🔮 Forecasting

What you'll learn:

• Which calculations answer the big question: “Is this business model viable?”

• The basics of forecasting an income statement to show how the business will perform.

• Build an income statement using a simple template.

All of this talk about assumptions is really leading toward one goal: creating a forecast for how the business might perform. By themselves, assumptions are just specific guesses as to how one aspect of the business might work, such as the cost to acquire a paying customer.

Forecasts are all the calculations that take that value and answer the big question “Is this business model viable?”

Why forecasting matters (even if we’re guessing)

Forecasting isn’t about being “right” about future numbers. It’s about figuring out what metrics we need to achieve to make our business profitable. It doesn’t matter if we think the product will sell for $30 or $300 – so long as we know how either value will affect the overall viability of the business.

So, let’s think about forecasting as a worksheet that we will modify a million times as we learn more about the business to figure out which aspects are working, and which needs help.

The process itself is incredibly cathartic, as it will force us to track down answers to things we may have overlooked, such as the cost of our product as we grow, the point at which we start needing to hire people, or how we’re going to actually pay to acquire all these new customers.

While these are certainly going to be guesses initially, what we’re focused on right now is how the values of those guesses impact our overall business model and profitability. All of these guesses (we call them Assumptions) are going to get plugged into the document that will soon rule our lives – the Income Statement.

WTF is an Income Statement?

Good question. An Income Statement is just a spreadsheet where we add up all of our income in one area and all of our expenses in another. We subtract income from expenses and are left with our profit (or loss) which we call Net Income.

World’s Most Basic Income Statement

Simple and easy right? As the business grows we can get into more complex models, but for now, we’re just going to keep it super simple.

How do we Forecast an Income Statement?

Long before we’re ready to start collecting money we'll likely set up forecasts for how our business will perform. Even if we’re already collecting money we’ll still need to constantly set forecasts for the future, so the exercise is the same. Our forecasts are just a method for us to populate the income statement with where we think the numbers might land.

In this phase, we’ll begin dropping those numbers into the spreadsheet one by one. We’ll walk through each of them to make it easy to understand. At first pass, this may look like a lot to digest, but remember, it’s just the same category of numbers repeated 12 times for each month.

The proper financial term for this is a Pro Forma Income Statement (something we may hear in our discussions with investors) which simply means “a forward-looking income statement” which simply means “we guessed at the values here.”

The income statement is the lifeblood of a company. Everything we do – from how we handle marketing, to who we recruit, to whether this idea really makes any sense – will map back to the income statement. We can pretend that “we’re killing it with our marketing!” but if the income statement says “we’re losing a ton of money every time we acquire a customer” – the truth is in the numbers!

Using the StitchCrew Income Statement Template

We've provided a specific Income Statement Template for us to walk through together.

The intention of this document is to blend a forecasting tool with a simple financial management tool without creating a lot of complexity. It’s possible that we might grow out of this tool in 6 months and need something more customized or complex.

It doesn’t matter if we use this specific template. What matters is that we understand the fundamentals of startup finance, so we can modify our approach to fit our own needs.

This is How We Do It

This is how we’re going to build an income statement.

• Step 1: Overview of all the Tabs. We’re going to zip through each of the tabs to explain what they mean and how they relate to each other.
  

• Step 2: Focus on Assumptions. We’ll start populating real numbers with our assumptions. The assumptions will frame most of what the rest of the income statement will show, like our revenue or key expenses. Over time the assumptions will be replaced with actual data.
  

• Step 3: Populate Fixed Items. Here we’ll fill in estimates for items that aren’t Dynamic or mission-critical to the business model. Since many of our assumptions will tell us things like how much revenue we might have, it will also provide some initial guidance on how much we can spend in certain categories in order to get to break even.
  

• Step 4: Finalize Projections. Once we have the first pass at all the numbers we’ll then begin the process of tweaking the numbers (assumptions, budgets, etc.) so that we can align the model with a break-even goal. This isn’t always possible, especially in Year 1, but it’s always a good place to start to figure out whether we’re heading in the right direction.

Right now, don’t worry too much about understanding all of this. Some of this stuff, like how to populate the fixed items or manage the assumptions will just come with time and practice. For the time being, we just need to make sure we cover the basics: where to track revenue and where to track costs.

Step 1: Overview of all the Tabs. Trying to provide one income statement to rule them all is damn near impossible, so instead, we’re trying to provide a version that will be useful to as many folks as possible, but also one that can be easily modified to fit our needs.

Here’s a quick summary of how each of the tabs work:

Overview. The “Overview” is our main dashboard that shows us how all the inputs on our Income Statement play out. It’s completely driven by what we enter into all of the other tabs and performs one super important calculation – how much money we made (or lost!) in the form of our Net Operating Income.

Revenue. Any revenue (income) items that we have, from product sales to consulting sales to partner income, will all be recorded in the revenue tab. The only “cost” we typically include here are returns and chargebacks directly attributed to our revenue.

Cost of Goods Sold. For businesses that have specific costs to deliver a product, we will capture those costs in the “COGS Tab”. Isolating our costs of goods sold helps us keep a close eye on where specifically we can improve these margins regardless of how the rest of our business is performing.

Marketing. Assuming our business has a significant marketing cost component, we will isolate these costs as well so that we can manage our budget dynamically over time and constantly monitor our marketing spend versus our revenue.

Staffing. Here we will capture all payroll-related expenses, including full-time and contractor costs, as well as the associated payroll taxes and things like healthcare costs.

Miscellaneous Expenses. The “Misc Expenses” is a catch-all for the various categories of monthly charges that will typically include office services, SaaS charges, meals, and other one-offs that aren’t specific to payroll, marketing, or direct COGs.

Assumptions. In order to forecast our business on a go-forward basis, we’ll use our Assumptions tab to project what our business might do throughout the year. As our projected months turn into actual months, we will replace our projections with actual data.

It’s possible to add more tabs to this or modify these tabs in any way we see fit. The only thing to be mindful of is that each tab maps back to the “Overview” Tab so just make sure that whatever information gets added into a new tab, we double-check that the math works.

Step 2: Focus on Assumptions. We spent all of Phase 2 specifically talking about how just a handful of key assumptions can drive a huge part of our forecasts in the income statement. Now it’s time to put those assumptions to work.

We’ll start by using the last tab – “Assumptions” – in the income statement. Please feel free to jump back to the explanations in Phase 2 of this course in case we forgot what some of these terms mean.

What’s the Goal Here?

The Assumptions tab gives us a worksheet to help determine what the right values will be to populate in our income statement. The tab itself is just a worksheet – nothing in the income statement changes when we monkey with these values.

*A Warning About Assumptions!

Almost everything we will do in forecasting involves assumptions, which means we’re guessing. There’s a 99.9% chance that our guesses will either be flat out wrong or a .1% chance that we will have just gotten lucky. Either way, there is no way we’re going to have the “right” answers from the get-go. Believe it or not – having the wrong answer is OK for once. The goal of forecasting isn’t to be fortune-tellers (though that would be amazing) – it’s to figure out which assumptions have the most impact on how our business performs.

What To Do Next with Our Assumptions

The Assumptions worksheet by itself is just a quick way to monkey with the key drivers in our business that will have the most impact on the viability of the business model. These aren’t just fake numbers though! We will use these values to help us populate the rest of our Income Statement to build out the entire forecast across all aspects of our startup. If we’ve gotten a fairly good handle on the assumptions, the next step is to begin populating the Fixed Cost items in our Income Statement.

Step 3: Populate Fixed Items. Now let’s move past the Assumptions tab and begin populating the rest of the Income Statement with our forecasts. Our input on the Assumptions tab will do most of the work to populate the Revenue, COGS, and Marketing tabs. That means we’re only going to focus on understanding the “Staffing” and “Misc Expense” tabs for now.

Where all the remaining tabs will be populated in this spreadsheet:

“Staffing” and “Misc Expenses” are considered “Fixed Cost Items” because they shouldn’t change dramatically over the course of the year, and also because they are often not directly correlated to sales volume. There are some nuances we should be aware of, but this should be pretty easy.

Staffing Costs: Here we will estimate the projected staffing costs for the year as well as capture and report the actual costs as the year continues.

Since this Phase is more about forecasting than it is the final tracking (that’s next) we are only concerned with making estimates for each category right now. We will discuss how to plug in final numbers in the next Phase.

Miscellaneous “Misc” Expenses: Our “Misc Expenses” tab is the catch-all for any other costs that don’t neatly fall within our other prescribed tabs. This could range from anything from our Web hosting bill to the Taco’s the company sprang for.

4 Major Categories of Misc Expenses

As always, if we miscategorize one item it’s not a huge issue. We can correct it later. The categories are mostly meant to help us get a quick view of where our expenses are going and where we can expect to increase versus places we might be able to save.

Summary

Forecasting isn’t a one-time thing, especially for startups. We should be updating this forecast constantly as we get more and more data about how our business will perform.

It’s not uncommon for a first-year startup to be constantly adjusting the numbers and watching the forecasts swing all over the place on a regular basis.

To the extent possible, it’s also helpful to share this document with as many management and team members as possible, so that everyone can understand the push/pull relationship that each department has with the other. The Engineering Team may want to hire a bunch of new developers but if the Marketing Team is falling behind on their numbers (which has an effect on Revenue) that capital may not be available. The better equipped the entire team is with the mechanics of the Income Statement, the better they can work together to make key decisions in unison.

At this point, we have all that we need to build and adjust our financial forecasts. The next step is going to be replacing our forecasts with actual numbers as each month progresses. To do that, we’re going to learn how to turn this forecasted income statement into an actual accounting income statement.