Running your startup without a budget or forecast is a lot like packing a suitcase for a trip you know nothing about.
Imagine I invited you on said trip but didn’t give you any more information. How would you even begin to pack? You don’t know the length of your stay, where you’re going, what the weather’s like, etc.
Without a plan, you’ll likely bring a lot of stuff you don’t need while forgetting some essentials. You might go out and buy a fleece-lined parka, only to find out you’re enjoying a tropical beach vacation. Perhaps you don’t bring your work laptop, but then discover that on the beach, we’re meeting with several high-profile investors.
Early-stage companies that operate without a financial plan run the risk of misallocating resources, wasting time and failing to align on business goals. A proper budget or forecast, on the other hand, spurs resource efficiency, acceleration of timelines, accountability, and the versatility to adapt on the fly with data-driven insights.
Startup founders will give themselves a great start by understanding the differences between a budget and forecast and mastering the three most relevant types of financial models. Let’s learn how financial modeling helps you “pack your suitcase” for your startup’s growth journey:
Budget vs. Forecast
The terms budget and forecast are sometimes used interchangeably, but they’re not quite the same. Both are financial tools used to reflect the results of your startup’s strategic plans, with a few key differences.
What is a Budget?
A budget is a financial plan that reflects the results of the strategic plan if executed exactly as modeled over the fiscal year. It is rigid and can be interpreted as the limits for spending. Many of us are familiar with the question, “is this in budget?” when making purchase decisions. In the startup world, there are many more factors that should be considered.
As with all financial plans, budgets facilitate accountability for financial results. They are generated before the start of the fiscal year, and are usually updated semi-annually or quarterly. Budgets stay more static than their cousin, the forecast.
High-growth companies should align goals with their budgets but also be aware that circumstances change quickly. Agility, responsiveness and adaptation are key characteristics of a successful startup, so it’s best to use a financial model that shares those attributes.
What is a Forecast?
A forecast is a financial tool that reflects real-time estimates of financial results based on dynamic execution of your strategic plan.
It’s updated more frequently than the budget — usually monthly or quarterly. Often it’s presented as a rolling forecast, which operates on a rolling 12-month period rather than a calendar year.
The forecast can be used as a tool to guide business operations and dynamic strategic decisions, including scenario analysis, merger and acquisition decisions, pricing strategy, optimal product mix and response to unforeseen external factors.
How does a forecast relate to the different types of financial models? Forecasting is a company’s way of preparing for the future by determining expectations. Financial modeling involves taking the predictions from a forecast and incorporating real-life numbers from the company’s financial statements. This produces a predictive model to guide decision-making.
What is Financial Modeling?
A financial model is a representation of financial outcomes experienced, or expected to be experienced, based on a set of business decisions, operational inputs and predicted metrics.
In other words, financial modeling answers the question, what is the financial outcome of my startup’s business plans? Financial models present similar information to financial statements but often divide that information up in different ways with different presentations.
Thorough financial modeling drives strategic growth and allows founders to predict when they should adjust their plans or stay the course.
3 Types of Financial Models
Here I’ve outlined three popular types of financial models:
Quota Model and Compensation Planning
This form of model typically focuses on employees and their compensation, with extra emphasis on the sales team. Included in this model is information on commission plans, accelerator and bonus programs, quota attainment projections, hiring roadmaps, profit sharing plans and more.
Quota model and compensation planning is especially important for high-growth SaaS companies, because so much of their resources are applied towards sales and marketing efforts to grow annual recurring revenue.
Bookings and Revenue Model
The bookings and revenue model zeroes in on the customer-focused aspects of your business, such as pricing and packaging, customer retention, pipeline development and sales conversion.
It’s different from a financial forecast because it models the inputs and events that ultimately lead to revenue. (Think: qualified leads, demos and conversion metrics.) It utilizes these specific aspects of bookings and revenue (that may be non-financial in nature) to ultimately predict top-line revenue.
Startup founders and operators need the tools to make data-driven decisions. Scenario planning helps you prepare for major events in your business’ roadmap, such as mergers and acquisitions, facility expansions, new product introductions and unexpected external events.