You have recently started a startup or you are in the process of creating a new business. A financial plan is of extreme importance to also include in the plans you create for your business. Why? First of all, it helps you determine short-term and long-term financial goals. This is very important in order to create a economically viable business. In this article, we highlight the do’s and don’ts when it comes to financial planning.
Getting to a financial plan is probably not the hardest. Online you can find enough excel templates and some excel-savvy can always help you to get around. The hard part, however, is how do you get to the numbers? How do you forecast sales? What is the size of your target group and your market? And what will you invest in your business to grow. Below we will discuss two methods to forecast your financials.
Top down forecasting
You can forecast your finances by using a so-called top down approach. This means that you take the industry estimates as a starting point and then you narrow it down into targets that fit your company. This method helps you to define a forecast based on the market share you would like to capture.
You could use the TAM SAM SOM model in order to estimate your market share.
TAM or Total Available Market is the total market demand for a product or service.
SAM or Serviceable Available Market is the segment of the TAM targeted by your products and services which is within your geographical reach.
SOM or Serviceable Obtainable Market is the portion of SAM that you can capture.
For example, your company has created an app. You look at the number of the consumers who have purchased apps for their phones. If there are 100 million active users of phones and half of them buy at least one app per month, you can extrapolate from there. You could estimate that of the 50 million active users who purchase apps, 1% of these consumers will purchase your app. That would give you 500K new customers.
But be careful using this model! Entrepreneurs generally tend to be too optimistic while putting this into numbers. So base your numbers on facts and create realistic projections.
Bottom up forecasting
The bottom up approach is less dependent on external factors. bottom-up forecast is a detailed budget with spending plans by department. Hiring plans and revenue projections are based on actual sales forecast. Contrary to the top down approach, the bottom up approach starts with an inside/micro view and builds out to the macro view. This approach is a more strategic approach where you look at your current situation, your capabilities and you see where you can reasonably expect to go from there.
Instead of looking at the market potential, you need to look at your own market (existing customers or social media followers) and map out how you can turn your current standings into new sales.
Since you will be looking at the real numbers it is harder to get unrealistic projections with bottom up forecasting.
No matter what approach you will probably build some numbers on assumptions. As a startup, you probably have no historic data available so you will probably use one of the above mentioned methods plus assumptions to present the proof behind your numbers. Assumptions can be anything that validate your numbers ranging from market research, contracts with suppliers, pricing validation to conversion rates and website traffic.
Using this also helps you when you discuss with investors as they are interested in the reasoning behind your numbers.
Good luck with creating your financial model.
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