All of this talk about assumptions is really leading toward one goal: creating a forecast for how the business might perform. By themselves, assumptions are just specific guesses as to how one aspect of the business might work, such as the cost to acquire a paying customer. Forecasts are all the calculations that take that value and answer the big question “Is this business model viable?”
Forecasting isn’t about being “right” about future numbers. It’s to figure out what metrics we need to achieve to make our business work profitably. It doesn’t matter if we think the product will sell for $30 or $300 – so long as we know how either value will affect the overall viability of the business.
So, let’s think about forecasting as a worksheet that we will modify a million times as we learn more about the business to figure out which aspects are working, and which need a ton of help. The process itself is incredibly cathartic, as it will force us to track down answers to things we may have overlooked, such as the cost of our product as we grow, the point at which we start needing to hire people, or how we’re going to actually pay to acquire all these new customers.
While these are certainly going to be guesses initially, what we’re focused on right now is how the values of those guesses impact our overall business model and profitability. All of these guesses (we call them “assumptions”) are going to get plugged into the document that will soon rule our lives – the “Income Statement”.
Good question. An Income Statement is just a spreadsheet where we add up all of our income in one area and all for our expenses in another. We subtract income from expenses and are left with our profit (or loss) which we call “Net Income”.
World’s Most Basic Income Statement
(Income minus Total Expenses)
If that doesn’t sound too hard – it’s because it’s not! As the business grows we can get into more complex models, but for now, we’re just going to keep it super simple and get on with our lives.
Long before we’re ready to start collecting money we will likely be setting up forecasts for how our business will perform. Even if we’re already collecting money we’ll still need to constantly set forecasts for the future, so the exercise is the same. Our forecasts are just a method for us to populate the income statement with where we think the numbers might land.
In this phase, we’ll begin dropping those numbers into the spreadsheet one by one. We’ll walk through each of them – category by category – to make it easy to understand. At first pass, this may look like a lot to digest, but remember, it’s just the same category of numbers repeated 12 times for each month.
The proper financial term for this is a “Pro Forma Income Statement” (something we may hear in our discussions with investors) which simply means “a forward-looking income statement” which simply means “we guessed at the values here.”
The income statement is the lifeblood of a company. Everything we do – from how we handle marketing to who we recruit to whether this idea really makes any sense – will map back to the income statement. We can pretend that “we’re killing it with our marketing!” but if the income statement says “we’re losing a ton of money every time we acquire a customer” – the truth is in the numbers!