Don’t focus on financial forecasts, focus on business dynamics
Last week I wrote about business plans and planning. If you read the post you know that I am no big fan of business plans but think planning is important. One essential part for planning is to understand your business dynamics. These differ largely depending on industry, type of business and stage/maturation.
In many pitch decks the only “business dynamics” that can be found are the most obvious ones in the “financial section”. Entrepreneurs tend to write a table or build a fancy graph with their financial forecasts. Usually that includes revenue, costs, EBIT etc.
Interestingly these forecasts are often displayed in a very accurate way e.g. “in 2016 we will have a revenue of 7.025.231 €”. That obviously is a lot of crap. No entrepreneur actually knows what their sales will be. Not even for the next month (unless they are 0 €). Please stop pretending.
The truth is, forecasts are a lot of guess work based on assumptions. Most often these assumptions are based on an idealized world. Have you noticed that financial forecasts go nothing but up? That’s certainly not what is happening in the real world.
The problem is that these seemingly exact figures give a false sense of security. They are often build using elaborate Excel models. After a while of fine-tuning your model, you start thinking: “Yeah I got it now, this is what it’s going to be like”. I know what I am talking about. I have been there too many times.
Also building these models can be a lot of fun and it is easy to get caught up in fine-tuning it. The more you fine-tune, the more it will reflect the real world, right? Maybe. Maybe not. Quite frankly, it doesn’t matter if you are a bit more accurate about your revenue in 2016. Why? Because you will most probably be doing something different then. Yes, you will pivot. Most (if not all) young startups do.
That means: In 2016 you probably won’t be earning your money with what you think you will be earning it. There are just too many factors you cannot influence nor predict. You cannot model the real world!
What is important at an early stage is to know your business model and the business dynamics that drive it. It is e.g. important to understand what drives revenue/cost. In the early stage most of the time it is all about understanding who your customer is and how you can reach her. Depending on your business, stage etc. example questions could be something like this:
- How do I get users?
- How much does it cost to get users (user acquisition costs)?
- How many users come back? What drives them to come back?
- How many users will pay for my service? How much revenue does a user bring?
- How many users will refer my service?
Hopefully you are measuring (most of) these dynamics. However, some answers you might have to estimate. That is okay. With your answers you build your model. Then you can use it to get insights about what drives revenue/cost etc. However, instead of looking at absolute numbers look at dependencies e.g.:
- If I increase my conversion rate by 1%, what would happen ro my revenue?
- If I reduce marketing spend, what would happen to profits?
- If I can keep customers longer, what would happen to referrals?
- If more people came through referrals how much more money could I spent on marketing?
This can give you a good sense about where to focus on next. After all, it doesn’t really matter if your model predicts 7, 15 or 20 million € in revenue in 3 years. What matters is to get from 0€ revenue to 1.000€ revenue and from there to 10.000€.
You aren’t there yet. Fantasizing about how much money you are going to make in 5 years doesn’t make you any money now. Building an elaborate model doesn’t get you new users.
Put away your forecasts and models and focus on making progress and getting traction.