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Waterfall is a perfectly efficient visual way to see your key metrics
Venture Investor, VenRock Partner, Waterfall Evangelist
Reforecasting is necessary but does not need to be complicated or time intensive.
Having all forecasts on one page is efficient and helpful for BoD members.
Waterfall is applicable to any company at any stage.
Lesson: BoD Management with Brian Ascher
Step #7 Waterfall Method: Waterfall is a perfectly efficient visual way to see your key metrics
There are a couple of key tools that are really relevant. I think one of the most powerful tools is called the waterfall report. And that's really where, whatever key metric you're looking at, whether it's financial metrics like sales, or expenses, or cash on hand, or it's operational metrics, like head count or number of customers or users, you have the annual plan and that's laid out on the top. And then you have the actual reporting intervals as columns, whether it’s monthly or quarterly. It's generally one of those two. And then you have your re-forecasts on some frequent cases. It's either monthly re-forecast or at least aligned with every board meeting.
And the idea is to have the current working view of that given metric updated all the time. So as you look down a column, let's say it's quarterly sales, you could say, "Okay, the plan was for $2 million of sales." After the first month we realized we were going to be behind, so we said "$800,000." And then the second month we said, "No, it's going to be $700,000." And then we came in at $650,000.
And over time what you'd like to see is that you're getting better and better at forecasting your business. You have a good visual. You can't always be perfect in December of the year before at forecasting what December of the next year is going to be. But certainly as you get closer to those results you see them, and over time you start to get better at forecasting. It's a perfectly efficient visual way to see how predictable your business is getting and what you thought in the past, and how that thinking evolved over the course of time for all the key metrics.
I'd say it typically works out to be eight to ten key metrics for a waterfall report, some of them financial, some of them operational. And I think it's just a super powerful tool. But it only works if you're willing to re-forecast. It is useless if it is all just the same number as planned, except for the bottom number, which is the actual, and it's just wildly off. Then you haven't gotten any value out of it.
So it takes a little bit of work to do the re-forecasting. Sometimes there is push-back from a CFO who is like "Oh, my God, re-forecasting! That's going to take so much effort and we have got to get the whole team..." It doesn't necessarily have to be a formal re-forecasting. You don't necessarily have to get the whole team in the room and grind on it for hours at a time. It could just be a solid current working view of the CEO or the CFO. You know, they ought to run it by each other, but even a good informal guesstimate is better than saying we have no idea how the quarter's going to look even though we're two months into the quarter.
For companies that don't want to go all the way to a waterfall, it could just be a re-forecast half way through the year. That would typically be on financial metrics. It may include some of the key operational metrics.
But I think another very standard report that you'd want to have is just always showing the quarterly plan, the plan by quarter, since business tends to operate on quarterly cadence. And then forecast and update it as often as quarterly but at least midway through the year. And then actuals, turn the forecasts for the past quarters into actuals. And I like to see just a reminder on one simple page what was last year, it could be the full year, and if you already have next year, if you're already in Q4 and you know what next year is going to be, put that out there. Even if you have a three-year view in the future, it's nice to see that all on one page.
Sometimes entrepreneurs don't appreciate that their board members, whether they're investors or outside directors, they're not living the business every single day and they might have a portfolio of ten companies. So it's not always easy to remember what the Q3 forecast was. And so having it there on just one page is a very efficient way, and it's a template, so it's not hard to update the numbers. That's a great one.
And then, ideally, you're going to want to have a dashboard of some key operational metrics. It could be customer satisfaction. It could be bug count. It could be a variety of things. And it's best if that really comes from management, and they fundamentally believe that these are the important indicators of the business.
And I think it's important to revisit that every year or so and say, "Are these still the right metrics? Are these still useful to everyone in the room?" Some of them are actually more useful to management than to the board and then it's time to take them out of the deck. Let's stop having to pretty them up into PowerPoint and just slim down those board decks.
What I like about the waterfall method, in particular, is that it's so efficient. You always see plan by granular detail of months or quarters, and then you can really track your progress of how your visibility improved or not. You have this historic record that, when you look back over the year, you could say, "We're starting to see some visibility and predictability in the business. That's a good sign," or, "You know what? We're just getting surprised all the time here. Two months into a quarter, we're getting surprised by the end results. Why is that? Is there a fundamental problem here? Is there some inherent lumpiness in the business? Is there a better way we can approach the market so that we have better visibility?"
I think it achieves a lot of different objectives and very efficient real estate. I first learned the Waterfall from one of my partners who had been doing venture for ten plus years and swore by it as the best reporting tool. I wrote a blog post on it, "the single best board reporting tool." I think it's great.
I think the waterfall tool is applicable to any type of company and any stage. It may be the case that you're a consumer company that is not yet worried about monetization, so there's no need for financial metrics around sales.
You could use it for purely operational things around users, active users, posts, or whatever the right metric is that's a key success factor. You're still going to want to have some ability to forecast what those are and ideally see your forecast as you get better and get closer to the end of that time frame and ideally improve your long-term forecasting as you get more experience running the business and you start to figure out what moves the needle and how things work.
It's always useful for, at the very least, cash and headcount. If you are not using the waterfall for cash, how are you figuring out–you have to have a current working view on cash that has to be updated. You can't ever rely on, "Well, we had a plan from last December. We'll figure out how cash is going to be when we see the end result at the end of the year. You're always doing that so, at the very least, headcount, cash, and a waterfall.
Waterfalls, you know, are not necessarily always the scarlet letter of bad news and missed plans. There's definitely plenty of periods where you came out ahead of the original plan or the quarter got off to a slow start, so you started to revise down your forecast for that quarter. But then things came back strong in the end, so you actually increased your forecast from that first or second month of the quarter. So, they contain plenty of happy news.