Since last checking in with the SayAhh team, they have spent a few months consumed with building an early version of the product and speaking to potential customers, all the while watching their cash balance steadily diminish. They realize the clock is ticking and have decided that it is time to create a robust set of financial projections in order to provide themselves with a better sense of when they will need to raise more money.
The co-founders decided to divide-and-conquer, with Dick tackling expense projections and Jane tackling revenue projections. Their plan was to combine the two in order to predict their cash burn over the next two years (with a focus on the next twelve months). Jane asked Josh, who provided SayAhh with solid advice on setting up their accounting systems, for help in creating the revenue side of their financial forecast. Josh told Jane to take a first shot and he would comment. Here’s a snapshot of what Jane produced:
Josh worded his feedback carefully:
“Jane, this is a good start. I am glad to see that you are forecasting revenues based on business drivers. In this case, the # of users and the average monthly revenue per user. That’s what you should be doing. However, do you really understand the key underlying drivers of your business? Based on the drivers you chose, I am not so sure you do.
Certainly the # of users matters. But take it a step further. What drives the # of users? Presumably you will have new users, return users, and lost users each month. Decomposing users into these three component parts is important because it will allow you to better understand what is going on with your business, which will in turn allow you develop actionable strategies for improving your business.
For example, assume the # users remains flat for four months in a row. If you only track monthly users, you might assume that you are not attracting any new users and you need to change your marketing approach. However, what if it turns out that your marketing approach is just fine and you are bringing in lots of new users every month, but at the same time you are losing an equal number of existing users? In that case, the problem is that users don’t like your product. You need to fix that problem, not adjust your marketing approach. Take another shot at this and come back to me with a model that you think drills down to the key drivers of your business.”
Jane did some research, had a nice glass of wine, and really thought through their business model. Then she came back to Josh with a revenue model built on a set of key business drivers:
Josh told Jane that her second effort was much better and Jane in turn felt that she now had a much better understanding of SayAhh’s business model. A skeptic might assert that it is a waste of time for a pre-customer startup to forecast revenues since they are guaranteed to be incorrect. When I look at a startup’s revenue projections, I don’t pay much attention to the actual numbers for just that reason. However, I do look at the structure of the model to see if they really understand their business and are actively tracking their key business drivers.
In the next post, we will see how Dick fares with the expense forecast.
Note that Jane’s second attempt is a step in the right direction, but by no means perfect. Tying the number of new users to advertising spend seems particularly questionable, for example. What other problems do you see? What has been your experience/advice in developing revenue projections?