Put down your expenses first, not revenues. It’s easier to start with expenses than revenue, because it’s something that you have a lot more control over. Revenue on the other hand is a lot harder to estimate, due to the fact that there are a lot of external factors that you cannot control. So, start by building a list of common categories of expenses. Your accountant (if you have one) may call these ‘accounts’ See some examples below:
– Legal/Insurance fees
– Postage Costs
– Office Rent
– Utility Bills
– Phone Bills/Mobile Phone/ Internet Costs
– Advertising & Marketing
– Cost of Goods Sold
– Direct Labour Costs
Forecast revenues with both a conservative view and an aggressive view. Most entrepreneurs will move between a conservative reality state and an aggressive dream state, which helps keep you motivated and helps you inspire others around you… including your potential investors. So don’t ignore your optimism and end up creating a forecast based only on your conservative view. You risk demotivating you and your team or end up not getting the getting the investment you need.I would recommend that you follow your vision and build two sets of revenue projections. A conservative view as well as an aggressive view.
By building two sets of revenue forecasts (conservative, aggressive), you’ll start to make conservative assumptions that you can relax a little for your aggressive forecast.
Check the key ratios to make sure your projections are sound. After making aggressive revenue forecasts, it’s easy to forget about expenses. Many entrepreneurs I meet, optimistically focus on reaching revenue goals and assume the expenses can be adjusted to accommodate reality if revenue doesn’t come through. Positive thinking might help you grow sales numbers, but it’s not enough to pay your fixed overhead costs.
The best way to reconcile revenue and expense projections is by a series of reality checks for key ratios. Here are a few ratios that should help guide you:
What’s the ratio of total direct costs to total revenue during a given quarter or given year? This is one of the areas in which aggressive assumptions typically become too unrealistic. Beware of assumptions that make your gross margin increase from 5% to 60% for example.
Operating profit margin. What’s the ratio of total operating costs – direct costs and overheard, excluding financing costs – to total revenue during a given quarter or given year? You should expect positive movement with this ratio. As revenues grow, overhead costs should represent a smaller proportion of total costs and your operating profit margin should improve. The mistake that many entrepreneurs make is that they forecast this break-even point too early and assume they won’t need much financing to reach this point.
Headcount per client. If you’re a solo entrepreneur who plans to grow the business on your own, pay special attention to this ratio. Divide the number of employees at your company–just one if you’re a solo player–by the total number of clients you have. Ask yourself if you’ll want to be managing that many accounts in five years when the business has grown. If not, you’ll need to revisit your assumptions about revenue or payroll expenses ….or both.
Building an accurate set of growth projections for your start-up will take time and many revisions as you build out your experiences.