I was speaking with a couple entrepreneurs recently about their financial modeling as they were trying to forecast what their business would look like over the coming months/years. I have written on where to start with financial modeling, keys to building a successful model, using financial modeling to vet ideas, and we also have a free budget template. But one of the first questions I often ask is: what assumptions matter?

What assumptions matter

Hint - not all assumptions are the same. The growth rate in team meals or marketing software spend is not as important as the topline core metrics: number of customers and annual contract value (multiplied together equals revenue). You also will want to look at leading indicators (leads, demos, close rate, etc.) to ensure your current pipeline matches your upcoming revenue forecast. Churn rate could be critically important to your growth. Understanding cash flow and what drives it can help you avoid running out of money before you expected. Spend most of your time focusing on the metrics and assumptions that matter.

How do you test those assumptions

Once you have identified these, how do you test the assumptions? Historical data of actual performance is one way. Pilot data of a new model may inform how things can change over time. Industry benchmarks and customer discovery can also be a clue. You can make any assumptions multiply together to get to a number, but how do you justify why you are using certain assumptions? Also I recommend continually adjusting your assumptions (living model) based on the most current data available as you are always learning and things change over time.

What is best case/worst case scenarios

Knowing that every forecast I have ever built or seen is wrong, how do you plan for different scenarios? I love building a best/projected case scenario of what you think could happen. Then build a worst case scenario (could be no new revenue for an early stage startup). When you have a plan for those two paths, 95% of outcomes will fall in the middle and you will be prepared how to handle any in that range. You can also build in triggers to know when to make certain hires based on hitting certain milestones, this way your expenses don’t get too far ahead of revenue.

It is great to do financial modeling. Make sure you understand what assumptions matter, how to test those assumptions, and how to model different scenarios for a range of the key assumptions.