Updated: May 17
“I feel like I’m pulling numbers out of thin air. It's still unclear to me how to ‘project’ and build believable financial assumptions.” — Liz
Good news: everyone feels this way and it's totally normal! Many entrepreneurs worry when it comes to their numbers. I almost drove my first company into the ground. That’s what it took for me to decide to learn enough startup finance to be successful.
Start by filling your brain with questions, not answers
The important thing is to start building your mental map. Don’t worry about getting the numbers exactly right, or even close. No one can accurately predict the future (ahem, Covid) so don’t worry about precision yet.
Here’s how powerful this is:
“I’ve worked through the Rocket Pro Forma hiring plan and realized how much $$ gets spent on salaries. Thus, I am focusing on key positions (salaried) in these early years, and using independent contractors in budgets for projects or consulting, hourly for fulfillment, and interns where needed (they can be wonderful help!).” — Liz again
What an incredible confidence boost in just a few days! Liz put together a first draft of her pro forma projections, realized she didn’t like it, and created a version she likes better. Best of all, she can now explain to anyone—including an investor—why she’s taking this approach.
Just get started and keep moving. The answers will come to you as you fill your brain with questions. You’ll learn in stages:
Pulling ideas out of thin air
Researching likely answers
Adjusting as you run your business
Mastery based on experience & data
You may only need to get to stage 2 to raise money, although many investors respond better at stage 3.
Stage 1: Pulling ideas out of thin air
Here’s what this sounds like:
“I have been gathering exact data for operating expenses, too, and made advances in product development which is a big part of COGS [cost of goods sold]. I still have to work out the revenue model. I am clear how it works conceptually but am unsure how to translate into the model and actual numbers.”
We can actually watch the learning happening here. Find a good pro forma template for startups and work your way through it.
Think of your startup’s pro forma financial projection as a living document that will evolve over time (exactly the same as your pitch deck, except that you’ll keep using—and improving—your pro forma projections even after you raise the money).
The goal of the first time through is to build the mental map of how money flows through your startup, so don’t worry about the quality of your answers yet. You’ll learn to find better answers later.
Stage 2: Researching likely answers
You’re not the first person to start a company, no matter how unique your idea is. There are standards and industry averages that investors expect to see in your startup’s financial projections. These aren’t mysteries, and they’re easy to find once you start looking for them. For example:
I recommend aiming for annual revenue per employee of $200k to $500k by year three of your pro forma financial projections. Anything less makes you look inefficient, and anything more starts to make you look unrealistic. Here's my deeper dive on revenue per employee.
Your conversion rate (CVR) is what percentage of visitors to your website purchase and/or take some other action like email registration. A good starting guess is 2%, meaning that for every 100 visitors to your site, 2 people will take the action. You may get better over time and converting visitors, so a good financial model template will let you adjust your numbers for each year.
The subscription lifetime is how many months your subscribers stick around before canceling your service. A good starting point is usually 18 to 24 months. Again, you may get better at retaining subscribers, so a good financial model template will let you adjust your numbers for each year.
You can do a little research on any metric—ask Google and/or the mentors you work with—to find a good starting point. I find it’s best to get several opinions and decide from there because no one has all of the answers, especially when it comes to your business.
Stage 3: Adjusting as you run your business
Magic happens when you find your first paying customer—and your second, your third, and beyond. You haven’t created a business unless you have both revenue and expenses (without revenue it’s just an expensive hobby—or an unofficial charity).
As you start spending and making money, you’ll be able to adjust the assumptions in your startup's financial projections based on actual results.
For example, founders often ask me what their conversion rate (CVR) and cost to acquire a customer (CAC) should be. There is no "should." There is only the individual answer for your startup—which no one else can answer.
Here’s how I started answering this question when I launched Rocket Pro Forma:
For CVR (conversion rate) I compare weekly unique visitors tracked in Google Analytics with the number of weekly purchases. My CVR hovers between 3.8% and 4.2% each week.
For CAC (cost to acquire a customer) I first need to know what it costs to get a complete stranger to look at the RocketProForma.com website. I ran a test on Facebook Ads that cost me $64.67 to learn that my cost per click averages around 60 cents:
Now I can calculate my CAC as ( CPC divided by CVR ).
In my case this is ( $0.60 / 4% ) so my CAC = $15 per customer. I can compare this to the $44 to $99 that my customer spend per purchase. So my revenue per customer is 3x to 7x my cost to acquire each customer. I should be able to build a healthy business off of these numbers.
And it cost me $64.67 to figure it out.
Stage 4: Mastery based on experience & data
Not only does your skill with financial projections improve over time, your data gets better as you run your company. You’ll also start adding to your management team as you grow, so you’ll have help. Possibly even from seasoned executives who have done this before.
You’ll never achieve perfection, but you’ll learn to come closer each time.