Using the waterfall...

One of the toughest jobs of a startup CEO is putting together an accurate revenue forecast. While it's always difficult to predict the timing/sizing of revenues in a brand new company, I strongly agree with Fred Wilson that it is important to forecast often.

One of the forecasting tools I recommend to my portfolio company CEO's is a Waterfall Forecast. Typically, this is an Excel spreadsheet that allows a company to show how the forecast for a given month (or quarter) has changed over time.

Over time, a waterfall forecast creates an environment of accountability and allows a CEO (and Board of Directors) to determine key trends. Are revenues shifting month-for-month (ie, did a sale get pushed back by a few days into the next month) or is there a non-linear shift (ie, did revenues get pushed back by several months)? Is the company getting better or worse at forecasting revenues over time? If the company is missing its revenue forecast, are they able to adjust their expense forecast accordingly?

I've attached an example waterfall forecast for Ashloooogle.com (a made-up company). Let's walk through their Revenue forecast. Their revenue budget is highlighted in green (row 9). The next row (row 10) shows how they did in January (the yellow cell, B10) and what they forecasted for the remaining months. The next row (row 11) shows how they did in February (the yellow cell, C11) and what they forecast for the remaining months. And so on.

You can learn a lot by reading a waterfall forecast. For example, you can see that despite revenue shortfalls in January and February, the management initially refused to lower their forecast for the year -- they just reallocated the revenue to future months. In this case it only took two months for the management to realize their plan was too aggressive -- a surprisingly quick reaction time. In March (where revenues were just 37% of plan) they drastically cut their revenue forecast. They also tried to control their Operating Expenses -- their March forecast was 15% below their budget -- but notice that they weren't able to cut Opex dollar-for-dollar...

If you were a board member of Aschloooogle.com, what would you have done at the end of February? The end of Q1? The end of Q2? The end of Q3?

Model Waterfall Forecast - http://www.firstround.com/ModelWaterfall.xls

Another good perspective on forecasting can be found here - http://onlyonce.blogs.com/onlyonce/2005/11/notsocounter_cl.html