Comments on: Beware the Hockey Stick in Your Budget

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By: Nari Kannan

Nari Kannan — Sat, 19 Dec 2009 12:52:32 +0000

Brad:

One of your best posts! Great advice for young companies, especially on staggering expenses by a quarter while letting revenue lead!

– Nari

By: Brad Feld

Brad Feld — Fri, 18 Dec 2009 16:15:05 +0000

While I agree at a conceptual level, this is what gets put forth as a “revenue projection” in many cases. The underlying problem is not “management integrity”, it’s a combination of “spreadsheet math” + “optimism” + “pressure on the cost side to expand the expense base to grow.” This is easier to deal with when you are a profitable company – when you are still losing money all of the bad inputs tend to creep in all at once with no governor on them.

By: Steve Bell

Steve Bell — Fri, 18 Dec 2009 10:22:04 +0000

Here's the thing… it's not just a revenue projection! The underlying customer relationships, business development contracts, and contractual understandings are what creates revenue. The management team's integrity, right?

If a startup's management team is projecting revenue that may or may not happen, with the numbers coming in from a sales force, or b-d director who really isn't sure.. then that is a "wishful thinking" scenario, with low probability of execution.

Right? Otherwise… what am i missing here…

-steve b.

By: David

David — Fri, 18 Dec 2009 04:27:53 +0000

I like that I'm in the trickiest of all cases. Also, I'm not entirely clear–how does one shift their expense plan forward one quarter? So what does that mean for our expense plan in the present?

By: @markstoneham

@markstoneham — Fri, 18 Dec 2009 01:19:28 +0000

It hurts more when you get whacked with your own stick. I find the best resource when revenue forecasting is a sense of reality, and as a CEO it's a hard thing to attain in all the excitement of growth (or anticipated growth).

If you get yourself in a situation where you are ramping the numbers because someone in particular expects them to, then expect to feel your stick coming back at you in six months – as Brad says, Q1 is easy… Instead, use your board to cross-check your own sense of reality on growth. It's not weasling out on taking decisions, but regard them as a resource that isn't 24/7 on the same thing that you are and might have a more balanced view.

It's always better to get the revenue forecasts right than expenses. If revenues miss it's always a surprise. Costs are very predictable and happen in slow motion. Nobody likes (bad) surprises!

By: Brad Feld

Brad Feld — Thu, 17 Dec 2009 21:38:05 +0000

Build the model that you plan to have prior to the “move the expense plan forward one quarter.” Then – after you’ve built your plan, shift the expenses forward by three months – basically repeat Q1 in Q2, then Q3 is what your old Q2 was, and Q4 is what your old Q3 was. This will take a little massaging since things don’t work out perfectly on month / quarter boundaries, but you basically control expenses in Q1 and Q2 (so your first half of the year is approximately Q1*2) and then you start scaling in Q3.

By: Brad Feld

Brad Feld — Thu, 17 Dec 2009 19:37:04 +0000

Smart approach!

By: Nathan Beckord

Nathan Beckord — Thu, 17 Dec 2009 19:30:44 +0000

When building financial forecasts– especially in the context of presenting them to existing or future investors– I find it helps to build what you truly expect to happen over the coming year, then stagger sales by 2-3 months and double expenses and see what happens to cumulative negative cash flow. We keep a tab open that summarizes this figure so we can see the level of sensitivity to these changes. But the challenge is to avoid the tendency to present what you think investors want to see…if a company presented what they really believed to be both 'realistic' and 'worst case' forecasts, wouldn't most investors want to automatically apply a haircut anyway? (i.e., since they're so accustomed to overly optimistic hockey stick projections…the metaphor perhaps is grade inflation)

By: Zack

Zack — Thu, 17 Dec 2009 17:09:56 +0000

Brad – this is great advice for entrepreneurial companies of all stages. As a venture lender, I see tons of plans and can vouch for the hockey stick problem in case 3 (growing revenue). Too heavy a reliance on growth rates leads to inaccurate and often-times hurtful expense forecasting, which can really hamstring companies in a year when the top line doesn’t materialize as planned. Often, the end result is the need for more capital at a price which is not too entrepreneur friendly.