3 Steps to Understanding and Projecting Startup Finances
Updated: Jan 31
Understanding the finances for your startup can be overwhelming, and the task of projecting your finances into the future only adds more layers to the complexity. The book Levers by Amos Schwartzfarb and Trevor Boehm, breaks down startup finances into 3 steps: creating a revenue formula, listing out your assumptions, and building a model around your assumptions. Each step will give you a deeper insight into your business, expose the levers you can pull to impact your business, and allow you to have a full understanding of your startup's future finances.
Your company's revenue formula is the equation that is specific to your business with all the variables that impact how much money you will make. Creating your revenue formula will remove all of the emotion and noise around what decisions and actions have a direct impact on your revenue. This formula will help you prioritize and start seeing the levers you can use to control your business. An easy way to create your formula is to understand how your customer goes from not knowing who you are, to purchasing something from you. This is called your customer journey.
For a freemium SaaS company, you might start with your ad or social media post views. From there, a percentage of your views will turn into website visitors, these visitors will become free users, and finally, some free users will become paid users. Your total paid users multiplied by your subscription price will be equal to your revenue. The formula below takes the total number of ad views and multiplies that by the conversion percentage during each step of the customer journey, and then multiplies it by the subscription price.
With the revenue formula for the freemium SaaS company, you can see that tweaking things like ad messaging, landing page copy, upselling within the app, or the simple changing of the subscription price will have a direct impact on the revenue. These are the levers of this freemium SaaS company.
Now it's your turn to create a revenue formula for your business, and uncover the levers to your business.
With your revenue formula in hand, the “lean startup process” can now take place, where you can make assumptions about the levers of your business and start testing them. Assumptions can be anything from what your initial conversion rates are, that your messaging in your ads is effective with your target audience, or that users will pay for the value you are bringing to them.
For the sake of financial understanding of your business, let's focus on your financial assumptions. I recommend making assumptions you have based on each part of your customer journey. I find using a visual aid like a sales/marketing funnel to be a helpful way to break up the customer journey and to use the top, middle, and bottom of your funnel as ways to categorize your financial assumptions. Below is an example of listing out and categorizing some financial assumptions, their values, and where they came from.
This process can get very tedious and overwhelming, so I recommend focusing on one channel you are using to reach your new users, and then adding more assumptions for other channels after you have finished the first one. There are a lot of common assumptions for each channel so doing one will make the rest easier, and there aren’t a lot of similar assumptions as you move further down your sales/marketing funnel, so the process does get faster for the lower parts of your funnel.
Completing your assumptions list will give you a crystal clear understanding of what to expect from each channel, reasonable benchmarks to measure up against, and what assumptions you need to test to get data for.
Building Your Financial Model
You now have everything you need, besides expenses, to build your financial model. If you need help with tracking expenses, check out our blog post on 3 Steps to Mastering Your Accounting.
I’m going to give you a shortcut to make creating your financial model easier. the Levers book has a sample financial model google sheet, but I added a couple of things that helped me organize better and do some simple revenue projections and bottom-up TAM (total addressable market) calculations. You can find the Dium version of the template here, the template has some sample data to help guide you on what your final financial model should look like.
Your job now is to enter all of your assumptions around your revenue formula into the correct places in the template. You should see the template getting to work as your monthly and yearly models start being created and honed with each additional assumption you enter. There are also sheets to help you track your expenses like salaries, COGs, and operating expenses. Filling these out will further hone your financial model. You now have a super calculator for your business, which will help you visualize the impact of each lever of your business.
In all of the sheets, you can add as many columns of data as you need to project out as far as you need. Typically it is good to model out to 3 years minimum and to have a worse case, best case, and current trajectory case model. This will help you see how much cash you need in reserve, decided on expense increases or decreases, and allow you to make smarter hiring decisions.
For advanced Google Sheets/Excel users, it helps to name the cell with the value of your assumption so that you can relate back to it easier on other sheets.
Running a business can be overwhelming, but you can remove a lot of the noise and uncertainty by creating your revenue formula. Through your research-based assumption, you can set reasonable goals and expectations. By using a financial model, you can simplify and visualize how all the levers in your business affect your revenue and profit. If you are looking for more help with this, you can get access to one of Dium's Startup Experts here. The Expert Access Service will give you unlimited email access to a startup expert for your startup questions, and a 1-hour monthly call for accountability and mentoring.
Note: Levers was written around the core curriculum that Amos uses for guiding his startups at TechSqure Austin, TX. I highly recommend picking up a copy ($1.99 for the kindle version) as there are a lot of concepts and tools in the book that will have measurable impacts on your vision and understanding of your startup.