Financial Forecasting for Startups: A Step-by-Step Guide
Creating a financial plan for your startup can be quite tricky. Without previous data (experience figures) and with numerous uncertainties, it is often a leap of faith. While every business segment and type of company requires its own approach, there are general guidelines. In this article, I’ll give you the basics. Once you have those in place, you can always add sector-specific data. And don’t worry, you don’t have to be a maths prodigy or Einstein to follow the steps. 🙂
Table of Contents
STEP 1: Who are you writing your financial plan for?
As an entrepreneur, especially if you have a startup, it is essential to know who you are writing your financial plan, also known as a ‘forecast’, for. Banks sometimes prefer a specific format, while investors often don’t want to get bogged down in the details during a first meeting.
This step-by-step plan focuses on a financial plan that you draw up primarily for yourself. After all, at the end of the day, you first want to find out for yourself whether your ideas can be profitable and what investments might be involved.
STEP 2: Calculating your turnover and margin
Nobody has a crystal ball with which to look into the future. This is why almost all financial forecasts – and certainly those of a startup – are based on assumptions. The easiest way to start is with assumptions you can make in terms of your turnover.
Below are some methodologies and scenarios with questions you can use, but they may not all apply to your startup.
Calculate revenue and margin based on the conversion methodology
This method is often used in e-commerce, but you can also use it for traditional shop visits. It starts by estimating the expected number of visitors to the website (or shop) per month. On the day your site goes live, these will probably be very few, but you can grow the number of visitors by:
- Using SEO
- Online Advertising (SEA)
- Building brand awareness
- Email marketing
- Partnerships with other sites
- A PR campaign
- Traditional advertising campaigns
Indicate per month over a 2-year period how many site visitors you expect to get based on your activities. To get a feel for this, you could ask industry peers how many visitors they have, how they got them, and how long it took them to do so.
The average conversion rate of a well-built e-commerce site is around 1.5% of all visitors. In other words, if you get 100 visitors a month to your site, 1.5 purchases will be made.
The next step is to estimate the number of products or services per purchase. Within retail, an average of 1.4 products are bought per purchase. But within other industries, this can be many times higher.
Now that you know how many purchases are made per month and you know how many products or services are paid for per purchase, you can multiply this by the average price per product or service to work out your total turnover per month. Suppose you have 10 products worth 50 euros and 10 products worth 100 euros, your average selling price will be 75 euros. Provided you expect to sell the same number of each product.
Then you estimate the average cost price per purchase in percentage. You can then calculate the total cost price for that month and know what your gross margin per month is.
As an example, the following calculation comes out of this:
|Month 1||Month 2||Month 3||Month 4|
|Site visitors per month||100||150||250||500|
|Purchases per month||1.5||2.25||3.75||7.5|
|Number of products per purchase||1.4||1.4||1.4||1.4|
|Total number of products sold||2.1||3.15||5.25||10.5|
|Average selling price per product||€75.00||€75.00||€75.00||€75.00|
|Average cost per product||30%||30%||30%||30%|
|Total cost price||€47.25||€70.88||€118.13||€236.25|
|Gross margin per month||€110.25||€165.38||€275.63||€551.25|
Pro-tip: You could consider adding another variable where you include in your calculation what percentage of customers will make a repeat purchase. But since you’ve already included growth in the number of site visitors, you could also omit this and state that repeat customers are included in that growth.
Calculate revenue and margin based on acquisition
If you are going to provide a product or service that is not easy to sell online, you will have to do acquisition. Think, for example, of offering advice or bulk delivery to other businesses.
This method is similar to the conversion method but slightly different. In the acquisition method, you first estimate how many potential customers you think you can visit or reach per month via Direct E-mail Marketing, for example.
Suppose you can make 3 appointments a day and do acquisition 4 days a week. Then you visit roughly 48 customers per month. If you then estimate what percentage of these customers will proceed to purchase, you can make the following calculation:
|Month 1||Month 2||Month 3||Month 4|
|Amount of sales appointments||48||48||48||48|
|Purchases per month||0.72||0.72||0.72||0.72|
|Number of products per purchase||50||50||50||50|
|Total number of products sold||36||36||36||36|
|Average selling price per product||€75||€75||€75||€75|
|Average cost per product||30%||30%||30%||30%|
|Total cost price||€810||€810||€810||€810|
|Gross margin per month||€1,890||€1,890||€1,890||€1,890|
Pro-tip: The model above does not take into account repeat purchases. For example, if you sell expensive garden furniture or coffee machines, this is not necessary because you only buy them once every so many years. However, if you sell coffee beans, it is important to add this.
Calculating turnover and margin based on commissions
An increasingly popular way to earn is to charge commissions on sales. You do not buy anything but agree on a commission on all the sales you generate.
The influence of seasons
Once your revenue model is in place, in some cases it may be necessary to add the influence of seasons. Seasons can affect your sales and margin in three ways.
- Less or more sales are made in certain months. This can involve both more customers and more purchases per customer.
- There are (many) discounted sales in certain months.
- A combination of the above.
The easiest way to process this is to enter the basic numbers first and then manually change the percentages and numbers. For the Excel gurus among us, you can also automate this so that you only need to adjust a few parameters, but that’s not necessary.
STEP 3: Calculating your costs
Depending on the nature of your business, you will have certain costs that are very specific, but some costs are common to every business. These include:
- Wages and/or management fee(s)
- Rent or mortgage
- Marketing costs
- Office costs
- ICT costs
- Administration costs
- Bank costs
- Travel and transport costs
- Representation costs
- Insurance costs
- General/unexpected costs
- Depreciation costs
There are also costs that not every company incurs but are common. These include:
- Renovation costs
- Licensing costs
- Training costs
- Stock costs
Forecast salary and/or management fee(s)
While you can’t pay out in wages or management fee(s) that you don’t have, it is still wise to enter a realistic amount initially. The question, of course, is what is realistic.
When you write a financial plan for an investor, they want you to fill in an amount you can live on and what you really need. This is because they realize that if you underpay yourself you will eventually run into trouble. As for employees, this is the same. You can make a plan where you hire and thus pay fewer employees and start doing everything yourself, but in the long run, this will also cause problems.
When writing a financial forecast for yourself, it is wise to think like investors. Be realistic and only later see what may or may not be left at the bottom of the line. You can always decide later to pay yourself less in management fee(s) – temporarily – after all or pay out the amount at a later date.
You enter wages and management fee(s) per month, including tax and company allowances. This varies by country and sometimes by industry and can be found online.
Forecast rent or mortgage
Even if you start from home in an attic room, it is still wise to include an amount per month for rent, mortgage, gas, water, electricity, and maintenance. Rents are easy to find online and remember that it is very common to pay no rent for the first 2 or 3 months if you are renting premises for a longer term.
Forecast marketing costs
As with many startups, costs usually come before benefits. Especially when it comes to marketing. You sometimes can’t avoid investing heavily in advertising first to build brand awareness. But how do you know how much to spend?
What makes it a little easier to estimate this is by dividing the marketing costs into 3 types of budget.
Initial marketing costs
This involves costs such as facade advertising, trade printing, and car stickers, for example.
Marketing expenses based on turnover
A safe way not to overspend is to reserve part of your margin for marketing purposes. Some companies use 1 to 2 percent of their total turnover and spend that on marketing and promotion
Occasional marketing expenditure
Whether you want to do a big marketing campaign once or hang a sign along the field of the local football club, these are all incidental expenses.
If you are not yet making sales and believe you need to do a lot of promotion first to make initial sales, it is wise to test whether your idea can catch on first. Not with your close friends and acquaintances, but with complete strangers. Can you sell your product or service in a 1-to-1 conversation and actually get paid for it? in this case, initial marketing expenditure may be worth considering. If not, you are taking a lot of risk.
Forecast office expenses
Every entrepreneur needs a desk, a pen, a stapler, folders, or a notepad. All these expenses fall under office expenses. These costs too can be divided into initial expenses and ongoing expenses. You only buy a desk once every few years and for pens, folders, and notepads, for instance, it is best to reserve a small amount per month.
Forecast ICT costs
Everything electronic falls under ICT costs. This includes, for example, your laptop, keyboard, (3d) printer, cables, electronic cash register, site hosting costs, etc. Telephone costs used to be a separate heading, but these days it usually falls under ICT costs.
If you need expensive machinery or like, say, a carpenter various tools, it does not fall under ICT, but under a separate heading ‘Inventory’ or ‘Machinery’.
Forecast administration costs
One of the simplest costs to forecast is your administration costs. But make an appointment with an accounting firm, ask for the estimated cost and you’re done.
Forecast bank costs
Every bank charges fees for using an account. But if you take out a loan, they will charge interest for it. In that case, rename the heading to “Bank charges and interest” and enter the sum of both amounts.
Forecast travel, and transport costs
Travel and transport costs include all costs related to travel. From the purchase (or lease) of your car or bike to a bus ticket and airline tickets. O
Forecast representation expenses
If you are an entrepreneur, you want to look good in a suit and maybe go out to dinner with a client once in a while. That kind of expense is called representation expense. It is actually a kind of marketing, but in person.
Forecast insurance costs
You can insure yourself for all sorts of things but read the small print carefully because, from my own experience, I know that very often no payment is made in case of damage. When it comes to insurance, think mainly about basic insurance for burglary and theft, for instance, and travel insurance if you have to be abroad a lot.
Forecast general expenses/unforeseen
As in your personal life, unforeseen costs will always come your way. That’s why it’s standard to include a small amount per month in your forecast that you can use to pay for those costs.
Forecast depreciation costs
Depreciation costs are last because they are the only outcome of the investment in inventory and ICT. By country, the rules are different, but ICT equipment you write off in 2 years and office furniture in 5 to 7 years.
This means you divide the total investment in ICT by 24 months and include the outcome per month in your forecast. You do the same with your office furniture, but divide it by 60 or 84 months.
Forecast renovation costs
If you need to renovate an office space or factory hall before you can start, divide the costs over the months in which the renovation takes place.
Sometimes you can agree with the landlord that he will bear the costs and include this in the rent. If you pay all the costs yourself, you should also include that amount in the depreciation costs.
Forecast licence costs
If you use specific software that you have to pay for every month, you call it license fees.
Forecast training costs
All costs for training, in-service training, and the cost of a mentor or coach are included in training costs.
Forecast stock costs
If you have (a lot of) stock, it is important to know how long you think it will be in your warehouse (or shop) and whether there will be any depreciation during that period. Clothing that you don’t sell is worth much less than a year later. You can calculate that depreciation in that case by taking a percentage of your total stock value and including it as an expense.
STEP 4: Forecast your net profit or loss
You know your total gross margin and the sum of all costs per month is your total expenses. Subtract the total costs from your total gross margin and you have your net profit or loss.
STEP 5: Fine-tuning & worse case / good case scenario
Only now does the real work actually start. Of course, you want to make a profit from day 1, but rarely is this possible. So be honest with yourself and don’t start calculating yourself rich.
What many people do is duplicate the basic sheet created by the above twice. You call one sheet ‘Good Case Scenario’ and the other ‘Worse Case Scenario’.
The names say it all because in both sheets you manually adjust the figures based on what could possibly happen. So you come up with setbacks for the ‘Worse Case’ sheet and windfalls for the ‘Good Case’ sheet, as it were.
Keep the windfall and setbacks realistic, though. This is not about earthquakes, war, and floods. It’s more about things like a big new client that you don’t expect or a client suddenly quitting.
Is your startup still viable if you first make a loss
To know whether your startup is still viable if, say, you make a loss in the first 12 months depends on three things:
- Do you have enough startup capital to cover those 12 months
- Do you have an investor or can you take out a loan to bridge those 12 months?
- Do you have to pay the investment immediately or can you agree on a longer payment period?
Generally, it is quite normal for your startup to make a loss at first and that doesn’t have to be a bad thing, as long as you are profitable in the future. Of course, if you add up all the losses per month and profits per month over the 2 years you have projected, the number should be positive. Otherwise, you work very hard for 2 years and have only accumulated debt.
Outsource your startup forecasting or do it yourself?
As a startup entrepreneur, you really don’t need to be an expert in everything, but being able to draw up a financial forecast is really one of the core tasks of a founder. You need to be able to do this to get and keep a feel for the business.
Financial forecasts, like describing your purpose, are a method of knowing whether you are not only doing things right but also whether the things you are doing are right for the business. They are necessary tools to make timely adjustments.
KPIs for a startup
Key Performance Indicators (KPIs) represent a few essential metrics you want to steer on. They are the goals you define yourself that you absolutely want, but also have to achieve to ensure the continuity of your business.
A KPI could be a turnover to be achieved, the number of customers, or the progress of a certain product development. It doesn’t matter so much whether you make 50 euros or 75 euros a month in overheads, but a 1% conversion or a 1.5% conversion can mean the difference between success or failure. Therefore, it is wise to choose about 3 KPIs that you steer by.