Cashflow forecasting for fast growth technology companies
How often have you heard people say things like “this raise gives us £354k of headroom in May of 2018” or “this raise gives us 17 months of runway”. No it doesn’t!
Accurately forecasting cashflow in fast growth, Series A stage businesses is impossible. The worst thing you can do is try.
The reality is that you are stuck between a rock and a hard place. If you take your budget and use that for cash planning you are risking the business on achieving an extremely aggressive target. If you lower your budget to put less risk in the cash plan then you are not setting ambitious targets, it’s harder to achieve the growth you want and to raise money.
This often leads to people producing two budgets, “base” and “target” or any number of other names. I don’t think two budgets work. You inevitably end up working to the lower one and everyone has forgotten about the higher one a few months into the year. You normally set the comp plans against the higher one, then have to redo them all against the lower one.
I believe in having one budget that you re-forecast properly halfway through the year (see this fantastic article by Brad Feld). This budget should have a P&L, balance sheet and cashflow BUT the cashflow is only one of the inputs you use for your cash planning.
I would then suggest that you run a separate, more crude cashflow forecast that is updated for actuals each month and produces a chart that shows your worst case cash headroom (in months) and your budget cashflow forecast. In this scenario your worst case needs to be your genuine worst case, be honest with yourself on this, I often run it with zero growth.
The worst case cashflow should have fully loaded costs. Don’t give in to the temptation to start reducing your overhead budget. You almost always need to invest in overhead to solve problems and the point of this exercise is to give yourself time to do that.
This range gives you a decent estimate of the cash risk you have in your business. It also gives you a good feel for when you need to start taking action on the low side (action = pausing or shifting investment or looking to raise funds). And on the upside it gives you the confidence to bring on costs knowing you are not putting too much risk into the business. I can’t stress how important re-forecasting this range every month is. It is the only way you can confidently optimise your costs to achieve the growth you want.
When thinking about a Series A funding round I like to see 12 months of runway in the worst case. This means I can be confident that we have time to iterate the plan, make people changes and product improvements and start to see the results before the next funding round. When you don’t give yourself the time and cost headroom to deal with un-budgeted head winds then you can end up in a horrible sort of start up death spiral.
Or to use a car racing analogy. Building an early stage company is not a drag race, there will be corners and you have no idea how sharp they are going to be! If you only forecast like there won’t be a corner you will either not get round the corner when it comes, or you will have to break so hard you’ll come out the other side too slow to stay in the race. If you only forecast really sharp corners then you’ll get round the corners but you’ll always be going so slow you’ll never win anything. Forecasting the cash range and constantly iterating is how you get close to the racing line.
