can protect themselves with effective forecasting. Forecasting can strengthen your business plan or improve your financial management, which puts your organization on a more financially secure path. That’s why it is essential for entrepreneurs to understand the basic techniques of financial forecasting for startups.

As the owner of a startup, you will need resources to grow and scale. Precise forecasts may be the key to convincing investors and lenders that external financing will make your project profitable. Forecasting also helps you organize internal operations in a more profitable way, whether through sales budgeting or evaluating different areas of the enterprise. In order to help you make the most of your organization and resources, we will briefly explain the importance of financial forecasting, how it works, and how it benefits your enterprise.

What is financial forecasting, and why does it matter?

Generally speaking, financial forecasting for a startup is the process of calculating an enterprise’s future income and expenses. As a rule, financial forecasts are based on historical data and reflect expected changes in external market conditions. Depending on the issue at hand, you may create a variety of short, medium, and long-term forecasts to answer crucial questions about your business. Short-term options focus on the first year of the firm’s operation, while long-term calculations cover 3 to 5 years.

According to the U.S. Bureau of Labor Statistics, there are almost 32 million small businesses offering various goods and services across the country. Notably, about 20% of these firms fail during the first year of operation; after five years, the figure reaches 50%.

CBInsights specialists decided to find out what factors most often lead to bankruptcy. According to their research, the most common factors include:

• Launching a business whose offers did not have stable demand (42%)
• Cash flow problems (30%)
• Challenges with costs and pricing (18%)
• Lack of precise financial planning and business model (10%)

Competent forecasting allows us to solve most of these problems. Clearly, financial forecasting is an essential business practice that more owners would benefit from properly enacting.

Financial projections are closely related to budgeting. If you have computed that profit will increase by $20,000 in a year, you may budget to allocate capital properly, e.g., you can spend $12,000 on equipment and $8,000 on an advertising campaign. Effective budgeting is crucial for success.

How to create a financial forecast for a startup business

Financial forecasting for startups is a multi-step task, and the most difficult step is usually obtaining data. According to auditing firm Ernst & Young, there are a few primary ways to receive forecasting information: based on the market share you want to capture (bottom-up) or existing data (top-down). Experts advise using a bottom-up forecasting method in the short term (up to 2 years) and top-down in long-term projections (up to 5 years). With these options in mind, let’s go through the main stages of creating a practical financial model.

Conduct deep market research

Market research helps you to better understand your industry when launching a business. This process helps you form a target audience to consume your commodities, which you can then use to form a profile of the ideal customer. This small step will help you predict profits as you consider consumer trends.

Forecasting expert Sean Heberling, the SEO of Marion Street Capital, reports that his company once helped an automated manufacturing enterprise create and conduct a survey of its potential customers known to other organizations in the industry. The team at Marion Street Capital encouraged respondents by providing anonymous copies of other companies’ responses, allowing them to compare results with other enterprises in the industry. Using forecasts based on the survey, Marion Street Capital helped the client secure $25 million in investments. Of course, this is just one example of the tremendous economic power of forecasting.

Collect relevant financial data

In order to make predictions, you first need to summarize your revenues and expenditures into a workable estimate. If you are making financial projections for a startup, this requires some guesswork. Most importantly, you should ensure that your estimates are based on verifiable data. If you have historical information, you can simply export capital inflows and outflows for the last 12 months into a spreadsheet. When estimating salary projections, you can use the Glassdoor database.

Determine spending

Your organization’s spending budget represents how much you plan to spend during your first years of operation. It is essential to anticipate all operating and overhead costs of running your business. According to financial experts, it is best to divide between fixed and variable expenditures, as this helps you to more efficiently plan your budget and increase profitability.

Palo Alto Software founder Tim Berry advises that lower fixed costs provide less risk. This may be theoretical in business school, but it is all too tangible when you are actually signing a check to get your organization running. In addition, you should keep in mind that your spending will vary depending on the stage of development. You will likely have higher marketing costs when you are just starting out, compared to later on in your business’s operations.

Calculate Return on investment (ROI)

Your return on investment, or ROI, is the capital you will receive after paying your bills and investing in a growth strategy. To calculate ROI, you should determine how much money you must spend to launch a business and compare this value with predicted earnings. This indicator is necessary to convince potential investors that your organization is profitable, and that they may benefit from investing in your vision.

Setting a Time Frame

Choosing the period when you will receive ROI simplifies the interaction with investors and helps you set and track goals. For instance, you can consult income and expense forecasts to help you predict when your business will break even. This goal will help you to implement advertising campaigns, as well as determine your pricing policy and the optimal moment to launch your startup.

Main components of financial forecasting

Your organization’s financial forecast paves the way for the creation of three key fiscal documents. Let’s take a look at how each of these statements may help with your company’s plans for development:

• The profit and loss statement contains data on income and expenses. It provides valuable data on actual or projected results for your organization’s operations. Investors use this report to assess the financial health and performance of your firm.
• The capital flow statement demonstrates the inflow and outflow of capital in the enterprise. Management applies insights from this document to provide debt control, capital risk management, working capital preservation, renewal of investments, and other important fiscal controls. The movement of financial resources is critical when discussing startups, as it is directly related to the burn rate. If you don’t have a clear idea of your company’s cash flow projection, your enterprise will sink faster than you realize.
• The balance sheet summarizes the firm’s assets and obligations. This document can be compared with the income statement, given the different periods of validity of securities (the ownership of assets and liabilities does not fit into the same financial period indicated in income reports).

We recommend that entrepreneurs analyze each report individually to identify potential hazards and growth opportunities. For example, if the forecast shows a significant increase in the gross profit of the enterprise. you should review your spending to see if it’s worth investing the extra profit in hiring more people or implementing other development measures.

A few recommendations on how to form financial forecasts

At first glance, creating an economic forecast seems rather simple; after all, it combines different projections in a fairly straightforward way. Still, there are some precautions you should adopt in order to obtain the maximum return on capital:

• Update forecasts regularly: your original forecast may indicate that you’ll reach $700,000 monthly recurring revenue in 3 months, but notice leads are visibly declining. In this situation, it might be worth revisiting your financial plan based on the reduced number of leads. Updating your forecasts will ensure that your predictions are not based on outdated information.
• Create multiple financial projections for a startup: many entrepreneurs make the mistake of drafting only one financial plan. Business may go better or worse than expected, so you must understand the algorithm of actions and have several projections at your disposal.

As a business owner, you may be wondering about the many variables that can affect your financial forecasting, such as sales force performance, conversion rates, market conditions, and macroeconomic factors. Fortunately, there is no need to consider every factor or obsess over creating ideal projections. Actually, creating the perfect forecast is impossible, as there is always some simplification and estimation involved.

Final words

Generating forecasts can be a time-consuming and intricate task, especially if you, like many other business owners, lack extensive experience in this area. It is important to remember that your financial specialist can only generate accurate financial projections based on error-free accounting information. However, despite the paramount importance of accurate financial records, many startups choose to handle their accounting internally in order to lower costs.

If you would rather delegate the creation of documents and forecasts to seasoned financial experts, BooksTime may be the best solution. Our dedicated team offers a full range of CFO and accounting services for startups and small businesses, all with the speed, security, and convenience of state-of-the-art accounting software. With BooksTime, you can be sure that your financial calculations are correct, up-to-date, and complete!

This article is not intended to provide tax, legal, or investment advice, and BooksTime does not provide any services in these areas. This material has been prepared for informational purposes only, and should not be relied upon for tax, legal, or investment purposes. These topics are complex and constantly changing. The information presented here may be incomplete or out of date. Be sure to consult a relevant professional. BooksTime is not responsible for your compliance or noncompliance with any laws or regulations.

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Author: Charles Lutwidge

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Financial Forecast for Startup: Complete Guide

Table of contents.

A financial forecast is a way of forecasting income and expenses for a business. A financial forecast for startups is the key to business planning for startups and helps to get investors interested and financially prepared to analyze the feasibility of a startup business idea. Creating financial projections is a key task when planning a startup. In this article, we’ll explain a startup financial forecast, discuss the key elements, suggest steps to create a financial forecast, and provide tips on how to succeed.

What is a financial forecast for a startup?

A financial forecast is an analysis of financial data that helps predict a project’s future income and expenses. A financial forecast is an important step in business planning for a start-up company. A financial projection for a startup can help prepare for the first few years of operation. It is also a useful analysis to share with potential investors to raise funds for a startup . To have better financial experience, many startups use financial reporting software , which allows them to ease the process and have better management for the startups. Moreover, to streamline operations, gain in-depth insight, and ensure precision in forecasting for optimal startup management, many mature startups opt for financial management software . This software allows them to ease processes and keep everything finance-related in one place.

What are the elements of a financial forecast?

The financial forecast includes three key financial statements: income statement, cash flow forecast, and balance sheet. These documents help make a financial forecast for a startup. Here’s how each plays a key role in financial forecasting. You should create surveys for financial statistics from your clients. You can make surveys online freely and share them on your network to get the necessary results for your startup.

Income statement

Your income statement contains information about income, expenses, and your profit over some time, such as one year. These numbers are very important for predicting financial projections for your startup: It is essential to know that businesses that run themselves have highly developed marketing strategies, especially affiliate marketing strategies. And they are ready to grow their business online with the most effective strategy.

• Income : The money you earn from selling goods and services before your expenses are deducted. Income forecasting helps you budget.
• Expenses: All investments you make to start and run your business are expenses. For example, materials, equipment, employee salaries, advertising, insurance, office space, and legal fees to obtain a business license. It is important to accurately forecast the costs of doing business.
• Total Revenue : Revenue is the profit you make from a business. You can calculate or predict this by subtracting your expenses from your income. It is important to share this number with investors or loan officers to ensure your business is profitable.
• Income Tax: The law requires you to pay income tax, so to get a projection of how much you can earn from your business, be sure to include income tax.
• Net income: After accounting for total income and income tax, you get net income, which is the amount of money your business makes. This is an important number because it shows how sustainable your business idea is.

Cash flow forecast

A cash flow forecast is a more detailed analysis of expenses and income which is a crucial part of data analytics in finance . If you plan to start a business , focus on research and budgeting to estimate your cash flow and develop a cash flow statement. Startups can use these predictions to show that they can recoup money borrowed from a bank or investors and when they can repay the loan. Here are the three elements of a cash flow forecast

Cash income: This shows an overview of sales forecasts for a specific period of time, such as a month. You can predict sales with market research and consumer behavior analysis.

Cash payments: The amount you need to pay monthly to cover expenses is a cash payment. This is a useful forecast for budgeting. For startups aiming to streamline their financial processes, it’s often beneficial to hire fintech developers to implement advanced solutions

Reconciliation of cash receipts with cash payments means subtracting cash payments from your cash receipts. Once your business is up and running, you can include the previous month’s total revenue to keep track of revenue.

Do your Market Research

When starting a business, it is important to do market research to learn more about the industry. Once you’ve created the target audience you want to sell to, you can determine who your customers might be. This helps predict revenue because you can do market research to uncover the consumer trends of people who fit your target audience demographics.  Researching potential customers can help you decide which location is best for your startup and how you plan to market your products. These decisions affect your finances. You should also find sources to develop your startup. There are many incubators that help with office space, workforce, and financial support to have the most success with your startup. You can apply for them and have better results with your startups, as they help you to be more dedicated and have better opportunities.

Appreciate Your Team Members

If you want your startup to succeed, you need to motivate and appreciate your team members, who are a big part of your journey. You can prepare unique glass award s and promote their success. Afterward, you can take a picture of the glass awards and raise social media awareness about their achievements and dedications.

ROI Forecast

To make a return on investment (ROI) projection, determine how much money you need to spend to start your business and compare that to your projected income. ROI is the profit you make after paying your bills and investing money in strategies like marketing for your startup. This number is useful to convince people to invest in your business because you can show that your idea is profitable.

Set a Time Frame

Setting a time frame for when you can get ROI helps convince investors and is important information to have when starting a business , as it helps you set and track goals. Use your financial income and expense projections to determine a specific date when you predict you can start making a profit.  This goal can help determine marketing campaigns, pricing, and your startup’s launch date. Also, remember that you do not need an office to start your startup, especially in the IT field. You will be more aware of virtual office benefits , as virtual offices reduce costs and boost productivity levels.

Create Growth Goals

Growth goals are your business goals that are related to expansion in any sense. For example, a growth goal might be to increase sales by a certain amount . Goal setting can determine where to invest the most time and money in your startup. This can help with financial spending projections, especially. For example, if your growth goal is a certain sales volume by the end of the year, consider investing in a marketing team to ensure your sales goals are met.

Creating growth goals also provides more information about your company that you can share with potential investors.

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7-step guide to financial forecasting & planning for any business

What is financial forecasting, why is it important, and how to properly conduct financial planning and forecasting

• What is financial forecasting?
• Why is it important?
• 4 common types of financial forecasting
• How to do financial forecasting in 7 steps
• Financial forecasting FAQs

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Uncertainty is one of the constant aspects of doing business. Many factors beyond your control can potentially influence the market in ways you didn't expect. For example, new technologies are constantly changing operations across almost all industries at a fundamental level. 

It pays to know what to expect in the near future and plan ahead, hence the need for financial forecasting. Every business (including monopolies) could benefit incredibly from regular  financial forecasting . Here is a comprehensive guide on the importance of financial forecasting for your business model and how to do it.

Failure to conduct regular financial forecasting leaves you flying blind.

What is financial forecasting? 

Financial forecasting refers to financial projections performed to facilitate any decision-making relevant for determining future business performance. The financial forecasting process includes the analysis of past business performance, current  business trends , and other relevant factors.

However, some aspects of financial forecasting may change depending on the type and purpose of the forecast, as will be discussed later. 

Importance of financial forecasting 

Hypothetically speaking, failure to conduct regular financial forecasting leaves you flying blind. Regular forecasting has extensive benefits for some of your business' fundamental operations, including: 

Annual budget planning 

A budget represents your business' cash flow, financial positions, and future goals and expectations for a set fiscal period.  Financial forecasting and planning  work in tandem, as forecasting essentially offers an insight into your business' future—these insights help make budgeting accurate.  

Establishing realistic business goals 

Accurate forecasting will help predict whether (and by how much) your business will grow or decline. As such, you can set realistic and achievable goals—and manage your expectations. 

Identifying problem areas 

Financial forecasting  can help you identify ongoing problems by analyzing the business' past performance. Additionally, you can identify potential problems by getting an insight into what the future holds. 

Reduction of financial risk 

You risk overspending by creating a budget without financial forecasting. In fact, most of your financial decisions would be ill-informed without the input of a financial forecast's results. 

Greater company appeal to attract investors 

Investors use a company's financial forecast to predict its future performance—and the potential ROIs on their investments. Additionally, regular forecasting shows your investors that you are in control and have a solid business plan prepared for the future.

4 common types of financial forecasting 

Businesses conduct financial forecasting for varying purposes. Consequently, forecasting practices are categorized into four types: 

1. Sales forecasting 

Sales forecasting entails predicting the amounts of products/services you expect to sell within a projected fiscal period. There are two sales forecasting methodologies: top-down forecasting and bottom-up forecasting. 

Sales forecasting has many uses and benefits, including budgeting and planning production cycles. It also helps companies manage and allocate resources more efficiently. 

2. Cash flow forecasting 

Cash flow forecasting  entails estimating the flow of cash in and out of the company over a set fiscal period. It's based on factors such as income and expenses. It has many uses and benefits, including identifying immediate funding needs and budgeting. However, it is worth noting that cash flow financial forecasting is more accurate over a short term. 

3. Budget forecasting 

As a financial guide for your business' future, a budget creates certain expectations about your company's performance. Budget forecasting aims to determine the ideal outcome of the budget, assuming that everything proceeds as planned. It relies on the budget's data, which relies on financial forecasting data. 

4. Income forecasting 

Income forecasting entails analyzing the company's past revenue performance and current growth rate to estimate future income. It is integral to doing  cash flow  and balance sheet forecasting. Additionally, the company's investors, suppliers, and other concerned third parties use this data to make crucial decisions. For example, suppliers use it when determining how much to credit the company in supplies. 

How to do financial forecasting in 7 steps 

Many integral aspects of your company's current and future operations hinge on the results of your financial forecasts. For example, forecasting results will influence investors' decisions, determine how much your company can get in credit, and more. 

As such, accuracy cannot be overemphasized. Here is a step-by-step guide to ensure that you do it right: 

1. Define the purpose of a financial forecast 

What do you hope to learn from the financial forecast? Do you hope to estimate how many units of your products or services you will sell? Or perhaps you wish to see how the company's current budget will shape its future? Defining your financial forecast's purpose is essential to determining which metrics and factors to consider when doing it. 

2. Gather past financial statements and historical data 

One of the components of financial forecasting involves analyzing past financial data, as explained. As such, it is important to gather all relevant historical  data and records , including: 

• Liabilities 
• Investments 
• Expenditures 
• Comprehensive income 
• Earnings per share 
• Fixed costs

It's important to ensure that you gather all required information as your financial forecast's results will be inaccurate if you exclude relevant data.

3. Choose a time frame for your forecast 

Financial forecasts are designed to give business owners an insight into the company's future. You get to decide how far into the future to look, and it can range from several weeks to several years. However, most companies do forecasts for one fiscal year. 

Financial forecasts change over time as factors such as business and market trends change. Consequently, it is worth noting that financial forecasting is more accurate in the short term than in the long term.

4. Choose a financial forecast method 

There are two financial forecasting methods: 

• Quantitative forecasting uses historical information and data to identify trends, reliable patterns, and trends. 
• Qualitative forecasting analyzes experts' opinions and sentiments about the company and market as a whole. 

Each method is suitable for different uses and has its strengths and shortcomings. However, qualitative forecasting is more suitable for startups without past data to which they can refer. 

5. Document and monitor results 

Financial forecasts are never 100% accurate and tend to change over time. As such, it is important to document and monitor your forecast's results over time, especially after major internal and external developments. It is also important to update your forecasts to reflect the latest developments. Using  forecasting software  to automate related tasks may help too.

6. Analyze financial data 

Regularly analyzing financial data is the best way to tell whether your financial forecasts are accurate. Additionally, continuous financial management and analysis helps you prepare better for the next financial forecast and gives you crucial insights into the company's current financial performance. 

7. Repeat based on the previously defined time frame 

Smart companies conduct regular financial forecasting to stay in the know and in control. As such, it is advisable to repeat the process once the time period set for the current financial forecast elapses. It's also prudent to keep collecting, recording, and analyzing data to improve your financial forecasts' accuracy.

Get accurate metrics for financial forecasting—absolutely free 

An efficient system of collecting, storing, and analyzing data is necessary for accurate financial forecasting. ProfitWell Metrics is a subscription analytics software designed to do all of this on one platform. Some of the metrics that you can get using this program include: 

• Monthly and annual recurring revenues 
• Market and customer segments 
• Customer acquisition and retention 
• Customer lifetime value 
• Churn rate 
• The average revenue per user 

ProfitWell Metrics collects and records all  important metrics , giving you enough data to work with when conducting a financial forecast. Additionally, the data collected in real-time offers crucial insights to help you update your forecasts and other projects accordingly. 

ProfitWell Metrics also integrates seamlessly with other popular data analytics programs, including Google Sheets and Stripe. More importantly, it's 100% free and secure. 

Take the headache out of growing your software business

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Financial forecasting FAQs 

Some of the most frequently asked questions regarding financial forecasting include: 

What is the role of forecasting in financial planning? 

Financial forecasting estimates important financial metrics such as sales, income, and future revenue. These metrics are crucial for finance-related operations such as budgeting and financial planning as a whole. Consequently, forecasting functions as a guiding tool (or marking scheme) for financial planning. 

What is the difference between financial forecasting and modeling? 

On the one hand, financial forecasting entails predicting the business' future performance. On the other hand, financial modeling entails simulating how financial forecasts and other data may affect the company's future if everything goes according to plan. Financial modeling is done for very specific and often discrete purposes. 

What is the difference between financial forecasting and budgeting? 

Financial forecasting and budgeting work in tandem and are often misinterpreted as meaning the same thing. However, financial forecasting entails estimating and predicting the company's future performance (financially and in other aspects). On the other hand, budgeting is the company's financial expectations for the future (expectations based on financial forecasts and other data). 

What are the three pro forma statements needed for financial forecasting? 

Pro forma statements are financial reports designed to give insights into how different scenarios would play out based on hypothetical circumstances. There are three pro forma statements: 

• Pro forma statements of income 
• Pro forma cash flow statements 
• Pro forma balance sheets 

Pro forma statements may be hypothetical, but they help companies prepare for an uncertain future. Consequently, they're useful when conducting financial forecasts. 

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The ultimate guide to financial modeling for startups

Multidisciplinary professional services organization

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Do you have a startup and do you want to build a sustainable financial future discover the best practices in the ultimate guide to financial modeling for startups..

W e have three very easy questions for you:  

• Do you want to build a (financially) sustainable business?
• Are you looking for funding?
• Do you want to avoid going bankrupt?

Probably you have answered yes at least once. If you have founded your own company, probably yes applies to all three questions.

To cover all three having (some form of) a financial model is crucial. Whatever the reason is for you ending up at looking at this article, apparently also for you financial modeling is an important topic, otherwise you wouldn’t be here, right? ;)

Well, you have come to the right place! Having supported around a thousand startups and scale-ups with their financial models over the past couple of years with the EY Finance Navigator team, we have written everything you need to know and all the best practices available around financial modeling for starting businesses: the ultimate guide to financial modeling for startups!

NOTE: in this article we are not sharing any financial modeling templates. Why? There are tons and tons of them already available online: simply look for ‘financial model template’ on the web and you are done.

This article is written with the purpose of doing something a template cannot do for you: helping you understand the different elements and technicalities of a startup’s financial model, learn how to fill it in and do checks on your data so you are able of making sense out of the outcomes yourself. And if you need  additional support, feel free to reach out using the contact form.

Need help building your financial projections?

Check out EY Finance Navigator: our financial modelling software for startups, trusted by entrepreneurs in more than 50 countries.

Find out more

Three reasons for having a financial model as a startup

Why it’s important to build an economically viable business

Before we dive into the technicalities and different elements of a startup’s financial model we are going to broaden our view a bit and address why forecasting in general is an important topic for startups. Almost all companies perform some kind of financial planning or budgeting, but there are particular reasons why a financial plan is important for startups specifically:

• You need one to build an economically viable business. Why? Because by quantifying (and then validating) your business plan and business model, assumptions and vision you are able of finding out whether you can turn your ideas into a sustainably operating business. Moreover, if you build different versions (“scenarios”) you are better prepared for the future, especially if things do not go the way you planned. What if you launch half a year later? Answering such a question in your “worst case scenario” helps you anticipate how your cash flow, profitability and funding need are impacted.
• You need one as part of the fundraising process. Financiers will typically ask you for a financial plan when you engage with them to raise funding, whether them being angel investor, VC, bank or subsidy provider. Certain investors will require more details then other, but building a model is wise even if you only need to provide them with high-level data. Why? Because it helps you answer the tricky questions a financier might have when he or she dives into your business case. Moreover, how are you planning to raise funding if you did not properly calculate how much funding you actually need?
• You need one to inform yourself and shareholders. How do you know how your company is doing if you don’t have any targets to achieve or steering information to compare against? How are you going to update your shareholders on how you are spending their money and whether you are performing as promised without any financial plan to benchmark against? You will need a forecast to do so.

Do these reasons apply to your case as well? Good! Then definitely continue reading…

Two different approaches to financial modelling for startups

Building a financial model is not difficult, but how to get the numbers?

Often building a financial model is not really an issue. The amount of templates you can find online are countless and there’s always someone Excel-savvy around to help you out with the technicalities. The REAL problem (and question we get most often) is: how to get to the numbers?

…how do you forecast sales? …what is the market size of my sector? …how much should I spend on marketing? Etc.

There are two main methods to answer these questions: top down forecasting and bottom up forecasting.

Top down forecasting

Using the top down approach you work from a macro/outside-in perspective towards a micro view. Typically industry estimates are taken as starting point and narrowed down into targets that are fit for your company.

In essence the top down method helps you to define a forecast based on the market share you would like to capture within a reasonable timeframe. A useful aid to perform top down forecasting is the TAM SAM SOM model.

The TAM SAM SOM model captures the market size on three levels: the total worldwide market for a product or service (TAM: total available market), the part of that market you address with your specific offering (the niche market) adjusted for your geographical reach (SAM: serviceable available market), and the part of SAM you can actually realistically capture (SOM: serviceable obtainable market), given the existing competition. SOM is therefore equal to your sales target as it represents the value of the market share you aim to capture.

Example of a TAM SAM SOM visualization (source: EY Finance Navigator’s financial planning software for startups)

Based on the sales targets you define using the TAM SAM SOM model the next step is to estimate all costs that are needed to build or deliver your product or service and all expenses that are needed to perform all sales and marketing, research and development, and general and administrative tasks for your company to stay alive.

When estimating these you obviously aim for profitability within a reasonable timeframe. In other words: at some point all costs and expenses should not exceed your revenue targets anymore so that you get to a positive EBITDA (earnings before interest, taxes, depreciation and amortization).

Bottom up forecasting

The pitfall of the top down approach is that it might seduce you to forecast too optimistically (especially sales). Often entrepreneurs calculate SOM (equal to sales) by taking a random percentage of the market, without really assessing whether this target is realistically achievable.

A tiny percentage of a market might seem insignificant, but could be way too optimistic for instance in the year of your launch. Therefore, it could be useful to complement the top down method with the bottom up approach.

The bottom up approach is less dependent on external factors (the market), but leverages internal company specific data such as sales data or your company’s internal capacity. Contrary to the top down method, the bottom up approach begins with a micro/inside-out view and builds towards a macro view. This means a projection is made based on the main value drivers of your business.

Short example: let’s assume one of the main drivers of an online SaaS business is online marketing. One of its online marketing tactics is to advertise its product via LinkedIn. The company could define the costs per click using LinkedIn’s advertising tool, estimate the number of website visitors it will attract as a result, the conversion from website visitor to a lead, and the conversion from lead to customer.

Based on these metrics the company will have a good idea of potential sales, of course constrained by the budget available for online advertising. Performing a bottom up analysis therefore does not only force you to think about what are realistic targets for your company, but also to think about the ways in which you will spend your resources.

With the bottom up approach, you estimate revenues, costs, expenses and investments in the same way as described above: based on the resources at hand and the company data that is available. The pitfall of the bottom up method though is that it might fail to show the optimism needed to convince others of the potential of your company.

If you are a startup founder and you are looking to raise funding, the bottom up approach might not do the trick. Investors usually expect startups to grow fast and gain significant market share rapidly. The bottom up method might fail to reflect that.

It is difficult to create a forecast with a steep growth curve if every sale has to be rationalized and if its point of departure is the maximal capacity of your company (or budget for advertising purposes). With the bottom up approach it is hard to take into account factors such as virality or word of mouth. Moreover, the whole reason why external financing is needed, is often to expand capacity and grow faster than a company would do organically.

Therefore, when you build your startup’s forecast it could be advisable to combine both the bottom up and top down methods, especially when you plan to achieve a strong growth curve by means of external funding. Use the bottom up method for your short term forecast (1-2 years ahead) and the top down method for the longer term (3-5 years ahead). This makes you able to substantiate and defend your short term targets very well and your long term targets demonstrate the desired market share and the ambition an investor is looking for.

Assumptions

No matter what approach you use to build your startup’s financial model, it is crucial you are able of substantiating your numbers with assumptions. As a startup, historic data is often not available so you need to be able to present the ‘proof’ behind your numbers.

This will also help you when you start discussing with investors, as they are typically interested in knowing the reasoning behind your numbers. They are considering to put money in your company, so you do not want to give them the feeling you are selling baloney!

Assumptions can be anything that validate your numbers: market research, web search volume, contracts with suppliers, pricing validation, historic sales, conversion rates, bills of materials, website traffic, etc. It could be useful to create a “data room” (e.g. a Drive folder) in which you collect these kinds of evidence. By doing so, you are slowly building a library that underpins all the numbers you have put in your model and you are well prepared in case an investor might request a due diligence process.

Now, that is more than enough background to get started. Let’s get to it: the financial overviews a good financial model (of a startup) should include!

Three outcomes of a startup’s financial model

Every sector, company, business owner and investor is different, but a good financial model usually contains at least the three outputs.

Every sector, company, business owner and investor is different. All of them have their own interests and all of them value different metrics. From that perspective it is thus fair to say every financial model has its own characteristics. Therefore it is possible to customize every model to its user.

However, a good financial model usually contains at least the three following outputs: the financial statements, an operational cash flow forecast and a KPI overview.

1. Financial statements

Any decent financial model includes a forecast of the three financial statements: the profit and loss statement (P&L), the balance sheet (BS) and the cash flow statement (CF). The financial statements are the generally accepted way of communicating financial information across companies, banks, investors, governments and basically anyone that needs to show and/or understand financial performance in some way. Since any financial professional is able of interpreting financial statements having a forecast of them in place is typically a requirement in practically any fundraising process.

The profit and loss (or income) statement is basically an overview of all the income and costs your company has generated over a specific period of time and shows you whether you are profitable or not.

The P&L shows several crucial performance metrics such as the gross margin, EBITDA and net margin. EBITDA (earnings before interest, taxes, depreciation and amortization) is very important for investors as it provides insights in the operational performance of a company and allows them to compare efficiency when comparing different companies. The P&L can be used for comparing different time periods, budget vs. actual performance, performance against other companies etc. and can therefore show weak or strong performance.

Example of a profit and loss statement (or: income statement) (source: EY Finance Navigator’s financial planning software for startups)

The balance sheet is an overview of everything a company owns (its assets) and owes (its liabilities) at a specific point in time. It shows a snapshot in time (for instance the end of the year) and is therefore different compared to the profit and loss statement which shows all revenues and costs that were generated during a certain time period.

Liabilities show the obligations of a company and how it has financed itself using debt, whereas assets show how these funds are used within the company (for instance as capital to pay for inventory or assets such as computers and buildings). The difference between the value of assets and liabilities consists of equity, which is the paid-in capital by investors that finance the assets not covered by debt (assets = liabilities + equity).

Because of this the balance sheet is always ‘in balance’. Shareholders' equity represents the net value of a company. In other words: the amount that would be returned to shareholders if all the company's assets were liquidated and all its debts repaid.

Example of a balance sheet (source: EY Finance Navigator’s financial planning software for startups)

The cash flow statement shows all cash going in and out of a company over a specific time period. The cash flow statement consists of three different parts: the operational cash flow, the investment cash flow and the financial cash flow. The separation between these three categories provides you with insights on where money is going in and out of the company.

Operational cash flow shows the cash inflows and outflows caused by core business operations. Investment cash flow shows changes in investments in assets and equipment. In most cases (concerning startups) investment cash flow will have a cash outflow (because investing in assets costs money), but in some cases investment cash flow can also be positive in case a company is divesting (selling assets, e.g. selling real estate).

Financial cash flow relates to cash changes arising from financing activities. Cash inflow occurs in case of raising capital (such as loans or equity) and cash outflow occurs in case dividends are paid or when interests on cash financing are paid (e.g. to bondholders).

The cash flow statement allows management to make informed decisions on business operations and allows it to prevent and monitor company debt. Moreover it helps define a company’s investment needs and supports the timely payment of expenses and debts.

Example of a cash flow statement (source: EY Finance Navigator’s financial planning software for startups)

2. operational cash flow overview.

For fundraising purposes a forecast of the financial statements is typically shown on a yearly basis. Monthly overviews are in most cases not really needed, because for early-stage startups it is more about showing the long term growth potential than about giving an insight in monthly operations.

However, for the actual day to day financial management of your company it is useful to include an operational cash flow for the coming 12 months ahead in your financial model.

Why? Because it addresses questions yearly financial statements cannot answer, for instance about the timing of cash in and outflows. This is important to anticipate (see section ‘Working Capital’ below).

Moreover, it provides you with an opportunity to track your actual performance versus your expected budget on a monthly basis, which helps you cut costs (if needed) and anticipate to potential cash dips months ahead.

To build an operational cash flow forecast you simply list all the categories of cash inflows and outflows (for instance in an Excel), add a starting balance (the cash you own at this very moment) and see what remains at the end of each month.

An example can be found below. If you would also add columns where you can enter your actual numbers (against the forecasted cash in-and outflows) you are able of tracking performance over time and anticipate cash issues early on.

Example of an operational cash flow budget (source: EY, 2018)

3. kpi overview.

The outputs of a startup’s financial model typically also include some company and/or sector specific KPIs (key performance indicators). As the name already implies KPIs are crucial metrics for your business.

KPIs do not only matter for an investor, but also for you as a company owner. Based on these metrics you track the performance of your company, experiment with different acquisition channels, business models and cost structures, and you use them to make you and your co-founders laser-focused on the targets you defined.

There are KPIs that show sales and profitability performance (such as revenue growth rate, gross margin, EBITDA margin or profits), KPIs related to cash flow and raising investment (such as the burn rate, runway and funding need breakdown) and company or industry specific KPIs.

SaaS companies for instance typically estimate and track, amongst others, the customer life time value (LTV), customer acquisition costs (CAC), LTV/CAC ratio and the churn rate. For SaaS businesses, these are crucial.

For your business or industry some other metrics might be more important. Perform a bit of research on the web, think about the most important drivers of your company and identify the ones most relevant to you and to potential investors. Include these in your financial model as well.

Example of several KPIs that could be relevant to startups (source: EY Finance Navigator’s financial planning software for startups)

The inputs to a startup’s financial model.

What are the six common elements that typically serve as the input sheets of a financial model?

The outputs discussed above do not all of a sudden appear out of nothing, obviously. They are the result of many calculations taking place in the background of a financial model, based on the data entered into different input pagessubstantiated by the assumptions and research performed by the person filling in the financial model.

In this article we are not discussing all the calculations that take place in a financial model, as that would be a heck of a job! As mentioned earlier, we focus on helping you understand the different elements and technicalities of a startup’s financial model, learn how to fill it in and make sense out of the outcomes.

If you want insights in the calculations you can download a financial modeling template online. If you do not want to worry about (errors in) calculations at all, try out our financial planning software for startups.

Below we have listed six common elements that typically serve as the input sheets of a financial model. One element we have left out as an input sheet is what you could call the financial model’s ‘settings’.

These define the setup of the complete model and include things such as the forecasting period (which is typically 3-5 years, sometimes ten for certain industries), the currency used, taxes that might apply, etc.

Before moving to the different inputs of a startup’s financial model, it is important to realize financial modeling is not a goal in itself. It should be a means to an end. And that end is typically to get more insights in the financial side of building a business, whether those insights are meant for yourself or for a potential investor.

A financial model is a quantification of your overall business and should therefore be a reflection of your strategy, business model and vision. It is therefore fair to say your financial model and business model canvas are two sides of the same coin.

If you are ever in doubt on what to include in your financial model or if you need to take a step back from the numbers, you can use your business model canvas as a tool to help you think about your financial plan.

1. Revenues

The first (and maybe also most fun) input sheet of a financial plan is the revenue forecast. Revenue projections can be tricky though, for instance when you have not achieved any sales in the past yet. So how would you go about this? For a deep dive we would recommend to have a look at our earlier article on how to create a killer sales forecast for your startup, but we will present the key takeaways below.

Forecasting revenues is typically performed using a combination of the top down (TAM SAM SOM model) and bottom up methods which have been discussed earlier in this article. Use the bottom up method for your short term sales forecast (1-2 years ahead) and the top down method for the longer term (3-5 years ahead). This makes you able to substantiate your short term targets on a detailed level, while at the same time your long term targets demonstrate the desired market share and the ambition an investor is looking for.

If you find it difficult estimating demand at all one way of tackling this is to perform keyword research. Keyword tools give you insights in the search volumes for keywords that relate to your offering. They can show you per city, country, continent (whatever you want) how much monthly searches are performed for that specific keyword on the internet.

This can give you a good indication on demand for certain offerings, compared across different countries. You could try for instance the keyword tool Ubersuggest. If you sell 3D printers, you could search “buy 3D printer” and see how much people search for these words per month.

Now you know the approaches to forecasting, this is how you actually put your forecast down on paper:

• List all the products or services that you are selling.
• Determine in which units you want to present your sales: for a soda producer, this could for instance be bottles sold, but also liters sold.
• Forecast per sales unit the number of units sold. This is based on the top down and bottom up analysis you have performed above.
• Add selling prices. Check out our article on new product pricing strategies if you want to learn more on how to determine pricing.

You could for instance end up with something that looks like this if you would prepare the forecast in Excel:

Revenue forecast example in Excel (source: EY, 2018)

The way in which you build up your revenue forecast depends a bit on your business model. The example above includes a traditional business model of a company selling products/services per unit.

However, for a SaaS business it could be better to prepare a revenue forecast based on existing customers, new customers and the churn rate. You can look for a financial modeling template for specific companies or business models on the web. Our financial planning software for startups also includes the usage of different business models to build up your revenue forecast.

2. Cost of goods sold (COGS)

Cost of goods sold (COGS) are those costs that undoubtedly need to be made in order for a company to deliver a service or produce a good. Without these costs, the product or service would simply not exist.

COGS differ based on the type of offering you sell. For a company that sells tangible products they would include for instance the costs of the materials used in creating the good. For a company that sells consultancy hours they would include the personnel costs of the employees delivering the service.

For a SaaS business COGS are different compared to ‘normal’ businesses as there is no regular production or service delivery process involved. However, also SaaS companies definitely incur COGS, such as hosting costs, customer support and onboarding costs, and online payment costs. From these examples you can notice that all of these costs have to be incurred in order to produce the good or deliver the service.

Not sure how to forecast COGS? One way of tackling this, is by looking at the sales targets defined in your revenue forecast. Let’s assume you sell a tangible good. From creating the revenue projections you know already how many units of sales you aim to have. You then add per unit of sales the costs of raw materials and labor costs involved in producing those goods.

Example: if you sell plastic bottles, you could calculate how much plastic (in grams) you need per bottle and what would be the price of a kilogram of plastic. Moreover, you need to know how much paper label you need per bottle and what is the price of that. Also, you need to know the costs of the cap.

If you know all of these costs required to produce one bottle you can multiply them by the total number of bottles sold. Finally you add the personnel costs for employees that are involved in production.

If you would prepare this in Excel it would probably look something like this:

Cost of goods sold forecast example in Excel (source: EY, 2018)

How to forecast COGS also depends on your business model. Sometimes it would make more sense to forecast COGS on total level, for instance per month. Or they could be a percentage of your revenues (for instance when you work with sales commissions). Our financial planning software for startups includes different types of COGS forecasting.

3. Operating expenses (OPEX)

Operating expenses are those expenses that a business incurs as a result of performing its normal business operations. Unlike the cost of goods sold, they are not necessarily needed to produce the goods that are sold or to deliver the services promised. They include costs related to the supporting and operational side of business, such as sales and marketing, research and development and general and administrative tasks.

Typical operating expenses for startups include: events, travelling, legal costs, online marketing, payroll costs (of employees not part of COGS), accounting, rent, utilities, insurance, prototyping, patent costs, IT costs, office supplies, promotional materials, etc.

If you are not sure about which expenses you might incur in the long term, you could always save a certain percentage of your revenues for the different expense categories. E.g. you could include 10% of your yearly revenues on a budget for sales and marketing activities.

Most important is that your spending on operating expenses aligns with your company strategy. Is the growth of your company heavily reliant on online marketing? Then you would expect significant spending in that category.

An example of what an operating expenses forecast could look like for instance for spending on sales and marketing, can be found below.

Operating expenses forecast example in Excel (source: EY, 2018)

4. personnel.

Personnel is probably one of the easier forecasts to build. With your personnel forecast you project the number of employees hired including their respective salaries, additional benefits and payroll taxes. To make personnel forecasting more simple you could split up your personnel into different categories, for instance:

• Direct labor: here you include the employees that will be solely engaged with the production of the goods sold or services delivered. Think of engineers and technicians for companies selling tangible hardware products, a junior advisor in a consultancy company, or customer onboarding personnel in a SaaS business. These costs are not part of operating expenses but are part of the cost of goods sold.
• Sales and marketing: for instance sales managers, marketing managers, copywriters, social media experts, etc. These employees are part of your operating expenses.
• Research and development: R&D managers, (software) engineers, technicians, etc. These employees are part of your operating expenses.
• General and administration: here you include back office and C-level personnel, such as the CEO, CFO, CMO, secretaries, bookkeepers, etc. These employees are part of your operating expenses.

An example of what a personnel forecast could look like, for instance for personnel working on sales and marketing, can be found below.

Personnel forecast example in Excel (source: EY, 2018)

If you want to check whether your personnel forecast is realistic, you could divide your projected revenues in a given year by the number of employees (‘FTEs’ or full time equivalents) for that year. This tells you how much revenue you expect to generate per employee and provides a solid basis for comparison with competitors and industry leaders.

When your revenue per employee is at a similar level compared to the top twenty tech companies (see the graph below) already in just a few years after your launch, this is a strong indicator that you might be too optimistic regarding your expected revenues or that you might invest insufficiently in personnel.

Revenue per employe (source: EY, 2018)

5. investments in assets (capital expenditures).

The fifth input sheet to your startup’s financial model are the investments in assets (or: capital expenditures). Capital expenditures are funds used by a company to acquire or upgrade physical assets such as physical property, intellectual property, buildings or equipment. This type of expense is made by companies to maintain or increase the scope of their operations. They can include everything from repairing a roof to building a brand new factory.

Typical capital expenditures depend on the type of business and industry. For startups it is quite common to invest in computers, software, office equipment and machinery, but buying a building would also apply as a capital expenditure.

Many startups are incentivized to categorize their expenses as capital expenditures instead of as operating expenses. This has to do with the fact that due to an accounting technicality payments related to investments in assets are spread out over several years in the profit and loss statement (see section ‘Deprecation’ below) and therefore do not show up all at once in the year of purchase. This means they have a less visible reducing impact on profits. Be aware that the rules for categorizing expenses as assets are quite strict though!

6. Financing

The final potential input sheet of a startup’s financial model could be a financing module. In this sheet you would add financing streams such as equity, loans or subsidies. The main goal of this would be to check the impact on your funding need when you add different types of funding in different years of the model.

When a model includes the possibility to input loans, it needs to account for the loan repayment and interest payments, as these have an impact on cash flows. Below you can find a simple example of a €100,000 loan with a duration of 10 years and an interest rate of 10%.

Loan input and repayment scheme example in Excel (source: EY, 2018)

The six different input sheets that are discussed above are all in some way linked to the outputs of the financial model. For the financial statements specifically the links are as follows:

• Revenues impact the top line of the profit and loss statement. In the P&L you deduct all costs, expenses and depreciation from the revenues to arrive at EBIT (earnings before interest and taxes). EBIT serves as input for the operational cash flow in the cash flow statement. If you deduct interest and taxes (see section ‘Taxes’ below) from EBIT, you arrive at the net profit. Revenues even impact the balance sheet as they define the accounts receivable position.
• Cost of goods sold also turns up in the profit and loss statement. Deducting them from the revenues results in the gross margin. The gross margin can also be presented as a percentage: the higher this percentage is, the more revenue is left for covering costs that are not directly related to production. Cost of goods sold also impacts the balance sheet as they define accounts payable and inventory.
• Operating expenses show up in the profit and loss statement as well. Deducting operating expenses and cost of goods sold from the revenues results in EBITDA (earnings before interest, taxes, depreciation and amortization).
• Personnel either shows up in the profit and loss statement as a separate line or it is included in the cost of goods sold or operating expenses. Personnel involved in delivering services or producing goods end up in cost of goods sold. All other personnel is part of operating expenses.
• Investments in assets (capital expenditures) do not show up in the profit and loss statement because, accounting-wise, they are not seen as costs or expenses. They are investments and can be capitalized, meaning a company can leverage their value for several years. Therefore, they show up as something a company owns in the assets side of the balance sheet. Their value is depreciated (reduced in value) over their lifetime which is shown as depreciation in the profit and loss statement. Even though investments do not show up as a cost or expense, investing in something does mean there is a cash outflow for your company (you have to pay, right?). Therefore investments also show up in the cash flow statement as investment cash flow.
• Financing impacts the financial statements in two ways. Firstly, new financing and changes in debt shows up in the cash flow statement as financing cash flow. Secondly, interest paid on debts end up in the profit and loss statement.

The financial statements themselves are also interrelated (see image below). For that reason it could be wise to have an experienced person supporting you building your model if you do not have this experience yourself, especially if you are looking for a more complex model including supporting schemes such as the ones mentioned in the next section.

Interdependencies in the financial statements (source: EY, 2018)

If you do not want to worry about all the calculations and the interdependencies in a financial model, you could try out our financial planning software for startups, which does all the thinking for you.

Other supporting elements of a startup’s financial model

What other elements are essential for your financial model?

As you might have noticed already, some of the elements mentioned above include some tweaking of the numbers before you get to the right information that is presented in the financial statements. Supporting schemes such as working capital, depreciation and taxes might be needed.

Moreover, when you build a financial model you automatically structure a whole lot of data which you can also use for other purposes, such as a company valuation. Therefore, below we present four elements that support a startup’s financial model.

1. Working capital

Working capital is the capital that you need in order to sustain your daily operations. Technically speaking working capital is a comparison of the value of your current assets compared to your current liabilities.

In other words: the value of the things your company owns and that can be converted to cash on the short term (in less than one year) compared to the value of the things your company owes to others that are due on the short term (less than one year as well). Current assets include cash, accounts receivable and inventory. Current liabilities for instance include accounts payable.

Working capital is extremely important for startups, because it is a measure of both a company's efficiency and its short-term financial health. Working capital can significantly affect cash flow, so if a company's current assets do not exceed its current liabilities, then it may run into trouble paying back creditors in the short term. The worst-case scenario is bankruptcy.

Working capital can be impacted by payment terms. In order to assess your working capital position you should therefore not only steer your company based on revenue targets, but also on your cash flows. Forecasting for cash flow provides you with an overview of the timing of incoming and outgoing cash flows. How to do this is discussed in section ‘Operational cash flow overview’.

Why is this important? Well, when you focus only on costs and revenues and not on the timing of receiving and sending payments you could end up in serious trouble.

Consider that a large firm orders one hundred 3D printers at a startup producing a new type of 3D printers. The client expects the printers to be delivered within one month. As large firms often use long payment terms it might take up to 90 days before the startup receives the actual payment for the order.

This means that our 3D printer startup needs to finance the raw materials and production process itself. After all, the company has to deliver within 30 days, but still has to wait for 90 days before the payment is received.

If the funds required for production are not available for the startup then the order might be cancelled leaving both parties unsatisfied. If this happens consistently, the startup could go bankrupt even though orders are coming in.

Working capital is calculated based on the number of days your sales and payables are outstanding and the number of days you hold inventory before selling it. It shows up in the balance sheet. Therefore, a financial model might need a separate scheme that calculates working capital based on revenues, cost of goods sold and days outstanding.

See for instance the example of the calculation of accounts receivable below. With revenues being €100,000 in year one and payment terms of 15 days for outgoing invoices the accounts receivable position at the end of the year is €4,110.

Accounts receivable calculation example in Excel (source: EY, 2018)

2. depreciation.

Deprecation indicates the value reduction of assets a company owns. Based on the value of an asset and its useful lifetime depreciation is calculated. Depreciation is part of the profit and loss statement and impacts the value of assets on your balance sheet.

As an example, let’s say you want to buy some computers for your company. They cost you €20,000 and you can use them for four years. This means you will write off the total investment of €20,000 over a period of four years, which means you will depreciate their value with €5,000 every year for the coming four years (if they do not have any residual value left after that).

 A financial model needs a separate scheme that calculates depreciation based on investments and their related useful lifetime. Below you can find an example calculation of depreciation.

As you can see, in year one €20,000 was invested in computers, software and equipment and in year two €30,000. Both are depreciated over four years, resulting in the total depreciation per year; being €5,000 for year one, €12,500 for year 2-4 and €7.500 for year five.

Depreciation calculation example in Excel (source: EY, 2018)

Every company that is incorporated and registered at the Chamber of Commerce has to pay yearly taxes over its financial results: the corporate income tax. Taxes are deducted from your results in the profit and loss statement. Here you can find a list of corporate income tax rates per country.

If you want to include tax carryforwards in your financial model, you likely need a separate tax scheme as part of your model. A tax carryforward works as follows. As an entrepreneur it is likely that you have negative results in the first couple of years of operations. If you have negative results this basically means you have expenses that exceed revenues (more costs than income) leading to an operating loss. If you have a loss, there is obviously no income to be taxed by the tax authorities. This loss can be leveraged in future tax reporting periods to offset taxable income (you can ‘carry it forward’), which reduce the amount of tax you will pay in that specific tax reporting period.

Below you can find an example of a tax carryforward calculation based on a corporate income tax rate of 23%. As you will notice, year one had a negative result of -€50,000 which is settled with the positive result of €230,589 for year two resulting in a taxable profit of €180,589, resulting in a lower tax burden for that year.

Tax carryforward calculation example in Excel (source: EY, 2018)

4. valuation.

Many startups build a financial model for the purpose of raising funding. Part of the fundraising process are negotiations with an investor about the valuation of the company to be invested in. The good news is that when you have built a financial model for your company, all the ingredients are there to perform a valuation on your company as well by means of the discounted cash flow (DCF) method.

The main advantage of the discounted cash flow method is that it values a firm on the basis of future performance. This is perfect for a startup that might not have realized any historical performance yet, but expects large future earnings. During the (pre-)seed stage it is not uncommon for startups to not generate any revenues at all yet, while discussions with investors regarding ownership percentages and the accompanying valuation already take place. The discounted cash flow method is very suitable in that case, as it weighs future performance more than current performance.

The main downside of the DCF method when valuing startups is that the DCF is nothing more than a formula, a mathematical operation. This means that the quality of the valuation is extremely sensitive to the input variables of the formulas used to calculate the valuation. Moreover, it largely depends on your ability to create an accurate forecast of your firm’s future performance. After all, the future earnings are the foundation of the valuation.

A deep dive into discounted cash flow valuation is out of scope for this article. The main steps of performing a discounted cash flow valuation are presented below, but we have also written a deep dive into startup valuation:

• Step 1: create financial projections for your firm (tick in the box!).
• Step 2: determine the projected free cash flows.
• Step 3: determine the discount factor.
• Step 4: calculate the net present value of your free cash flows and terminal value by using the discount factor.
• Step 5: sum up all results of step 4.

Below you can find an example of a discounted cash flow valuation.

DCF valuation example in Excel (source: EY, 2018)

Depending on the desired outcomes and the corresponding complexity of your financial model you can decide whether or not to add additional schemes such as working capital, depreciation and tax carryforwards. You can look for a financial model template including these elements on the web. If you do not want to worry about these elements at all, our financial planning software for startups does all the calculations for you.

Scenarios and sanity checks

We have taken a look at all the different elements of a startup’s financial model. That means we are done! Right…? Not quite yet! For the pros there are some additional steps to take.

Firstly, it could be worth it to spend some time creating different versions (called scenarios) of your financial model. Entrepreneurs tend to be optimistic people, which is a good characteristic to have to keep up the energy and push through where others might quit.

Unfortunately, in many cases, the life of an entrepreneur tends to be a bit more disappointing in practice than it is on paper (at least from a financial perspective, don’t get too depressed now). Therefore, next to your default financial plan (called your ‘base case scenario’) you might want to prepare a scenario which is a bit less optimistic (your ‘worst case scenario’).

What if you launch six months later? What if sales do not ramp up as expected? What if your costs turn out to be double of what you expected? Answering such questions helps you anticipate how your cash flow, profitability and funding need are impacted in a less optimistic scenario.

Do not forget to create a ‘best case’ scenario as well. Why? You can give potential investors a sneak preview of the upside potential of your company and most importantly: it is fun to see the financial impact of aiming for the moon!

Secondly, it might be wise to perform some sanity check on your financial model to make sure you avoid common pitfalls in the financial models of startups. You can find ten common errors below:

• A mismatch between the financial model and the business plan: a financial model should resonate with the overall business strategy
• Overoptimistic or very pessimistic revenue projections: check out section ‘Revenues’ on how to forecast sales
• A funding need that is not adequately explained: make sure you include a breakdown of costs
• Underlying assumptions that are not clearly defined: you should be able to provide clarification or proof to the numbers
• Not enough employees as part of the personnel forecast: do not underestimate the number (and costs) of employees you need to build a fast-growing company
• Revenue projections which are not aligned with the market size: by definition revenues cannot be larger than the size of the market
• Operational expenses that are being left out: make sure expenses are aligned to your strategy
• Operational expenses which are misaligned with the forecasted revenues: make sure expenses resonate with revenues
• No realistic view of the gross, EBITDA and net margins: when speaking with investors, always be prepared to answer questions on your current and expected margins
• Disregarding the importance of working capital: do not underestimate the effect of payment terms on your funding need

How to raise money for your startup?

Many startups create a financial model because they are looking to raise external funding. Whether you are applying for a loan at a bank, trying to convince an investor of the potential of your firm or are applying for a subsidy or grant; in most if not all cases you will need to provide your counterparty with a financial plan.

There are different ways of raising money for your startup and these can be categorized into two main categories.

Financing via debt: an example of financing via debt can be a loan which you receive from a bank, a business or an individual where you agree on specific terms regarding payback and interest. For startups it can be difficult to receive a loan from a bank as they often do not meet the minimum criteria in terms of revenue generation and offering collateral.

Some advantages of using debt are as follows:

• The control of your company remains with you and your current shareholders.
• Interest on debt can be deducted from your tax.
• Debt often has a disciplining effect on a management team, as the resulting cash flows are limited so the management will be encouraged to be more efficient and create value.

Financing via equity: an example of financing via equity is funding you would raise from an angel investor or a VC in return for shares of your startup. For startups, financing via equity is more common than debt financing, because receiving a loan can be difficult (banks are in general more risk averse).

Equity investors take more risk by investing money in a company in exchange for shares, meaning they could lose it all. Since an equity investor becomes a shareholder when he/she invests in your company you will (partly) lose control of the firm. Moreover, you will need to share your profits with your new shareholders and sometimes they might want to be actively involved in the management of your company as well.

Of course there are other ways to fund your startup, such as crowdfunding, convertible notes and subsidies. If you want to learn about even more types of funding, we have listed 12 sources of finance for entrepreneurs . Make sure you pick the right one!

Why you should always engage in financial modeling as a startup

There are different reasons why to engage in financial modeling as a startup. You might need a financial model to build an economically viable business, to be better prepared for the future, to communicate your company’s performance to potential shareholders or new investors, or to set targets for your company you can work towards.

The two main approaches towards financial modeling are the top down method (leveraging market size data to build a forecast for your company) and the bottom up approach (using internal company specific data such as sales data or data on the internal capacity).

It could be useful to combine both methods as it allows you to substantiate short term targets on a detailed level and it allows you to demonstrate the long term desired market share and the ambition an investor is looking for. No matter what approach is used, a forecast stands or falls based on its underlying assumptions.

Typically, the outputs of a startup’s financial model consist of a three to five (sometimes 10) year forecast of the financial statements on a yearly basis (profit and loss statement, balance sheet, cash flow statement), an operational cash flow overview for the coming 12 months ahead, and an overview of the company or sector specific key performance indicators (KPIs).

These outputs are the results of the calculations taking place in the background of a financial model, based on the data entered into different input pages of the financial model. These input pages consist of, for instance, forecasts of: revenues, cost of goods sold, operating expenses, personnel, investments in assets (capital expenditures) and financing.

For some of the outputs supporting calculations and schemes are required. These include, for example, working capital, depreciation and taxes. Using the data that is typically part of a financial model you are also able of creating a valuation of your startup using the discounted cash flow method.

It can be worthwhile to create several scenarios of a financial model (worst vs. base vs. best case) and to check for common pitfalls in financial modeling for startups. Creating multiple scenarios and performing sanity checks helps you get closer to a realistic case, instead of presenting an overly optimistic or an unattractive case.

Having a financial model can help in the fundraising process, as external financers typically require you to provide a forecast. This makes sense, considering the fact you are asking them to put their money in your company.

There are different sources of funding, the main ones being debt and equity financing. However, more and more sources of funding emerge, such as: convertible notes, crowdfunding, initial coin offerings and, of course, subsidies and grants.

If you have made it all the way to the end of this article: well done! With the information we have shared you are well equipped to start forecasting, maybe even build your own financial model and make sense out of the metrics and data that are presented by your model.

As mentioned earlier there are tons of financial model templates for startups to be found on the web. If you need more support, feel free to reach out to us here!

Financial modeling is an important topic especially when you founded your own company. We have written everything you need to know and all the best practices available around financial modeling for starting businesses. If you need help, reach out for us here .

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A Guide to Financial Projections For Startups

• Written by Lyle Del Vecchio
• 19 min read

Starting out in business can be tough. Entrepreneurs, whether they’re freelancers, micro-business owners, or sole proprietors, have a rough road to travel if they plan to survive long enough to grow. In addition to having a solid business plan and an understanding of the market for the goods and services you plan to sell, it’s critical to master the financial ins and outs of doing business. And for small businesses—especially new business startups in need of funding—one of the most important financial tasks to master is financial projections .

They might sound daunting, particularly if you’ve never prepped a balance sheet or wooed potential investors. But financial projections for startups are easier to handle than you might think, provided you have the right approach, tools, and mindset.

What Are Financial Projections?

As they strive for profit and fight to ensure they have the capital they need to cover their expenses, businesses need a roadmap for navigating the future. Financial projections are part of that roadmap, because they are, in essence, a forecast of future expenses and revenue.

This forecast helps you craft a spending strategy, cash flow management approach, strategic sourcing, and investment planning for growth, innovation, etc.

It also shows potential creditors and investors how your company is likely to perform, so ensuring it’s accurate and complete is crucial to securing external funding.

You can think of financial projections as a kind of budget. They’re essential to creating a business plan for a new business or, for established businesses, building a new strategic plan to improve the financial performance and health of your company.

Financial projections come in two varieties:

Short-term projections generally cover a year, broken out by month.

Long-term projections generally cover a period of three to five years and are most useful in strategic planning or providing long-range financial performance data for potential investors.

Whether you’re securing additional funding, pivoting your business toward new markets, or taking your first steps toward entrepreneurship, the primary purpose of financial projections is to secure funding, credit, or a loan. Financial projections are commonly used in:

• Business plans.
• Financial performance projections for potential investors.
• Loan or line of credit applications.
• Internal process optimization (e.g., revamping your budgeting process).

Established businesses with a rich trove of historical performance and spend data to fall back on generally use this data as a guideline when drafting their financial projections. It’s a trickier prospect for startups, particularly small businesses, because they don’t have any spend or performance data yet.

In-depth research, a clear understanding of their target market and products, and a well-developed and considered business model help entrepreneurs craft financial projections for their startups that lead to funding and investment vital to starting, and maintaining, a successful business.

Your potential investors want to see you’re serious about your business, and have invested the time and research necessary to craft realistic financial projections for revenue growth, operating expenses, startup costs, etc.

Why Financial Projections Matter—Especially for Small Businesses

Today’s interconnected, always-on global economy has made entrepreneurship more attractive than perhaps any other period of time in history. The United States alone has nearly 32 million small businesses , selling everything from software to candy to custom bowling shirts.

Knowing you’ll be in such diverse and ambitious company might make the idea of a startup even more compelling. But the U.S. Small Business Administration (SBA) reports that around 20% of small businesses fail within their first year . After five years, that number climbs to nearly 50%. And only about a third of small businesses survive long enough to celebrate a decade.

And while, yes, external factors such as the COVID-19 pandemic have made life tough for both new and existing businesses, the hard truth is that most startups are planning to fail by failing to plan.

In studying 20 reasons why small business startups fail , research firm CBInsights found starting a business whose offerings didn’t have an established or potential demand contributed to collapse in 42% of failed businesses. Cash flow problems helped kill just under 30% of startups, 18% had pricing and cost issues, and 17% were effectively flying by the seat of their figurative pants by selling products without a business model.

Failing to do your homework (so to speak) can kill your startup before it can really get its feet underneath it. That’s why business-critical tasks like accurate and complete financial projections are so important to startups in particular. Your potential investors want to see you’re serious about your business, and have invested the time and research necessary to craft realistic financial projections for revenue growth, operating expenses, startup costs, etc.

Essential Components of Effective Startup Financial Projections

Most financial models fall into one of two categories:

• Top-down financial modeling , which starts at the macro level and uses marketing, industry, and other external data as a starting point for building financial projections
• Bottom-up financial modeling , which starts at the micro level (company specific) and then builds up to create financial projections.

The top-down approach is generally better than the bottom-up model for startups because they are in the early stages of existence and most often do not have the trove of existing data required for the latter.

All that said, financial forecasting doesn’t have to be terribly complex. To prepare financial projections, all you need is an income statement, cash flow statement, and balance sheet. These are the “big three” documents directly related to financial performance and essential to the preparation of accurate and complete financial projections.

• Expenses (both variable costs and fixed costs within direct and indirect spend).
• Earnings before interest, taxes, depreciation, and amortization ( EBITDA )
• Income taxes.
• Net income (total income after cost of goods sold (COGS), taxes, etc.)
• Operational cash flow (changes in cash flow affected by essential business operations, i.e. revenue and expenses).
• Investment cash flow (changes caused by investment in equipment and other assets, e.g. inflow from selling assets and outflow from purchasing assets. The latter is more common in startups).
• Financial cash flow (changes caused by fundraising and/or financing activities, e.g. loans for inflow and interest payments for outflow).
• The balance sheet contains all company assets and liabilities. It provides a useful point of comparison with the income statement, given the different timeframes on which these two documents operate (i.e., ownership of assets and liabilities likely extends beyond the financial period recorded on an income statement). The balance sheet establishes a company’s assets as the sum of its liabilities and shareholder’s equity (where said equity is the net value of the company, or the amount distributed to shareholders after the company is liquidated and has paid its debts.)

How to Prepare Realistic Financial Projections

If you’re starting a new business, you most likely don’t have your financial statements at hand, and so you’ll need to create them—ideally as part of a business plan. You can build them from any number of existing templates; the Service Corps of Retired Executives (SCORE), for example, has a free, comprehensive financial projections toolkit on its website.

In doing so, remember your numbers must be not only accurate and complete, but sustainable . That’s part of why financial planning requires you to “do your homework” and sometimes meticulous research to ensure you know how (for example) a typical business in your industry performs.

If you’re at the starting point and don’t have historical data available, be sure to tap resources such as your local SBA office , SCORE group, market research firms, or industry-specific organizations to get the information you need to develop realistic (but still optimistic!) projections.

Over time, as you accumulate historical data, you can leverage it to increase the accuracy of your projections and better secure funding while simultaneously identifying opportunities for further process improvement, innovation, or growth.

Let’s take a closer look at a five-step approach to developing your financial projections:

Step One: Sales Forecast

Startup businesses without access to historical data can examine healthy businesses in their industry to identify average revenue projections, as well as seasonal trends, potential issues created by upcoming industry or economic changes, etc.  

Step Two: Expenses Projection

Anticipating expenses can be challenging for startups, particularly since it’s next to impossible to predict potentially catastrophic costs from a worst-case scenario (e.g., natural disasters, force majeure, etc.). As will sales, however, it’s useful to examine healthy competitors and use their numbers as a guide until you have time to accumulate your own data.

Step Three: Balance Sheet Projection

Your balance sheet’s accuracy will rely on the accuracy of your sales and expenses projections, so make sure you’ve

Step Four: Income Statement Projection

Another projection that will most likely benefit from some in-depth marketing and industry research, the income statement projection is especially important for estimating long-term EBITDA and providing potential investors with evidence you’ve done your “homework” with regard to financial performance. Given that 73% of small businesses seek some form of financing, it quite literally pays to do so.  

Step Five: Cash Flow Projection

In-depth research and a close look at healthy businesses in your industry will help you get a grip on cash flow projections and help manage burn rate with optimal efficiency.

Best Practices for Effective Financial Modeling

No two businesses are the same, but you can improve your chances for comprehensive, accurate, and investor-friendly financial projections by following a few basic best practices.

• Create multiple financial models, including your best case scenario, a middle-of-the-road scenario, and a scorched earth, worst case scenario. Doing so will provide invaluable perspective and may also reveal opportunities to adjust your business plan to better meet both your own goals and the realities of the marketplace.
• Research, a solid business plan, and a willingness to temper your optimism with realism are non-optional when starting a business. Make sure your financial forecast is well-researched and aligns with your business plan. Refine it as many times as necessary to enhance sustainability.
• The first step to being great at something is being an absolute novice. Don’t be afraid or ashamed to take advantage of the powerful resources offered to startup businesses by government agencies, industry organizations, etc. Embrace mentorship so you can avoid the mistakes of those who’ve already traveled the path you’re about to travel—or at least make the same mistakes in interesting new ways!

Craft Better Projections and Reduce Your Burn Rate with Procure-to-Pay Software

Whether you’re starting a brand new business or have a trove of historical data you want to use to improve your business planning and process optimization, you can improve your financial projections through the use of procure-to-pay software like Planergy.

Why? Because you’ll gain full control over all your data, along with complete data transparency. Starting with complete and accurate data improves all your financial reporting and forecasting. Mobile-friendly, role-appropriate access to data means it’s easier to create financial projections on demand to meet changing market, industry, or economic conditions, whether you’re at the office or in a pitch meeting.

For startups, you can easily incorporate data from multiple sources into your database and create optimal financial projections using the powerful built-in data analysis tools. Create multiple financial models, from the aggressively optimistic to the dreaded worse-case scenario, and then fine-tune your projections based on your own research and current market conditions.

Starting with the best possible projections helps you attract the right kind of investors, secure funding when you need it most, and develop a cash flow management plan that keeps burn rate in check so you and your investors can rest easier even in an uncertain economy.

Accurate and Credible Financial Projections Pave the Way for Business Success

Starting a small business can be hard enough without struggling for capital you need to survive. With a proactive approach and by choosing the right procure-to-pay software platform, you can ensure your financial projections are credible, accurate, and readily accessible. With all the information they need at hand, creditors and investors will readily understand your commitment to success—and take a much keener interest in sharing it.

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