Jaime Medina
In the previous article, we discussed the dangers of being overly confident in forecasts. However, we see that all companies create business plans and budgets, and all of them make a medium- or long-term forecast, being one of the most important documents for investors and the company’s management. Why is that? Forecasts should not be given more value than they deserve… but they certainly have a lot of value.
First of all, forecasts provide anchoring and a magnitude estimate for the numbers. If we project the future using the most realistic business drivers, we get an initial, continuous picture of how the business will evolve. We know that the exact numbers from the forecast won’t be perfectly accurate, and the company will likely take actions that could positively impact these projections. But it’s definitely a solid starting point. If this steady outlook shows that the company could grow by 30%, it’s likely that actual growth will be somewhere between 20% and 50%. It’s very unlikely, though, that it will be 500%. Without this forecasting exercise, decisions can’t be data-driven. Similarly, even if the startup hasn’t launched yet, a forecast can give a rough idea of the figures. Whether we’re talking about hundreds of thousands, a million, or ten million in revenue over three or four years, a forecast provides a reasonable estimate.
Secondly, a realistic forecast can be extremely powerful. For example, if we have an accurate measure of the scalable CAC (customer acquisition cost), we can forecast effectively how marketing investment will drive new customer acquisition. We can also immediately see which business line is worth investing in. If done realistically, we can determine whether hiring three app developers will pay off in the short term before the next funding round. The examples of short-term use cases are countless and crucial for managing the company and making informed decisions.
Finally, and we can’t emphasize this enough, a forecast must be based on the unit economics of the business. No one can sell Ferraris by running one-euro ads. If our forecast predicts acquiring a large number of new customers but doesn’t include the necessary acquisition costs, we’ll end up with unrealistic and unfeasible unit economics. In the forecast, we can immediately see whether we need to invest more in acquisition or lower revenue expectations. The opposite can also happen. If we predict that an initiative won’t generate a healthy return on the investment we plan to allocate, there’s no point in moving forward with it. A variation of this is comparing mid- and long-term numbers, whether the business has already started or not, against industry benchmarks for that specific business model. If we forecast a SaaS business with a 30% margin, by checking against benchmarks, we’ll quickly see that this number doesn’t make sense, and we’ll need to rethink the business model.
Forecasting exercises are necessary, but they must be done correctly. With the right experience, dedicating enough time, and, most importantly, being honest with oneself, forecasting can become a powerful tool for making short-term decisions and setting the long-term direction of the business.
