Creating a Financial Forecast For Your Startup
You’ve been working hard on your startup, and now it’s time to create a financial forecast. Why should your startup create a forecast? There are so many reasons, but my top two are:
- To have a clear understanding of the costs it will take to make your business successful. That can make or break your business!
- If you plan to take on investors, get bank financing or even put your own money into your business, you need to understand how much money you will need before your business can pay for itself.
Generally, we recommend our users have six months of historic data before building their forecast. Is six months of historic data required? Not necessarily, this is just our recommendation. It’s a recommendation we set because forecasting and budgeting is much easier when you have data to start from.
Budgeting without that historic accounting information is absolutely possible, you are just going to need to work a little harder.
5 Expenses Startups Should Consider
Here are five major expenses to think about if you are early in your company’s life:
This one is pretty straightforward! If you don’t have rent yet but plan to have rent in the future (whether you’re renting your own office space or renting in a coworking space), you’re going to have to do some research on what the dollar value of that rent is going to be.
You’re also going to need to think through any software subscriptions you’re planning in the next year, especially the expensive ones. If you plan on cutting any of your current subscriptions, take that into consideration.
Don’t forget these fees! If you haven’t made employee hires yet but plan to within the forecast timeframe, you will need to estimate salaries AND payroll taxes. If you don’t have historic data to estimate your payroll taxes (and benefits if you plan to provide them), I recommend for payroll taxes to put in a conservative estimate of about 11%. If that number doesn’t sound right to you, ask a local HR or tax person what the appropriate rate is in your state and county.
If you’re thinking about benefits, it’s helpful to get a quote even though it can be hard to determine what the cost per employee is going to be. I recommend making a conservative estimate of 17%-20% to factor in both payroll taxes and benefits. If you’re thinking about adding additional benefits like 401(k) or bonuses, simply add some additional percentage points.
Payroll taxes and benefits are often completely overlooked when thinking about hiring employees. Thankfully, it’s an easy thing to add in our software as a percentage of salaries and wages (adding a percentage vs. a dollar value means as you add employees the payroll and benefits aspect is also automatically added).
4. Cost of Goods Sold
Not familiar with this term? Here is a great definition. Cost of goods sold (also known as COGS) is something you might not know yet as a startup. It is common to highly over or underestimate this metric. Typically any cost that varies in close relationship to the amount of revenue fits in this bucket. (Wood is a good example–if you build wooden children’s toys, direct cost of labor is an item if you run a services business.) For a good starting place, Google “typical cost of goods sold” or “gross margin for [insert your industry]” and see what comes up. A good definition of gross margin is here, but basically it is defined as Revenue – Cost of Goods Sold.
This is a tricky one and we aren’t a tax firm, but suffice to say you should think about taxes. Depending on the legal structure of your business you will need to set aside a significant portion of profits toward your quarterly or annual tax payments. This means setting aside cash to pay those taxes at a later date.
Making Forecasting Easier for Startups
This might all sound a bit overwhelming, but it truly is just thinking about the different plans you have for your business (hiring people, opening an office, providing tools for your employees to use), then adding numbers to those plans. Once you fit all of the pieces together you can get a clear picture of where your business is headed and more importantly: what kind of capital you will need to get it there.
Still feeling overwhelmed? Check out our Virtual CFO offering. We’ll facilitate a forecasting process to lift this uncertainty from you! But remember, you know more than anyone else about your business plans (and planned expenses), so for the most successful forecasting, we recommend jotting down a few notes before the call on the topics above and what you plan to spend.