Every business needs to have a realistic cash flow forecast to plan for the future. Specifically in SaaS, cash forecasts are crucial to understand how to finance the business, plan for future raises, and set growth targets. Because of the importance of an accurate cash forecast, it's crucial for founders to diagnose why their cash forecasts could be wrong. The following reasons aren’t meant to be a comprehensive list, but are five of the most common causes a cash forecast could be wrong.
1. The model is wrong for your business
It doesn’t matter how detailed and precise your forecast is - if your cash flow model doesn't align with your business model, you will inevitably be wrong. E-commerce financial models are much different than SaaS financial models because of the way they operate. For example, the SaaS model will need a financial model that accounts for subscription renewals, customer acquisition costs, and costs of goods sold.
2. Outdated operating assumptions
Garbage in is garbage out. Your cash forecast is only going to be as good as the assumptions it relies on. That's why it is critical to use current operating assumptions as drivers in your forecast - especially in a growing startup where every day is different than the last. No matter what tool you use to forecast your financials, make sure that you have a way to track your operating metrics real-time, so you can use your business' current performance to predict your future performance.
3. Errors in the forecast
Whether you're using a spreadsheet or software to forecast your runway, your model is susceptible to errors. It's crucial to understand that increased complexity fundamentally increases the probability of error in your forecast. Anyone who has created a financial model in a spreadsheet has found at least one if not multiple errors that materially changes the outcome of the forecast. Software can help with reducing errors, but it's always important to recognize that the more inputs there are in a model, the more places there are for you to make a mistake. Always sanity check your financial model by comparing with historical financials and ask yourself, "Do these numbers make sense?".
4. The expenses don't scale with revenue
An often overlooked component of a cash forecast is the cost of growth. It's easy to increase your growth rate and see an ever-increasing runway, but the reality of growth is that it's expensive. Building your model around your Customer Acquisition Costs allows you to learn how much growth you can afford while still managing your runway. Additionally, as you increase investment in growth, your Customer Acquisition Costs will likely increase, so be sure to change your assumptions at key inflection points in your company's growth.
5. Unrealistic assumptions
The final accuracy killer is unrealistic assumptions. One of the most challenging things as an early stage company is knowing what realistic operating assumptions are when you have little or no operating history. Talking to other startup founders, your accountant, advisors, or other experts can help you get some clarity, but ultimately you will still be making a guess on what realistic assumptions are. This is where scenario analysis can be really helpful. You should be creating multiple forecast scenarios with different assumptions reflecting varying levels of optimism about the future. Having multiple scenarios can help you know what to be prepared for and can give you a range of expected financial outcomes instead of a single estimate.
These are only five of many reasons your cash forecast could be inaccurate, but these are among the most common. Cashboard is a financial modeling tool that automates the creation of the financial model, gives you up-to-date analytics to be used in your forecast, and reduces as much of the human error as possible. Click here if you would like to schedule a demo.