Forecasting

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?”

Forecasting isn’t about being “right” about future numbers. It’s to figure out what metrics we need to achieve to make our business work profitably. 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 need a ton of 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”.

Good question. An Income Statement is just a spreadsheet where we add up all of our income in one area and all for 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

If that doesn’t sound too hard – it’s because it’s not! As the business grows we can get into more complex models, but for now, we’re just going to keep it super simple and get on with our lives.

Long before we’re ready to start collecting money we will likely be setting 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 – category by category – 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!

We’re going to provide a specific income statement template for us to walk through together. It’s a real income statement, not just a sample. We can absolutely use this spreadsheet to manage our startup. And guess what? This is literally the same spreadsheet we’ve used to manage not only Startups.com but also tons of other companies. This bad boy has some serious miles on it!

Download the Startups.com Template here!

Some things to know about this template:

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. That’s fine. We’ve used this same tool to manage businesses with 8 figures of revenue and it’s scaled wonderfully. Our mileage may vary.

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

If a Montell Jordan a la a Slick Rick beat isn’t playing, we suggest dropping everything and turning it on now – because “you gotta get your groove on, before you go get paid.” (I’m not gonna lie, I’m very proud of being able to torture in that Montell Jordan lyric into the beginning of a startup finance course!)

OK so for real, this is how we’re going to build an income statement.

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 of where to track revenue and where to track costs.

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 overview 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.

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.

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.

Let’s say we want to know how much revenue we’ll make in Month 6 – the Assumptions worksheet will help us do the math to figure that out.

We’ll walk through each of the assumptions in this worksheet one by one to give a little more guidance as to how to tackle each one, so don’t sweat it if it seems like a lot. We’ll make it easy.

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 by flat our 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 (thought that would be amazing) – it’s to figure out which assumptions have the most impact on how our business performs.

For example, if we assume that it will cost us $20 to acquire a paying customer, but our product only sells for $15, we know the “problem” in our business model is most likely that we need to figure out how to acquire customers for less than $20! Or perhaps it’s a “pricing” problem and we need to look at how to raise our prices to accommodate. Either way, the assumptions help tell a story of where we should be focusing our time.

Some startups aren’t driven by marketing budgets, such as enterprise or direct sales businesses. That’s fine. In those cases, we can modify the spreadsheet to replace “Total ALL Visitors” with “Total Sales Calls” or whatever stat represents our gross number of opportunities. Thereafter we can use “Conversion Rate” to estimate the number of opportunities that result in closed sales. From there the rest of the assumption worksheet should hold up just fine.

We really can’t predict any of our revenue until we have a handle on how many customers are going to come through the door. And in order to drive customers, we must know what we’re going to do to drive them. Note that in these examples we use “visitor” to mean anyone coming to buy from us, whether it’s to our website or to our storefront.

We’ll split our customer acquisition estimates into two numbers: Paid and Organic.

Within these two categories, we can do far more to predict our Paid Visitor numbers than our Organic Visitor numbers because there’s typically some type of cause and effect relationship between how much we spend versus how many visitors we get, especially with online spending. When we try to do the same for Organic Visitors, it gets a bit trickier, but we’ll take a look at both avenues to understand more.

Paid Visitor Assumptions

1. Budget. We’ll begin by starting with a paid media budget. Our example shows a “$1,000” budget that will begin driving all the assumptions around paid visitors. We can use any budget amount we want (or none at all - $0) to calculate the paid number of visitors.
2. Cost Per Visitor. Our budget will drive a set number of visitors to our site/store. If we know the cost for a visitor (sometimes referred to as “Cost Per Click” in online ad spend terms) we can enter that here. If we don’t, we can use a best guess and then go back and adjust this later. The Cost Per Visitor value will become extremely important long term as we develop our paid marketing efforts.
3. Total Paid Visitors. This is just a calculation – Our Budget divided by the Cost Per Visitor which drives 2,000 “Total Paid Visitors”. Interestingly if we don’t quite know our “Cost Per Visitor” in the early days, we can often just take the number of visitors we got last month and divide that by our Budget to determine our Cost Per Visitor. It works the same both ways.

That covers our needs on the Paid Visitor side of the calculations. If we are spending across multiple channels (such as Google Adwords and Facebook) we can blend these calculations if we’d like to get the total visitors from all channels.

Organic Visitor Assumptions

Notice that in this line item we have a single line “Total Organic Visitors”. We’re not using additional criteria here because there is no cost basis for our organic visitors. However, that doesn’t mean organic visitors aren’t important! They are incredibly important.

The more organic visitors (read: free visitors) we can attract, the more our “Blended Acquisition Costs” – which is the cost for all of our visitors when we combine both Paid and Organic – goes down. This is the Holy Grail of marketing!

However, we don’t have quite as specific a calculation for how many organic visitors we will drive, simply because we’re not paying for customers to visit us (unlike Paid). Therefore, the recommendation here would be to use a “best estimate” (read: guess) and start to learn as time progresses how much organic traffic actually comes through the door.

What’s most important to note now is that our Customer Acquisition Costs are a blend of Paid and Organic visitors, and the combination of paid and free customers will have dramatic effects on our bottom line.

Total ALL Visitors

This line item is a calculation summing up the “Total Paid Visitors” with “Total Organic Visitors”. There’s nothing to do here other than make note that this number (and growing it) will basically consume our lives in the near term!

Our “Conversion Rate” is the rate at which “Visitors” (any type) turn into “Paid Customers”.

In the early days we won’t know what this conversion rate is. Not only that, we’ll find it probably varies dramatically per marketing channel. We may find that 20% of the visitors we get from our newsletter convert to paid customers while only 2% of our Facebook ad customers pay us.

In this case we have two very different sets of numbers: the amount of conversion by marketing channel and the amount of conversion from all of our traffic. Both are incredibly important to track, but more importantly, we have to make sure we don’t project one set of numbers (like our 20% conversion rate on email) to be the same for ALL of our numbers (like Paid Marketing, SEO, or Referrals).

There’s no way we could possibly know our conversion rate at this very minute. Like all of these stats, we simply have to use a best guess and tune that number over time. I tend to use numbers in the 3-5% range as more of a “worst case scenario” but frankly these numbers will swing all over the place until we have enough data that starts to form a trend.

Also worth noting – it’s OK for these numbers to change and it’s definitely OK to be wrong about them. What matters when we’re doing our initial forecasts is just that we understand how these numbers push/pull at each other. We can see that if we double our “Conversion Rate” our Gross Margin jumps quickly. All of this is super important as we begin to learn the semantics of our business model.

In Phase 2 we spent some time talking about how we can think about Lifetime Value (LTV), which we may recall is the total amount of revenue a single customer will generate.

LTVs are great to use when forecasting the profitability of a single customer or specific costs like marketing. If we spent $100 in marketing to acquire a customer that would ultimately spend $500 with us we could show that as a profitable spend.

But using LTVs in our actual income statement won’t be terribly useful. That’s because in our income statement, we’re showing how much actual revenue our business generated in a given month. That’s great that our lifetime value for a customer may generate income in a few months or through until next year, but we need to know how much revenue we will generate each month.

Depending on our business model, we can choose to forecast our revenues using “One-time activity” or if we also have recurring revenue, we may also use “Recurring Revenue”.

1. One-time activity. We capture the value of the order each time we receive it. This is good for businesses that typically don’t have a monthly recurring component (unlike subscription businesses). Each month our revenue is tied to the performance of that particular month – if we sell $200 worth of hot dogs this month, our revenue is simply $200. The sample income statement here makes this easy by multiplying the “Total Number of Paid Customers” by the “Average Order Value”.
2. Recurring Revenue. For recurring or subscription-type businesses the model works a bit differently. In this case the value of a customer is spread out over a number of months and therefore we need to show both “new” and “recurring” revenue forecasts. Also, let’s not confuse “recurring” with “people might buy again”. Think of recurring like a subscription where the product is going to be repurchased every month until it’s “turned off”, like Netflix or our phone bill.

In order to forecast our “Average Order Value” we need to estimate the average value of an order placed within a single month. If someone buys $25 worth of hot dogs from us within the month – the average order value is $25. If they buy $1,000 worth of hot dogs throughout the year, we may adjust our forecasted “average order value” to be $83 ($1,000 divided by 12 months).

Not sure what to use? Start with a best guess and don’t worry about it. Over time as real data starts to stream in from early tests, we’ll start to shape the numbers closer to reality and get better forecasts.

In the event that our business also has a recurring element such as a subscription or monthly billing, we will also need to consider how recurring revenue will play a part in our ever-growing business.

In order to calculate how much recurring revenue we would collect from previous month sales, we would also need to know our “churn” number, which is the percentage of customers who will no longer continue with us the following month (they “churn out”).

Here’s an example of how we forecast recurring revenue:

Monthly Churn = 25% (we lose ¼ of our original customers at the end of every month)

In this example in “Month 1” we had $100 of “new” revenue. Each successive month we will churn 25% of the original $100 of revenue until we reach $0 by Month 5. In our income statement, we will want to include both “new” revenue for each month and then the sum total of all “recurring” revenue from all the prior months where we still have our original customers paying.

Now that just got us through how the new sales from Month 1 performed. We still need to stack that revenue on top of the “New Revenue” that we’d also generate in Month 2 which will also recur.

Here’s just a view of Month 2 to show how the stacking effect of recurring works:

Want to see even more fun with numbers (“No, Wil, I sorta don’t…”). Well, let’s look at it anyway because recurring revenues are badass.

Here’s how Month 3 would stack up even more:

If this sounds like it gets into complicated math, well – it can. Fortunately, the finance nerds at Startups.com (me + team) have already done some of the heavy lifting by adding a recurring revenue forecast that automatically calculates recurring revenue for future months based on new revenue.

We can adjust our churn values each month in anticipation of improving them over time (if that’s possible) so that our recurring revenue generated from new sales improves. The default value of “25%” is just a placeholder. That implies that a customer will be lost after 4 months. If we think our customer will stick around for 10 months, we’d use a 10% churn number.

If we’re running a subscription business, “churn” will be by far one of the most impactful assumptions in our business model, so we will always need to pay extra special attention to it.

Note that for the month of January there is no value for recurring revenue because the calculations are based on having data for “new revenue” which is only apparent in January (Month 1). Feel free to drop in whatever recurring revenue values that are predicted for January (Month 1) in this spreadsheet.

Our COGS estimates are sometimes the trickiest of all, because so many businesses represent their Cost of Good Sold so differently. We’re working with a “one size fits most” spreadsheet here and we can feel free to modify it to fit our needs.

COGS are generally understood to mean the cost of delivering the actual product. If a cost exists regardless of whether we sell anything, it’s typically a fixed cost and isn’t listed here.

We’ll add our fixed costs items a bit later, and if it turns out that we realized some items are “fixed” and should be moved out of here – we can easily update that later. We’re not so much concerned with where the items are listed initially but more so that we capture every item and work them into the right categories over time.

Before we dig in, let’s first explain that there are up to 3 options for calculating COGS:

1. No COGS exist. If we’re a software or Internet company, there’s a good chance our cost to deliver is irrelevant – we only have fixed costs that don’t change much no matter how much we sell. If so, we may have some credit card fees (listed in the assumptions) or associated small costs but that’s it – and we can largely ignore COGS.
2. Specific Unit Costs. If we know exactly how much it will cost to sell/ship each unit (including shipping costs, handling costs) we can enter that value which will calculate against the number of units we sell to drive our COGS. This is typically the case if we’re not manufacturing each product.
3. Variable Costs. If we have costs that are specific to delivery, but we have at least a minimum amount of cost to cover (such as the cost of supplies to manufacture our product) we can use a variable cost to show that our costs will specifically escalate from order volume.

Our sample income statement works with all 3 options or a combination thereof. We may decide that we have some unit costs that are easy to isolate, like if were buying product from a vendor as we sold it to a customer, but also some variable costs like hiring temporary staff to handle increased demand.

Credit Card Processing

Assuming we are processing orders through credit cards, we will want to capture the associated processing costs as they scale. The sample has a 3% estimate baked in for credit card processing, but our charges may vary a bit. We can adjust that variable within the formula for “Credit Card Processing” which is calculated as 3% of the “Total Revenue” line.

Product Unit Cost

A great way to estimate COGS in relation to our forecasts for growing our business is to distill each unit sold with a specific “unit cost”. A unit cost is typically considered the total cost of delivery to the customer, not counting any fixed costs.

If we were re-selling 8-Bit Nintendo gaming consoles, we would probably include the following costs:

Unit costs work amazingly well when we have well-defined costs of producing a single unit for sale. In this case we sold exactly one Nintendo unit, we bought one Nintendo unit, and we had some additional costs to pack and ship it. Easy.

Often though, our Unit Costs aren’t quite that simple. We may be purchasing materials in bulk that are intended for production into the units we are going to sell. In that case, we can still establish a unit cost, however we will need to divide the total cost of our materials by the total number of units those materials can generate.

If we were starting a lemonade stand, here’s how we would determine a unit cost:

Here we have $16 in materials for our very high end (“We only use Evian”) lemonade stand. We know that a Gallon of Evian will yield 16 cups, so our Unit Cost is $1 each. (Wow, that was a very convenient/lazy example, Wil).

Even though we may not sell all 16 units, our unit cost is still represented as $1 each. It gets more complicated if we have “spoilage” in which case we must throw out some portion of our materials which would drive the effective unit cost up due to fewer units for the same price. But for now let’s just use our best estimates to build a forecast. We can worry about the details when we get closer to the actual months.

Variable Costs

In cases where we can’t distill our sales into just Unit Costs, we may want to include Variable Costs into the mix as well. Variable costs often look and feel like “Fixed Costs” except they scale up and down based on how much product we sell.

It’s possible that we’ll “mistakenly” list some variable costs in the fixed cost areas and vice-versa. For now, don’t worry about it. We will quickly see which costs should be counted as “variable” the moment we start growing the revenue forecasts quickly.

Comparing Variable vs. Fixed Costs

While there can be a little bit of overlap on Variable vs. Fixed costs, what matters is that we try to assign costs that scale quickly with sales to Variable Costs so that we can see where our costs will increase over time.

We can add in more rows for variable costs if we need to, but for the purposes of the Assumptions sheet, this is intended to be a summary of our costs, not a detailed listing of every cost. We can create more detail on a separate worksheet or we can use our COGS tab to capture some more detail.

Our “Total COGS” line item will combine our “credit card processing fees”, “unit costs” and any “variable costs” into a single value. We will want to watch this number very closely as it will likely be the largest variable in managing our Gross Margin.

Gross Margin

Once we have all our other assumptions set, our Gross Margin will automatically populate itself at the bottom of the Assumptions worksheet. Gross Margin is the amount of income or loss we generate prior to any of the fixed operating costs of running the business.

A great way to think about Gross Margin is “If we can’t make a profit on a gross margin basis, no amount of cost savings or scale is going to save us!” That’s because whatever is left after Gross Margin is only ever reduced by more costs!

Gross Margin calculation explained:

The reason we make Gross Margin visible in the Assumptions worksheet is to give us immediate visibility as to how the tiny changes we make in our assumptions will affect our gross margin. We can see that if our “Unit Costs” increases by only a small amount or our “Conversion Rate” dips a bit, our Gross Margin will immediately be impacted to the negative.

That said, it’s pretty typical that in the formative stages of a startup Gross Margin will be negative – and that can be OK for a while. We’re learning and making investments to start, but our goal is to turn that knowledge into a million tiny tweaks we can make in order to get our gross margin positive, which can help us toward getting our entire business profitable.

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.

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

Let’s start by opening up the “Staffing” tab to get a feel for what types of costs we want to be tracking. Here we will estimate the projected staffing costs for the year as well as capture and report the actual costs as the year continues.

4 Major Cost Categories of Staffing

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.

W2 Staff

Our first category is W2 staff which (in the United States) is a designation for those employees which are rightfully employed by us. This is often referred to as “Salaried” employees but “Part Time” employees would be listed as well. What’s important about categorizing folks in this group is that they are most likely subject to Payroll Taxes (again, in the United States) which need to be forecasted as well.

Forecasting staff will be very different for each type of business, however there are a few things every team needs to do:

• Forecast base staff. To begin let’s add in all of the additional staff using current salaries. Those salaries may be $0 in some cases (yay startups!) but we should still capture all of the headcount that exists in our staff lines.
• Forecast future hires. Whether or not we can make future hires, we should add a list of folks that we would like to hire, using a value of $0 each month until we anticipate we may hire them. This is just a forecast, so if we add it into the wrong month, we can adjust later.
• Anticipate merit increases. Most companies budget about 5-10% per year for annual merit increases. Whether or not we decide to increase compensation, we should at least budget for those increases so that we’re not left with a shortfall when it comes time to talk raises.

We will make many adjustments to these numbers, so right now let’s just start with the people we can foresee adding this year and relative timelines (by month) of when they might start.

1099 Staff

Startups often use contractors in many varying capacities, especially in the formative years when there isn’t enough budget to take on full time help. In the United States, “1099 Staff” means workers who are not direct employees of the company and therefore are considered contractors.

For our purposes we’ll make a small distinction in where we track contractors between “1099 Staff” (here) and the “Misc Expenses” tab. A one-time service provider may be booked in the Misc Expenses tab. This is because the working relationship may be unpredictable in terms of frequency and amount of compensation. Under 1099 staff, we will have contractors who will be serving as 1099s on a predictable and expected basis. We will want to group this on the same tab as W-2s because these relationships will be on a recurring basis akin to core staff.

Payroll Taxes

In the United States, employers are required to pay taxes to the government in addition to those that they withhold for their employees. For W2 Staff there is an employer tax expense and an employee tax expense.

For our income statement we will record the employer taxes that we are responsible for as a business. This could include local employer tax depending on the municipality of operation or the home address of the employee, state employer tax for provisions like unemployment insurance, or Federal employer tax for social programs like Medicare.

Our employer payroll taxes will be captured at the bottom of the staffing tab. It may be difficult to forecast Payroll Taxes if we’ve never done this before or in the event that we have no payroll history. We’ve inserted a 12% estimate that calculates the total from W2 Employees and estimates a payroll tax liability.

It is important to note that our payroll processor service will provide us a report after each payroll we run of the applicable employer taxes paid by them on our behalf. This report will provide a centralized and transparent location to aggregate the expenses each month.

Benefits

All employee benefits that we provide should be captured here, ideally on separate line items so that we can forecast and track them closely. This would include Medical, Dental, Vision and Life Insurance coverage, 401(k) match contributions, and ancillary benefits like paid gym memberships or other persistent costs that are provided as part of employment.

Note that meals or other monthly reimbursements will be captured in the “Misc Expenses” tab since they are far more variable and are treated a bit differently.

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 round of lattes the company sprang for.

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 increase versus places we might be able to save.

Office Services

Our “Office Services” are loosely referred to as all of the core costs that exist just to keep the lights on. A good analogy here is to think about our personal costs – rent/mortgage, phone bill, internet service bill, electric, gas and water bill. These are the bare necessities we need in order to operate day to day.

There’s no absolute wrong or right to this category, but it helps to group items that we either absolutely know can’t go away or items that have a high degree of predictability. At Startups.com, we are essentially an “Internet Company” so our Office Services include Web hosting, Internet access, Office Rent and similar items we know we have to pay no matter what the state of our business.

We don’t need to predict every increase of every line item – we can’t. Instead, let’s just take our existing monthly charges (or those planned) and use the same values throughout the year. If we’re aware of some deliberate increases, by all means let’s mark them up in ensuing months. But don’t worry too much about having to “know exactly what we’ll be paying hosting fees in Month 9” – it’s probably not that critical right now.

Subscription Services

These days most startups run on loads of subscription services, whether it’s MailChimp to send email, Slack for team chat or a Startups Unlimited subscription to grow the whole startup faster (what self-respecting Founder doesn’t plug their own services?)

We isolate subscription services for two reasons – they are fairly easy to predict because most costs are consistent and they are the first costs we want to evaluate every month to make sure they are all still active and necessary. If we’ve ever signed up for any subscription online and had that sinking feeling when we got the first unexpected bill on our credit card statement – we know all about “ghost charges” that come back to haunt us!

Similar to Office Services, we can usually take all of the services we are currently using and copy/paste them across each month using the current charges for the time being.

Meals and Entertainment

We can optionally isolate “Meals and Entertainment” as its own category if we think the volume of either will be meaningful. If we’re only tracking a handful of items each month, we can also consolidate that in the “Other” category. The only thing worth noting is that under U.S. tax law, “Meals and Entertainment” are usually treated a bit differently as far as an expense (usually only a 50% credit) so it may be handy at the end of the year to have those expenses categorized.

In this case we won’t likely know exactly how many meals we will eat or where, so a single placeholder amount of across every month works just fine.

Other

We hired the world’s most creative minds to help us name this last category. After rejecting such contenders as “Not any of the Above”, “Homeless Wandering Post-Apocalyptic Line Items” and the runner-up “Dude I have no idea, I guess it goes here” we settled on “Other” to name this multi-dimensional category of expenses.

Aside from our cheeky introduction, there’s really nothing exciting about this category. It’s literally a catch-all for any items that don’t have a home elsewhere. If we notice over time that some of our items are recurring on a regular basis, we may move them into “Office Services” or “Subscription Services”. That’s about as crazy as it gets.

For the time being we’d be best served to use a single placeholder value that we spread across each month. We can then replace that placeholder by actual items and then modify that value as we start to see a recurring trend in monthly spend.

OK friends, now it’s time to wrap this baby up and send it home. That is if our “baby” is a Google spreadsheet and “home” is wherever documents are saved in the cloud.

All of the elements we need exist between our Fixed Items and our Assumptions, so most of the work is done already. We just need to make sure we properly insert our assumptions into the respective tabs, so we’ll walk through each of the tabs to make sure we don’t miss anything.

Here’s what we’re going to work on:

Let’s start with the “Revenue” tab and then work our way back toward the “Overview” tab which is automatically calculated from all of our other tab inputs.

Revenue

The Revenue tab includes multiple sources of revenue – Credit Cards, Checks, and “Other Sources”. We may not use credit cards or collect checks, so those are there just in case we use multiple forms of payment. In the event that our business only uses one form, feel free to populate the revenue projections in that line item and delete the others.

Ideally, we are pulling our revenue estimates from the Assumptions tab that we worked on earlier. To be fair, some businesses may not be able to utilize the Assumptions tab very effectively to drive forecasts, and therefore are going to need to default to a more traditional method of forecasting which involves making estimates per month. That’s OK, it’s just a bit less metric driven.

Total Revenue

In our Assumptions tab we calculated both New and (if relevant) Recurring Revenue for each month. Our next step will be to use those values in our Revenue tab under the appropriate income source – Credit Cards, Checks or “Other Sources”.

If some revenue will come from credit cards and other revenue from checks, and we’re not sure which to add them to, default to Credit Cards as a single place to add them. That’s because Credit Cards involve Processing Fees as well as a provision for Refunds and Chargebacks that will lower the overall revenue. In the event that some of this revenue is generated via Check, which does not impose a credit card processing fee, then we will be a little bit ahead. It’s better to err on the side of caution here then to have up to 5% or more of our income get caught up in expenses we didn’t plan for.

The next step is to insert the values of “Total Revenue” from the Assumptions tab into the “Income (Credits)” row of “Credit Card Revenue” or the “Total of Checks” row of “Checks Received”.

If we’re only going to use one category, then just make sure to use a “0” value for any other income sources.

Refunds and Chargebacks

If we’re processing via Credit Cards, we’re likely going to be dealing with both Refunds and Chargebacks. The income statement provided has a variable set for both items.

• Refunds are set to 3% (see yellow variable box)
• Chargebacks are set to 1% (see yellow variable box)

There is no specific rule for those values, and really, we won’t know what to use until we’ve processed enough transactions and can start to manage toward a trend. These are most helpful to create a projected line items so that we have some provision for potential losses.

The same provision is set for Checks Received whereby the 1% value can be adjusted to reflect actual refund trends once we get a better feel for them. If we find that we need to include yet another line item for refunds, we can add another row below “Other Sources” as well.

At this point we can adjust the percentage variables for Refunds and Chargebacks or leave them as is until enough data is gathered to adjust them further.

Forecasting without Assumptions

As we mentioned earlier, it may also be the case that the Assumption worksheet isn’t helpful in driving the revenue forecast and we may have to default to a more manual method. That’s fine. In that method we’ll still want to establish some basis for what might drive sales in each month.

This may include a traditional sales forecasting cycle that looks at sales opportunities (typical in longer sales cycles) and potential close dates and then factors a “close percentage” that determines the number of deals that will go through.

There’s no hard and fast rule here, but the closer we can get to using some isolated assumptions and metrics, the easier it will be to develop our plan, and if need be, defend it to folks like investors when raising capital.

Cost of Goods Sold (COGS)

Since our assumptions sheet is SaaS focused, we will need to handle COGS in its own tab. Remember, COGS are important if we sell (typically) physical goods - furniture, clothing, appliances, etc. Our assumptions for the COGS tab will include direct costs and variable costs. Direct costs are the costs associated with each specific unit of production.

For example, if we sell bicycles then our direct costs for the bike would be a metal frame, tires, spokes, bell, and brake cable. Let’s assume that the metal frame of the bike costs us $80 per bike. That's simple enough - we are matching direct input costs with units sold. If the tires, spokes, brake cable cost another $100 per bike then our total direct costs per bike would be $180. If we sell 100 bikes per month then the total direct costs would be $180*100 or $18,000. As a result, when doing our monthly assumptions for COGS it is critical to project units sold and the cost to make those units. If it costs us $180 to produce a bike, but we are selling for $160 then that’s probably a problem!

However, things can get a bit more complicated when we have production costs not directly related to any one unit. For instance, we may rent a production facility for $1,000 per month. This cost is not directly tied to any one unit, but it still needs to be accounted for in the cost of goods sold. Without the production facility, we would not be able to produce bikes - hence just as important as the metal frame or rubber tires.

This same rationale applies to all facility costs (rent, mortgage, taxes), salaries of facility maintenance personnel, production managers salary, wages of manufacturing labor, supplies for the production facility, utilities. These expenditures per month should be factored into our COGS tab. If we know rent will be $1,000 per month for the next 24 months we can forecast this cost out - same with salaries.

Note: supplies for the production facility could include inputs that are too difficult to attribute to any one unit of production. For example, if we use $200 per month of glue to paste our logo to the bike frame that would be input as its own cost in the COGS tab. Rather than trying to calculate the cost of each drop of glue per bike.

Marketing

Our marketing forecasts will be a bit of a hybrid between our Assumptions and actual financials. That’s because our marketing and customer acquisition may not be entirely tied to money. Many of our marketing channels, including word of mouth, email, press mentions, and social media may have little or no cost attached to them at all.

Our Assumptions tab only calculates the number of visitors that our channels will draw and what respective budget might drive that activity. The detailed values of which channels will drive traffic and what those relative costs are actually originating from the Marketing Plan, not the Income Statement.

In order to capture our marketing estimates, we’re going to have to determine which elements of our Marketing Plan will translate to the timing of cost on our financial plan. In the event that we don’t have a Marketing Plan then our next best option would be to use the whole dollar amounts of our “Budget” under “Customer Acquisition Costs” in the Assumptions tab and either add them into a single line item in the Marketing tab under whatever category feels most appropriate.

If we’re more enterprising and actually have a Marketing Plan, then we can layer in each of the cost estimates per channel into the appropriate categories. As always, it’s OK if we’re not 100% accurate as to which channel we’re going to spend in for any given month – so long as we recognize that the total outlay of marketing will generate something close to our revenue projections.

Right now we can choose to either enter a whole value for marketing spend or use a more detailed layout of marketing spend if we have specific channels that we have forecasted for. Remember that these are forecasted placeholders that we will ultimately swap out for actual spend values as each month ensues. We’re not concerned about which category we spend in – we’re concerned about the “Total Marketing Costs” line item at the bottom of this tab.

Overview (AKA The “Big Show”)

Alright friends, we have finally arrived at the “Big Show” – the Overview Tab. Great news – there is nothing to input here! All work is auto-magically done by the spreadsheet calculations. All we need to do now is sit back and let the money tumble in.

And by “sit back” I mean work nonstop. And by “let the money tumble in” I mean pray for profit.

If we’ve done our jobs right, all of our tabs should roll up into this fancy forecast that becomes the epicenter for all of our financial focus. When someone asks, “Are you making any money?” they are essentially asking us what the “Net Operating Income” line of this document says. If it’s a positive number – we win. If it’s negative, well, we know how that story goes.

Let’s do a quick run-through of the Overview just to make sure we understand the calculations and perhaps make some edits if we messed anything up.

Revenue. Our Revenue line item is going to be a combination of all of our forms of income, minus a couple “expenses” baked in if we have refunds or chargebacks. So what we’re seeing in the “Revenue” line is our income with Refunds and Chargebacks already subtracted.

COGS (Cost of Goods Sold). The Overview tab doesn’t display any detail for COGS simply because many businesses have fairly complicated details to display them all at once. That said, if there are a couple major COGS that we want to track, such as labor or unit costs, feel free to add a few line items here to display them as well.

Marketing. Our Marketing budgets will be listed by default as a split between online and offline as well as the catch-all for “other”. If we find that we’re only doing online marketing, we can remove the “Offline Channels” line item to keep the Overview tab tidy.

Payroll & Staffing. We rarely see changes to this category in that almost every company has a combination of staff and contract labor and needs to keep a line of sight on Payroll Taxes. The only exception is lack of benefits provision which can be removed if it’s not applicable.

Office Operations. We’d be hard-pressed to make many changes here as nearly every business will have some level of activity across these categories. At most, if the business is really small right now, we can probably roll-up “Office Services” and “Subscription Services” into a single category.

Total Operating Expenses. This is simply a calculation of COGS, Marketing, Payroll & Staffing, and Office Operations so that we can get a full view of how much it costs to run our business.

Net Operating Income. Revenue minus Total Operating Expenses = Profit (or loss). Maybe the single most important calculation in all of business! This is the number we will be constantly working toward improving.

Each of these categories represents all we need to know in order to work with and manage our forecasts! What we will learn in short order is that a million little tweaks to every category will have a powerful effect on how we manage the business to break even and someday (gasp!) – PROFIT!

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. At Startups.com we update our forecasts daily not just because our CEO is a maniac, but because we are very diligent about every detail of our business!

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.