Over the years I have written many business plans and created countless financial forecasts for startups and early stage companies. One of the most difficult aspects of creating a financial forecast is identifying realistic assumptions.
The earlier the stage of development of the company, the more difficult it typically will be to make reasonably accurate assumptions.
Depending on the main purpose of the financial forecast, or the business plan that the forecast will become a part of, the assumptions used for the forecast can vary. A forecast may be used for a bank loan, to attract investors, for internal strategic or tactical management purposes, or a combination of these.
Depending on that purpose, entrepreneurs need to make their assumptions in light of that purpose (or purposes), so that the forecast (as closely as possible) reflects the most likely future performance of the business, but also accomplishes the main purpose for creating the forecast.
The best place to start is to look to the industry within which your business will operate. Try to find similar companies that are at or close to the same stage of development as your enterprise, and review their performance to generate reasonable assumptions for your forecast.
Often this is easier said than done, as many early stage companies are privately held, and don’t report financial information through quarterly SEC filings, or release it to the public.
Some private companies are more transparent about their financial performance than others, and many share their performance, albeit not always on a regular quarterly basis, with their investors. If you have investors, chances are they have invested in other similar companies and may have access to valuable financial information for other companies that they can share with you.
Another place to look is the angel investor groups. If you can find an angel investor group that focuses on your specific type of business, it usually can be a great source of information.
Many angel investors join these groups because they want to mentor other entrepreneurs, sharing their expertise. Most angels made their money as entrepreneurs, and have a wealth of information about the company or companies they started, built and successfully exited.
I have found that most angels are very supportive and readily volunteer any information they may have about their industry.
If those sources fail, you can always turn to the Internet. There are numerous ways to search for financial information on individual companies, industries or sectors of the economy.
Often, public companies can be great sources of financial information, even if those companies are much larger and more developed than your enterprise. Public companies can serve as a good starting point to establish a baseline for assumptions, from which you can make adjustments to better fit those assumptions to your specific forecasting needs.
If your purpose in creating a financial forecast, and/or writing a complete business plan, is internal, meaning you are trying to create a strategic plan you can follow to understand the long-term viability and sustainability of your business, you will want your assumptions to be far more conservative (as opposed to forecasts for funding purposes).
This is not to say that your forecasts for funding purposes should be overly optimistic. Rather, the point of a strategic plan is to punch holes in your analysis as a stress test to critically evaluate your business operations.
I have written many business plans for which, after creating the financial forecast, it is painfully obvious that the business is not viable. All too often, the entrepreneur will argue with the assumptions to try to reverse engineer the financial forecast to force it to pencil out as a viable business model.
Those conversations are difficult, but the upside is that it is far better for the entrepreneur to find out their business concept is not viable at the concept stage, rather than a few years into the project, after the entrepreneur — and possibly investors — have risked millions of dollars, only to realize there is no hope of success.
In summary, the key benefit to creating a financial forecast is to have it serve its intended purpose, whether that be strategic planning or funding. Assumptions used for a financial forecast should be well-reasoned, and ample and appropriate time should be invested in developing reasonable and accurate assumptions so that the financial forecast accurately represents the most likely future performance of the enterprise.
The financial forecast is arguably the most important component of a complete and comprehensive, well-written business plan, so entrepreneurs should invest the required time in identifying accurate assumptions for the forecast to ensure the business plan is the closest possible representation of the future prospects of the business.
If completing this process is beyond the capabilities of the management team, expert assistance should be engaged to ensure that the financial forecast provides the most effective predictive value possible. The money spent on expert help will be a small fraction of the potential losses suffered in reliance on a faulty forecast.
— Craig Allen, CFA, CFP, CIMA, is president of Allen Wealth Management, and has been managing assets for foundations, corporations and high-net worth individuals for more than 25 years. He can be contacted at firstname.lastname@example.org or 805.898.1400. Click here to read previous columns or follow him on Twitter: @MPAMCraig. The opinions expressed are his own.