Back into Revenue

Posted on 26 August 2009

When doing a potential business evaluation or analysis, one of the most difficult things to do is estimating a potential start-ups revenue.  I’ve talked in the past about putting together an estimated revenue stream for a start-up, and how sometimes you just have to go with your gut feeling.

What I have learned to do is to back into my revenue calculation, using a worst case scenario analysis.  I start by building a spreadsheet that has all of my revenue drivers – assumptions used to derive the revenue calculations.  I then build out an income statement, once again, using the revenue drivers to calculate the top line of the income statement.  Finally I build a cashflow statement that ties to the income statement in a couple ways, but primarily via the net income.

When doing a traditional business analysis, it’s easy to get wowed by the “estimated return”.  Some folks will do a sensitivity analysis on the estimated revenues, maybe the estimated expenses, and come up with equally wow’ing returns which do nothing more than distract you from the real question at hand – is this opportunity viable.  As I’ve mentioned, the problem is that while guestimating expenses and start-up captial requirements can be done with relatively fair accuracy, in many business plans doing the same for revenue isn’t possible.  That’s why this approach is so valuable.

So, once you have your revenue assumption sheet linked to your income statement and likewise linked to your cashflow statement, you can start the process of backing into revenue.  On the income statement, you can start by putting in reasonable expectations for expenses, taxs, etc.  On the cashflow statement, you probably have a reasonable idea of how much start-up capital you have access to, or will need to operate the company prior to having a stable revenue stream.  In addition, based on the net cashflow you can do some simple hurdle rate calculations such as net present value (NPV) or internal rate of return (IRR).

Once all of those things are set, then go back to the revenue assumption page and start entering assumptions until you get to a point where the business plan is just able to get by.  The spot where, “if at a bare minimum we are able to do this revenue, we can keep our doors open for business”.  This is really the make or break revenue of the company assuming that your access to start-up captial is limited to some ceiling.  At this point, you can now step back and take a holistic view of the revenue assumptions and projections and focus on the companies ability to meet those revenues.  The question then becomes about “can we make this revenue, or not?”.  Hey, if the company actually does 2x your assumptions down the road, congratulations, it’s a good problem to have!  But in your analysis, assume worst case, and back into the minimum revenue that you can derive to have a operable company (or opportunity you are willing to invest in), and if you have confidence that your company can meet those minimum requirements, you might have a winner.

1 Response to Back into Revenue

  • […] revenue make sense, does it grow smoothly or are there huge spikes?  Is it conservative, did you back into the revenue?  If you are comfortable with those things, then it’s likely that your business plan is […]

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