Financial projections are most useful when compared with what the company has actually achieved and run through downside scenarios that show when cash would run out.
11 min read · Level 3
I think the most revealing question to ask about a plan is not 'how will you hit this?' but 'what will you do in month six if you are at half of it?'. A founder with a clear answer has thought about survival; a founder without one is betting the company on the forecast being right.
A plan typically shows revenue growing rapidly. Diligence compares it with history:
Year Revenue Two years ago 600,000 Last year 1,000,000 (+67%) This year 1,500,000 (+50%) Plan next year 4,500,000 (+200%)
The plan requires growth four times this year's rate. That is possible - a new product or sales team can change a trajectory - but it needs specific evidence.
Three scenarios for next year:
Scenario Growth Revenue Basis Plan 200% 4,500,000 company forecast Base 60% 2,400,000 recent history, modest improvement Downside 25% 1,875,000 growth slows, key hire delayed
1,500,000 x 1.6 = 2,400,000; 1,500,000 x 1.25 = 1,875,000.
Then ask what happens to cash in each. If costs are planned for 4,500,000 of revenue, the base and downside cases burn far more cash than planned.
Because investment decisions often rest on the plan, and plans are almost always optimistic. The question is not whether the plan is achievable but what happens to the company and your investment if it is not.
It also identifies the load-bearing assumptions: the two or three inputs that most change the outcome.
Educational, not personalised financial advice. Nothing in the Investor Academy is a recommendation to buy, sell or hold anything — what is right for you depends on your own circumstances and the rules where you live.
Cash under each scenario.
Planned costs next year 4,000,000 Cash now 2,400,000
Scenario Revenue Costs Cash burned Cash at year end Plan 4,500,000 4,000,000 none 2,900,000 Base 2,400,000 4,000,000 1,600,000 800,000 Downside 1,875,000 4,000,000 2,125,000 275,000
In the plan, the company generates 500,000. In the base case it ends the year with 800,000 and must raise again under pressure. In the downside it is close to running out. The investor asks what costs management would cut, and when, if growth tracks the base case.
Evaluating only the company's plan, or building a downside case that still assumes the planned cost base.
Compare planned growth with actual growth over several years.
Use growth rates grounded in history and plausible setbacks.
Show cash position at the end of each scenario.
Find what management would change if the downside occurred.
Whenever an investment decision depends on a company's financial plan.
Do not assume history always predicts the future, especially after a genuine change in product or strategy; ask for evidence of the change.
Investors and researchers have long observed that startup financial projections are systematically optimistic, with actual revenue frequently falling well short of plans presented at fundraising, which is why many investors discount or rebuild projections rather than relying on them.
Treat the plan as the upside case, and build the base case yourself.
Create a free account to read the rest and apply it to your own investing.