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The point where you are ready to find an investor for startup funding can be one of the most exciting and nerve-wracking parts of being an entrepreneur. To attract the best investment, you need a robust business model. You also need a forecast of what profits your business can expect to make in the future.
Proper forecasting can be one of the most important ways of how to get funding for a startup. When you go looking for startup funding, investors will want to know that your business plan is economically viable. They expect to see a return at some point after all. Even if an investor doesn't want to look at your forecasting themselves, having a solid business plan will let you answer their questions with total confidence.
Without a good forecast in place, you won't even know how much funding you'll need to ask for. Whether looking for seed funding or looking for more investment later, proper forecasting is always essential.
Here, we'll explain the difference between the two main forecasting methods and the most useful forecasting techniques.
The Types of Forecasting: Top-Down vs. Bottom-Up
There are two main forecasting methods, known as Top-Down Forecasting and Bottom-Up Forecasting. Each of these methods has a different set of pros and cons associated with them and appropriate uses.
With the Top-Down method, you first look at the industry your startup exists in as a whole and narrow it down to a reasonable target. First, you determine how much your enterprise is worth and how much of that industry you could access. Then you choose how much of the accessible market you could reasonably capture compared to your competitors.
This kind of forecasting will require a good deal of research about the industry you are operating in. If you know any experts in the field, this is the time to tap them for information. Looking at your competition and their growth can also provide useful benchmarks.
The Bottom-Up method starts with your company data, looking at your value drivers and estimating how much value they could generate. This could involve looking at statistics such as sales data or internal capacity. You do your best to estimate your revenues and costs based on the data you have and then estimate how these could grow.
Bottom-Up forecasting requires rigorous bookkeeping to be most effective. You need to have a total understanding of all the costs and revenue associated with your business. Hiring a consultant to help manage your bookkeeping will make Bottom-Up forecasting much more accurate.
Which Is Right For Your Business?
Generally, the Top-Down method risks being overoptimistic, as it's difficult to tell how the market will react to your startup. Conversely, the Bottom-Up approach can be too conservative to look exciting to investors and can struggle to provide a reasonable estimate of the far future. A good tip is to use the Bottom-Up method to forecast for two years and then start using the Top-Down approach.
Together, this will provide context for your company's immediate future and a longer-term goal for your startup to strive towards. More importantly, this double method demonstrates to investors that you understand realistic finances but also have the potential to give them a return on their investment.
What Goes In a Forecast?
Even once you've decided on the methods you want to use, it can be challenging to determine what should go into a forecast. Every investor will have their preferences which you should enquire about. Here are some of the most common tools you should be using.
1. Balance Sheet
The Balance sheet will be an overview of all of your startup's assets and liabilities at a particular point in time. It will also show how much debt your startup has, as well as equity.
Since you should be formulating a balance sheet every year, if not more frequently, it can provide a useful map of your finances.
Essentially, by understanding your startup's financial position and what factors created that position, you can create a realistic-looking figure of what your finances will look like down the road. A good forecasted balance sheet should include forecasts of net capital, fixed assets, financial debt, equity position, and cash position.
2. Cash Flow Statements
Cash Flow Statements show the entry and exit of cash into your startup over a specific period. You can get more specific by developing an operational cash flow statement that describes the money spent and earned from day-to-day operations. Cash Flow Statements give a better understanding than Balance Sheets of what times your company has its most and least cash in hand.
Cash Flow forecasting focuses exclusively on your income and expenses, estimated using your previous cash flow statements. You should also measure the cash your business has typically at the beginning of each month in a year. This way, you can track your cash flow trends and extrapolate them into the future.
3. Profit and Loss Statements
Profit and Loss statements are an overview of income and costs to indicate whether your company is profitable or not; typically, a Profit and Loss statement includes many useful metrics such as your gross margins, net margins, and EBITA, which can all let you better compare your efficiency to other companies.
Profit and Loss forecasts require revenue, the variable cost, gross profit, and net profit. With these, you can determine if your net profit in any given month is positive or negative, ad what costs are giving you those results. You can add or remove expenses to better match how you see your business operating in the future - combined with an estimation of sales; you can then forecast what your profit and loss will look like.
Get Help Forecasting Today
If all of this seems overwhelming, that's understandable. Knowing how your business is doing is one thing, but making estimations about the future is always tricky. It helps to have seasoned financial analysts in your corner.
At Punch Financial, we specialize in providing high-growth companies with a modern accounting experience. Instead of hiring a full-time strategic CFO at great expense, you can outsource your financial back-end and strategic needs to a firm with proven results for a fraction of the cost.
Our mission is to help you streamline your back-office, provide you with actionable data, and reduce your overhead. Let's connect to give you a customized quote and free consultation. You have nothing to lose but so much to gain.