How to calculate revenue: Secrets of a realistic startup forecast

Revenue is the heart of every business and the foundation for its growth. In the same way, forecasting revenue is the core goal of every financial model. Such models not only showcase and explain a company’s strategy and the revenue streams fueling the business but also have an impact on the team’s growth and expenses.

The creation of these models can easily become a real stumbling block for startups, as it’s not that clear how to build credible and realistic projections. On top of that, revenue forecasts usually raise a lot of additional questions from investors.

How can we make revenue projections easy and understandable but still impressive enough to win an investor’s attention? This article will help you to understand:

• what elements must be included in a solid revenue forecast
• how to arrive at realistic values
• what you should keep in mind when presenting this part of the model to your potential investors

Secret 1: Calculate your customers correctly

Revenue doesn’t come from just anywhere; it’s generated from your customers or users. Thus, before calculating the money your business will generate, you need to focus on accurately calculating the number of customers or users.

The approach greatly hinges on the business model as well as the user/client type and size. It’s extremely important to consider all of these factors together.

Let’s look at four different types of companies to better understand what aspects should be considered in each case.

You can read more about cohort analysis in our article.

We have analyzed the financial models submitted for our review and summarized the most common mistakes we see in revenue sheets:

1. It’s impossible to track what factors drive the revenue growth. It’s pretty difficult to justify the assumed monthly revenue growth rate you added yourself, but it’s pretty easy to defend your projections if you can explain the logic behind them. For example, you can show how your gross transaction volume and commission rate allow your business to generate the revenue you included.
2. Your annual revenue growth rate accelerates over time. As a rule, this rate should decelerate over time, unless there are additional factors boosting revenue growth. For example, the company could plan to add new revenue streams.
3. The same assumptions are applied to every year. This looks very unrealistic. The model shouldn’t be static; it has to be dynamic and consider factors like growth rates, inflation, and the economy of scale, among others.
4. Unrealistic growth rates. We recommend doing some benchmarking, which will allow you to see the revenue growth rates of businesses at the same growth stage and with a similar solution.
5. Assumptions not backed by benchmarks or other data. Obviously, not all the numbers can be checked (for example, the breakdown of subscribers by subscription), but you must always make sure to benchmark numbers whenever it’s possible.

Secret 2: Explain the logic of each revenue stream

The goal of revenue projections is not only to calculate how much your business will be generating in the next three-to-five years but also to show that you understand the mechanisms of your revenue streams. The investors will definitely want to see whether your logic works and looks realistic and if you understand all the peculiarities of your revenue. To make this possible, you need to determine the metrics that are relevant to the business model you selected and use them in your forecast.

Let’s look at an example. Your client is a marketplace. When building revenue projections, you need to employ indicators such as monthly active users, average transaction value, and gross merchandise volume (GMV). This way, you reflect the logic of your revenue streams and demonstrate that you know what metrics are used in this type of business.

Showing investors that you really know how your revenue generation engine works makes them more confident that you will be able to manage it. That’s why it’s essential not to underestimate this part of the model.

Secret 3: Don’t forget about historical data (if any)

Fundraising doesn’t always involve startups that only have an idea at the moment. More mature companies also raise funds. In such a case, it’s critical to make sure the forecast is based on historical data and implies a realistic revenue trajectory throughout the years.

Why is this so important? First, it shows the investor that you haven’t made up the numbers, instead following the existing logic and trends. Second, it shows that you understand how your business can scale in the coming years and how it will impact your cash flow.

Key factors to consider here:

• Inputs should be calculated based on the historical data whenever possible.
• The values in the first months of the forecast should be close to the values in the preceding historical months.

Secret 4: Make sure the numbers look realistic

Everyone understands that building a forecast may be highly arbitrary and that you cannot know exactly whether your business will follow the predefined path (especially if it’s an early-stage startup). However, you must ensure that your forecast makes sense and looks realistic. There are two key steps for achieving this:

• First, you should do a thorough benchmarking for your assumptions. You will never be able to guess what the next question from investors could be, so make sure you are prepared!
• Second, don’t forget to analyze the values you finally get in the model. If you only have an idea at this point, and your forecast shows a $50M revenue over two years, the projections are almost certainly too optimistic. Here, the analysis of metrics comes in handy. We’ll dive deeper into that in the next section.

Secret 5: Use metrics for a deeper analysis

Numbers can provide you with a lot of helpful information; you just need to understand their language. Metrics are a great way to understand how your business economics change over time and whether your model is realistic and reasonable.

Let’s delve into the most common metrics that will help you avoid strange numbers in your revenue growth rate, ARPA/ARPU, and LTV.

Revenue growth rate

This metric is a core indicator of how quickly your startup is growing. The benchmarks depend on the company’s stage and industry, and it’s important to use them when building a forecast. On top of that, don’t forget that this rate tends to gradually decrease over time. Though we consider this fact in our financial models, in some cases, the growth rate can jump if the company has some prerequisites to do so (e.g., favorable market conditions, new market entry, or a new revenue stream).

ARPA/ARPU

These acronyms mean average revenue per account and average revenue per user. Which name you use depends on the client type of the business. This metric is highly important to understanding whether the company increases monetization of the user/client base over time. It also has an impact on the customer’s lifetime value.

LTV

Customer lifetime value is a measure of the total revenue a business can generate from one customer before the client churns. This metric is usually compared to customer acquisition cost (you can find more information about this in our article).

Metrics matter, but they will tell you nothing without proper benchmarking. Always search for benchmarks relevant to businesses in the same industry, of the same size, etc.. Then, you can compare them to your KPIs. This is a great way to make your model presentation more compelling; you not only built the forecast but also compared the final values with the industry averages, ensuring that everything is reasonable and realistic. Investors will definitely appreciate it.

Summary

As you can see, revenue plays a central role not only in your business but also in its financial forecast, especially when you are fundraising. It’s critical to consider a range of different factors and ensure that your projections look logical, understandable, realistic, and attractive to the potential investor. Additionally, this part of the model will help you to estimate your revenue trajectory and potential to scale, as well as to make some important business decisions.

Here at Waveup, we have already helped over 500 projects by preparing high-quality fundraising materials. Our finance team is always ready to build solid financial models for both aspiring startups and mature companies. If your team needs one, feel free to contact us.