Budgeting and forecasting using growth rates

- [Instructor] When it comes to business operations for any company that's out there but especially for small companies, one of the biggest challenges is just going through and setting a basic budget and sales forecast oftentimes on something as simple as a monthly basis. So let's take a look at how this process works. I'm in the 02 04 Begin Excel spreadsheet. Now what you'll see here is kind of a basic setup for a small startup company, right? The company starts in 2020 and then operates through 2021 and we've gone through and applied some basic setup costs, right, related to setting up the company, product development, servers, marketing expense, things like that, as well as a few employees that we can grow over time. Now, initially, because the firm's a startup it has no revenues, it starts out with $55,000 in cash in 2020, particularly in July of 2020. Now, from there, we're going through and trying to figure out, okay, how do we think users are going to grow over time? So in the first month we get 10 users, in the second month we are up to a projection of 89 users. So for sitting here in August and we've got 10 users who might say, okay what do we think the rest of 2020 and into 2021 is going to look like? So we could go through and build a basic model that forecasts our number of users, and as a result, the revenues that we'll achieve from those users each month, and to do that, we're simply going to build based on a combination of a gradual increase in the number of users in this case 25 per month, plus a 5% per month growth rate. Now that might sound very quick, and of course it is, but for a startup company it's pretty easy to grow really fast, right? If you had one customer yesterday and now we've got two customers all of a sudden you've doubled your customer count. Most businesses can't do that, but of course, most businesses don't start with just one customer. So if we apply this formula across our entire forecast period, we can get both the revenues and the user count expected for the firm. And what you see when you kind of look overall is the firm's going to run into some cash troubles here, right? This is where budgeting and sales forecasting becomes so useful. We had $55,000 in cash in July, by the time we get to the end of November, we're in trouble, even though we're growing revenues we're not growing them fast enough relative to the expenses that we're taking on. So what could we do in this case? Well, one option of course, would be to try to grow the growth rate just a little bit faster. What if instead of adding 25 customers per month we instead added 35 customers for the first few months and then we scaled it back to 30 over time. And then we got that level for a few months and then we scaled back to 25. Now what happens? Well, now the firm's still runs into a little bit of a cash crunch, but it's much more minor, right? So in this context then, just a little bit of additional help from a revenue standpoint might make all the difference. What if instead of making $20 per user we instead were able to charge $22 per user, right? Let's just see what happens now to our revenue growth rate. All of a sudden, we get to having a monthly revenue of almost $60,000 by the end of 2021 and we have no cash shortages. Now you might say, well, wait a minute, we're just kind of picking numbers and adjusting them, right, how do we know that any of these things will happen? Well in a basic model like this we don't, we're essentially just guessing at what these growth rates might be. Is it going to be 35 users per month in growth rate or 25 or two, we don't really know? We're kind of guessing at what we think it might be and then hoping we can hit those levels. There's as much ambitious targets as they are actual sales forecasts. And this is pretty typical when we think about percent of sales type methods or basic methods of sales forecasting. They're really goals as much as they are forecasts. The alternative of course, is to use a more sophisticated model like a regression based model that builds an actual expectation based on other real world data. That's a little bit more complicated but it can be more accurate if we do it right. Regardless, at this point, you should be in good shape to go through and put together basic budget models on your own.