Growth-Based vs Driver-Based Forecasting: An Essential Guide for Startups
In the dynamic world of startups, understanding your trajectory is paramount. Forecasting plays a critical role in guiding your decisions and presenting a credible front to potential investors. Let's delve into the nuances of growth-based and driver-based forecasting, and why the latter often takes the crown for startups.
1. Growth-Based Forecasting
Growth-based forecasting relies on historical data to project future performance. The underlying assumption is that past growth rates can be a predictor of future outcomes.
- Simple and straightforward to implement.
- Can be limiting for startups with limited historical data.
- In practice, most founders plug the revenue numbers into a model first, and then start to model assumptions such as marketing budget and people costs. Some would argue this approach is not based on any well-thought out assumptions.
2. Driver-Based Forecasting
Driver-based forecasting, rather than looking backward, focuses on the present and anticipates the future. It leverages business drivers—variables directly linked to performance such as customer acquisition rates, market trends, and product launches.
- More dynamic and adaptable, suited to the ever-changing startup landscape.
- Requires an understanding of internal and external business drivers.
- Ideal for startups with little historical data and forces founders to think about the assumptions underlying the model.
3. Forecasting Foundations
For your forecast to hold weight, especially with discerning investors, it must be built on a foundation of credibility. Here's how:
- Understand Your Data Sources: Before diving into forecasting, identify where your data is coming from. Is it historical data from your startup’s operations, industry benchmarks, or research-driven estimates? The clarity on data origin ensures accuracy in projections.
- Model your assumptions:
- Base your assumptions on the driver's of the business to help you answer key questions like: "what payback do I get by spending £X on this marketing campaign?", "how much runway do I have, and how long until my next fundraise?" , to more longer term questions such as "how big can the company get" and "what valuation is possible?" - this can be crucial to your projections.
- For example, think about how you acquire customers? You'll likely need to spend money in 2 channels such as paid marketing to drive leads, and SEO / website content to drive traffic and conversions to your website / app.
- If you are thinking of hiring sales people, then you should consider the size of your contracts, it probably isn't worth building a huge sales team if you are driving less than £10,000 per customer each year.
- Factor in Seasonality and Anomalies: Not all months or quarters are made equal. Your sales might spike during the holiday season or dip during a global event. Adjust your forecasts to account for these known variables.
- Keep It Iterative: Forecasting isn’t a set-it-and-forget-it exercise. Regularly revisit and adjust based on new data, insights, or market shifts. The more you are on top of your model and see it as a tool you can regularly use for your business, the more accurate your forecasts will be.
4. The Role of Metrics
Metrics give context to your forecasts and help convey a compelling story to investors, the below are just a few essential metrics:
- Customer Acquisition Cost (CAC): A reflection of the cost-effectiveness of your marketing strategies.
- Lifetime Value (LTV): Indicates potential revenue from a single customer. A higher LTV relative to CAC is a sign of a sustainable business model.
- Monthly Recurring Revenue (MRR): For subscription models, particularly SaaS startups, MRR offers insight into the predictability and stability of revenue streams.
- Churn Rate: A low churn rate signifies strong customer retention and product or service satisfaction.
5. Why Engage with Accountancy Cloud?
Forecasting is both an art and a science. Startups need a blend of technological acumen and sector-specific knowledge. This is where Accountancy Cloud can be instrumental. With our expertise, we empower startups to craft forecasts that resonate with stakeholders, ensuring your financial narrative is both robust and compelling.
While growth-based forecasting offers a linear perspective, driver-based forecasting provides a more adaptable approach, especially crucial for startups. Integrating key metrics into your forecasts ensures they're insightful and compelling, paving the way for a brighter entrepreneurial journey.
Looking to refine your forecasting approach? Accountancy Cloud is here to guide. Reach out and let’s craft your future together.