Financial forecasting is a critical skill for startup founders and entrepreneurs.

At Kruze, we’ve advised over 1,000 startups that have collectively raised billions in VC funding, and we can very honestly say that startups with financial forecasts will, on average, perform better than those without. Forecasts help you plan for the future, make informed decisions, understand if you are missing or meeting your goals, manage your cash runway, and communicate your vision to investors. In this comprehensive guide, we’ll explore the ins and outs of creating a startup financial forecast.

What is a startup financial forecast?

A startup financial forecast, also known as a financial projection, is a prediction of a company’s future financial performance. It’s a framework that produces an educated guess about where your business is heading, based on historical data (if available), market research, and well-reasoned assumptions about future conditions. The outcome of the exercise should be that you’ve laid out assumptions on how your business will change (and hopefully grow!), and creates future versions of financial statements.

For startups, a financial forecast typically includes projections for:

  1. Revenue: Estimating future sales based on factors like market size, the number and effectiveness of sales people and marketing efforts, pricing strategy, and growth rates.
  2. Expenses: Predicting costs associated with running the business, including salaries, marketing, COGS, and product development.
  3. Cash Flow: Projecting the movement of cash in and out of the business, which for most startups should predict the company’s cash out date.
  4. Burn (or Profitability): Estimating how much cash the startup will use, or if/when the company will break even.
  5. Funding Requirements: Determining how much capital the startup needs to raise to achieve its goals - in particular, for VC backed businesses, it is critical to understand the startup’s trajectory as it approaches the next financing round. Will it have the metrics that it needs to raise another round of funding?

Why financial forecasts matter for startups

Financial forecasts are more than just numbers on a spreadsheet. They are a great exercise for a founder to really try to understand the company’s unit economics, how big of a team and how many people it will need, and other nitty-gritty details of what the company’s strategy will entail. Here’s why they’re crucial:

  1. Strategic Planning: Forecasts help you map out your company’s financial future, allowing you to set realistic goals and milestones.
  2. Resource Allocation: By projecting future revenues and expenses, you can make informed decisions about hiring, marketing and product investments, and resource allocation.
  3. Investor Communication: A well-crafted financial forecast can help you articulate your business potential to investors and stakeholders.
  4. Cash Flow Management: Forecasts help you anticipate cash flow issues before they become critical, ensuring your startup remains financially healthy.

How to create your startup financial forecast

Now that we’ve covered the key components, let’s walk through the process of creating your financial forecast. At Kruze Consulting, we’ve developed a comprehensive approach to building financial models for startups:

1. Determine the goal of the model

Before diving into the numbers, understand the purpose of your financial model. This will help you decide how detailed it should be:

  • For market sizing or back-of-the-envelope estimates, keep it simple.
  • If you’re raising capital, strike a balance - have enough detail to show market understanding, but avoid getting bogged down in minutiae.
  • For a detailed cash flow model for an operating business, more in-depth analysis is typical.

2. Determine the KPIs for your company

Identify and organize your Key Performance Indicators (KPIs). These should be numerical factors and assumptions that you can track over time. KPIs in a model are useless if you can’t measure your performance against them. Use industry-standard KPIs as a starting point. Understanding your KPIs and how you track against them is crucial for startups, so don’t skip this step.

3. Get a financial model template

Don’t reinvent the wheel. Use existing spreadsheet as a starting point - they’ll save you time and ensure you’re not missing crucial elements. Many free templates are available online, including those offered by Kruze Consulting.

4. Merge actual results into the forecast

If you have an operating business, incorporate your actual financial results into your projections. Starting with reality helps you level-set your expectations. Be wary of strange ‘kinks’ where actual results meet projections - these often indicate issues with your assumptions.

5. Start forecasting revenue

Begin with the top line of your income statement: revenue. Consider what’s driving your revenue growth:

  • Number of customers?
  • Sales team size?
  • Marketing spend?

Also, factor in your cost of goods sold (COGS) as you project revenue. For hardware or biotech startups with a long time to revenue, focus instead on mapping out the effort needed to reach critical product development milestones.

6. Project headcount needs

For most startups, headcount is the largest expense, at least until marketing spend ramps up. Estimate:

  • How many people you’ll need to achieve your goals
  • The cost per employee
  • Recruiting costs, even if you have a strong network

Remember to project hiring needs for future years as well.

7. Estimate other expenses

Research how other successful companies in your industry have scaled their expenses. As your company grows, make sure to add additional expenses - this applies to both operational costs and headcount-related expenses. Keep in mind that very few companies have over a 50% pre-tax profit margin, so be realistic in your expense projections.

8. Model working capital

Working capital can significantly impact your model’s cash position. Understand:

  • When your clients will pay you
  • When you’ll need to pay major vendors

This step is crucial for maintaining a healthy cash flow, especially for startups with longer payment cycles or inventory management needs.

9. Review your projections

Finally, perform a sanity check on your financial projections:

  • Does the summary make sense?
  • Is the model telling the story you envisioned for your startup?
  • Are the growth rates and margins realistic when compared to industry standards?

This final review is crucial to ensure your financial forecast is both ambitious and credible.

Best practices for startup financial forecasting

To create a robust and credible financial forecast, keep these best practices in mind:

  1. Be Realistic: While optimism is great, overly aggressive projections can harm your credibility. Base your forecasts on solid research and realistic assumptions. However, if you are using the model to raise funding, don’t be so conservative that you fail to attract an investor (but still be realistic).
  2. Use Existing Startup Financial Models: Leverage existing templates and models to ensure you’re not missing any crucial elements in your forecast. There is no need to reinvent a spreadsheet!
  3. Consider Multiple Scenarios: Scenario analysis makes better forecasts - create best-case, worst-case, and most likely scenarios to better understand potential outcomes.
  4. Focus on Key Metrics: Identify the most important financial metrics for your business (e.g., customer acquisition cost, lifetime value) and make sure your forecast addresses these.
  5. Keep It Flexible: Your forecast should be a living document that you can easily update as circumstances change.
  6. Seek Expert Help: If financial forecasting isn’t your strong suit, consider working with a financial advisor or consultant who specializes in startups.

Common pitfalls in startup financial forecasting

Avoid these common mistakes when creating your financial forecast:

  1. Overestimating Revenue: Many startups are overly optimistic about how quickly they’ll acquire customers and generate revenue.
  2. Forgetting COGS: Your startup’s cost of goods sold is important to forecast and understand; don’t assume that you’ll have a 100% gross profit margin business unless you have good reason to!
  3. Underestimating Expenses: Don’t forget to account for all costs, including hidden ones like taxes, insurance, and maintenance.
  4. Ignoring Seasonality: If your business is affected by seasonal trends, make sure your forecast reflects this.
  5. Failing to Update: Your forecast should be regularly reviewed and updated based on actual performance.
  6. Lacking Detail: While high-level projections are important, make sure you can back them up with detailed assumptions and calculations.

Using your financial forecast

Once you’ve created your financial forecast, put it to work:

  1. Guide Decision-Making: Use your forecast to inform decisions about hiring, investments, and growth strategies.
  2. Secure Funding: A solid financial forecast is crucial when pitching to investors or applying for loans.
  3. Set Goals: Use your projections to set concrete financial goals for your team.
  4. Monitor Performance: Regularly compare your actual results against your forecast to identify areas for improvement.

Conclusion