One of the best things you can do to safeguard the financial health of your business is to create an infallible revenue model. Your revenue model should give you a clear understanding of your cash flow and needs so that you can forecast profitability and plan accordingly.
It’s important to note here that there are two approaches to financial forecasting: top-down and bottom-up. According to David Ehrenberg - the founder and CEO of Early Growth Financial Services - top-down forecasting can be a bit misleading when it comes to getting realistic numbers, especially if you’re a company seeking funding.
David has worked with many clients to help them through the process of creating the perfect revenue model for their business. He’s put together this list of 7 key principals for you to consider when developing yours:
For example, if you have a team of engineers with good business sense, a technology model - where you identify where you are in your R&D (research and development) model and where you expect to be in the future - will be a good fit for your company.
What is special about your offerings? Your revenue model should show what is unique about you. For example, if you offer the kind of service that customers will subscribe to, this is a selling point.
If you’re looking for funding, it helps to identify strategic investors who are knowledgeable in your space. Make development choices that speak strongly to investors and build your pitch around these choices. Think big picture and long-term and try to find like-minded investors who aren’t just looking for profit short-term but are willing to wait for ROI to be realized.
Investors want to know what the time horizon looks like, when there is going to be money to be seen, what the next major milestones are and when are you going to start making revenue? And this is important information for you too, of course. But you can’t predict with any level of certainty too far out - no further than 12-24 months. Farther out, it just becomes a ludicrous exercise where you have meaningless numbers on the page.
The overall architecture of your approach may not change much over time, but you should continually be refining your model and forecasting. There are many revenue models to choose from. For example, if you’re a service-based business, you can sell services individually or offer a subscription model. Just keep an open mind and accept the fact that you may need to pivot your revenue model at some point if it’s not working to support your business.
Your variables will be process specific and will depend on what stage you’re in. Basically, you’re looking to find those variables that have the most impact on your revenue - and figure out what they are most sensitive to. You need to be able to isolate these particular variables so that you can address them individually. Analyze input and research values to identify if they are good where they are or if they need work. A sensitivity graph is a great tool for looking at each separate value and graphing its potential impact on revenue as that value changes. Charting this enables you to see at what point revenue improves or worsens as the data is manipulated.
The goal is to get your variables to a point where you can mitigate them. You want to be confident in your numbers (this means seeing them realistically). There’s no sense in hiding from risk; you should identify it, understand it, and directly address it. Mitigating for variables leads to transparency which is good for your own understanding as well as for investors (who are always going to find something even if you try to hide it).
Overall there is a lot of choice when it comes to developing your revenue model - but not having one at all is not a choice. From helping you to stay focused to helping you to develop your service, your revenue model is the necessary foundation for your company’s success. Combine this with a smart automation platform and you’ll be on track towards sustainable growth.
David is a financial expert and startup mentor, whose passion is helping businesses focus on what they do best. Follow David @EarlyGrowthFS