In Financial Modelling, a financial projection is all about assumptions to see how your business or start-up will perform. It would help if you constructed a separate Revenue Assumptions worksheet in your business projections to drive the rest of the financial model.
By creating your revenue assumptions, you will come to understand your business better than you ever have before. It will be your first glimpse into what the future holds.
Basic Formula used in revenue assumption
- No of Customers = Marketing Budget/ advertising cost to acquire one customer
- COGS calculation: Multiply COGS by COGS cost
- Total revenue = sum of payments from all services a business is offering
Historical results and Assumptions
Generally financial model begins with a company’s historical results. You start building the economic model and pull three, four, five years of financial statements and input them into Excel. Then you calculate assumptions for a historical period like revenue growth, gross margins, budget, variable costs, fixed costs, AP days, inventory days.
Revenue Assumptions – based on sales and number of customers.
A sales prediction is the primary tool for managing a company of any size. It is a monthly forecast of the level of sales you expect to achieve. Many companies draw up a sales forecast once a year. Accurately projecting your sales and constructing a sales plan can help you avoid unforeseen cash flow hurdles and manage your production, staff, and financing needs more accurately.
A basis for sales forecasts
Sales projection helps you to manage your business more effectively. Before you start, there are a few queries that may clarify your position:
- How many new customers or clients do you gain each year/month?
- How many clients do you lose each year/month?
- What is the level of sales you can make from each client?
- Any particular months where you acquire or lose more customers than other months?
You can also analyze how much marketing budget to allocate to gain customers or increase the number of visitors for the particular business.
We at Oak Business Consultant have helped many clients to build their financial models for their start-up or expand their existing business with revenue assumptions according to the business nature. Here we will enable you to look at one of the models that we made.
You can look at the marketing budget allocated each month and the expected number of customers we can gain within that particular budget. Each year is different, so you figure out and list any changing circumstances that can affect your sales. These changes – known as the sales forecast assumptions – form the basis of your projection.
Revenue Assumptions in existing businesses
Before you decide on a new product launch or an economic trend, look at the level of sales for each customer last year. Do you know of any customers who will buy more – or less – from you next year? How can you gain more clients? In the case of those who account for a greater volume of sales, you may want to ask them if they plan to vary their purchase level in the foreseeable future.
New businesses or start-ups have to make assumptions based on deep market research. Each start-up can also add in the new clients that it expects to gain without knowing who they? Enter “new customer” on your projection sheet as we did above in the sample. Depending on your business, you may want to justify the volume of sales in the projection.
How do you these assumptions in a model
Use assumptions as variables: Avoid hard-coding assumptions into formulas. Instead, make your assumptions so that you can change an assumption in one place, and all procedures and outputs will recalculate automatically.
Label assumptions: Try to use descriptive labels so you can deeply understand what assumptions mean.
You can see our model for better understanding:
Organize your assumptions together: There are several ways you organize, but a general best practice is to manage your premises together on a single sheet ‘input’ so that it’s simple to see all the assumptions for revenue simultaneously in an “input” for your model.
What do you need to ignore in Revenue Assumptions?
Make sure your revenue assumptions are linked to the detailed sales forecast, else you can end up with a completely contradictory projection. For example, if you suppose a declining market and declining market share, it’s illogical to forecast increased sales then.
Also, try to avoid making excessive adjustments to your projection, even if you discover it’s too optimistic or pessimistic.
Making assumptions in a model is relatively easy; grounding and justifying assumptions is harder. Start with a good, clean structure, but don’t get hung up on dropping your beliefs perfectly when you start creating a model. As you make your model, you’ll change what assumptions you want, add new ideas, and figure out new data to use. Just focus on developing and understanding, and coming back to your revenue assumptions once you have the model’s outputs ready to evaluate your business.