Revenue models for financial planning explained

- So your revenue model is going to drive your entire financial plan and in fact your business, as I've said before. Your revenue model allows you to forecast all the money that's going to come into the business and this is the important thing that you do. So I want you to consider a couple of things. First of all, while predicting revenue can be difficult, I want you to use all the information at your disposal to actually come up with this forecast. Use all that industry information, all the information that you know in your gut and that's going to help you in guiding you to coming up with the most accurate and the best revenue forecast that you can. Make sure that you take into account all things that will reduce revenue as well, like returns, spoilage, churn, attrition, all of those things are important. So in order to forecast revenue you also need to understand all the strategies that we've been talking about. So you need to understand your product and service and what your product strategy is overall and how that's going to feed into the different lines of revenue that you're going to actually create. You need to understand your pricing strategy. How much are you going to charge? You need to understand the market and what the market says. There's some industry statistics that actually come into play when you're projecting these things. You need to understand your competition. What are their benchmarks? How are they doing? You need to understand your distribution and selling strategy. That's critically important to understanding your overall revenue model and you need to understand your marketing strategies as I've harped on over and over. How are you going to acquire customers? How are you going to create demand? Those are all very important things. So when you're working with your revenue model, I think one of the most important things that you can do is determine how aggressive or conservative that you really want to be with your projections. Now, what's interesting is that if you're an optimistic person that you're going to always lean towards a little bit more aggressive and so what you think is actually conservative might be really aggressive and the reverse is true for a pessimistic person. So I want you to take into account what kind of person you are, whether you're a little bit more optimistic or whether you're more pessimistic when you're doing your financial planning. I know it sounds a little bit odd, but it's actually really important. I want you to take a balanced approach. Here's what's important, that if you're too conservative then investors are going to say, "I'm not interested. "I don't want to invest. "There's just not enough money here." And if you're too aggressive, the believability factor is just not going to be there. Investors are going to say, "I don't believe it. "I don't think you can do it." And then they're not going to invest. So you've got to find that balance of where you're actually going to hit which is really very important. Also, I love actually creating what I call multiple revenue forecasts. I like creating a conservative, a most likely and an aggressive format. When you force yourself into doing this level of detail, that's actually three separate forecasts and when you force yourself to do this you're actually going to be able to come out with better estimates that will actually be balanced because you're going to go with the most likely because then your brain actually will think about, "God, this is really aggressive," and then, "This is really conservative," and it will kind of settle into what that balanced approach is which is, "Here's my most likely case." And then you want to deliver the most likely case to your investors or anybody that you're talking to. Next, I want to take a look at our staffing model and since a staffing model is actually so important and it's an expensive component to your overall business and it requires a certain level of detail, I actually like to break this out from the expense model overall so that we can really get a handle on things. Now, we want to include two things in the staffing model. Number one, is want to include the number of employees and how employees will work but I also want you to include all your contractor information. And more and more today, businesses are actually outsourcing things or using contractors for things so we've actually included that in the financial model itself which I think is very important. So some things you need to know when you're actually figuring this stuff out. First thing, you need to know the staff that you're going to need to get to your MVP. What's your MVP? Your minimum viable product. That's very important. How am I going to get through my startup phase and how much staff do I need? You need to know the staff that you need post-launch as well. What's my staff look like post-launch? How am I going to support this business overall? I typically like to take the staffing model out about three years, just like my other financials as well, so kind of keep that in mind. And we need to also understand what are your staffing needs as your business scales? So what's your growth plan? What's your selling strategy because you need to know how many sales staff to hire and how they're going to actually get hired over time. What's your marketing strategies and how do you need to grow your marketing organization? How about product development? How are you going to keep that product development going on an ongoing basis? What is the staff that you need in order to do that? And if you're a services businesses this is even more important because as you're selling services you're actually using people in order to provide them so you need to actually predict how many services people that you're going to need in order to keep your business growing so in your execution plan you need to understand how you're going to support all these customers that you have now that are buying your products and services. That's going to be really important, all right? So some other things that I want to make sure that you consider are job descriptions or the roles and responsibilities of the people that you're hiring so you understand exactly how much each individual person costs. I want you to understand the cost of labor. So one of the things that I like to do is go to salary.com and put in all the information that you can put in about that job and it will come up within your region or even your city and actually tell you what the salary should be for there. I guarantee you, by the way, all the people you're hiring go to salary.com too and check it out so be careful with that. Also, the timing of each hire. When are you going to hire these people? How are you going to bring these people on and how long is it going to take to actually ramp these people as well 'cause you have to factor that in, training and education needs to be factored in to the overall plan as well. And then planned increases. So as you do your staffing model, over time, you're going to have to give people raises. You may not want to do that but you're going to have to. I like to estimate a 2% raise per year increase in my financial model. That's kind of the standard. It doesn't, and I do it for everyone. It doesn't mean that everybody gets a raise, but it kind of averages out. Some people get 5%, some people get nothing. It kind of averages out to about 2% per employee. And also take a look at your contracting rates and are they going to go up over time or maybe are they going to go down over time too. In some cases, when you're doing big volume, in fact your contracting rates will actually go down. And then finally I want to make sure that you include benefits into the overall model and I like to estimate about 20% for benefit calculations. We're going to do a more in depth model when we actually get to the staffing model itself and we figure out everything but generally speaking, 20% is a good estimate for all benefits including medical, including vacation time, all that factored in is about 20%. Then I want you to be thinking about temporary help or seasonal help as well. So if you have a cyclical business, these are some of the things that you need to consider as well. All right, the last model we're going to take a look at now before we get into financial statements is our expense model. This is really important. All that an expense model is is projecting all the costs associated with running your business. Now, I like to actually break up my expenses into four different categories because it really lends itself to actually creating the financial statements, so follow along with me here. First one is G and A and G and A stands for general and administrative. It's just a fancy term for that but basically all it is is your overhead, sometimes your rent gets calculated into here, your management salaries, your IT staff sometimes actually gets calculated here. Things that are not directly connected to the operations of your business get put in here. Executive salaries sometimes can also go in here as well. Next area is cost of goods sold or what we also call COGS. COGS is kind of a funny name but it's an accounting name that people use all the time. And these are, it's very important here, follow along, it's expenses directly related to delivering the product or service and to support it like support costs, salaries for delivering that service, raw materials, storage, IT expenses all get wrapped up in this thing we call COGS. Very important because that from that, we can actually generate what we call gross margin. Very important statistic in finance is gross margin. Our next category is product expenses. Now product expenses we like to separate out from all the other expenses because of the way that they're handled and the way they fall what we call below the line. They fall what's called an operating expense as opposed to above the line which we call a cost of goods sold. So this would be staffing, machinery, other things that go into actually creating the product, not the service, but the product. And then finally, another nice and very important category is sales and marketing. This also falls below the line and is considered what we call an operating expense and this is all costs associated with generating revenue. Right? So why do we break up all these things into different categories? Because this is how the accounting standards work so you don't need to question it too much but what this is going to do is it's going to give us those very important financial indicators if we break it up this way. Things like gross margin, operating margin and profit margin when we actually look at our financials that way. That's the rationale behind it. When we get into the models, you'll start to understand it a little bit more. We actually look at the spreadsheets associated with it.