What do I need to know about revenue models or forecasting?

The revenue model is the more important one to work out in the early stages of a startup, because it is intimately related to the business model - or how you intend to charge customers for your product or service.  Different businesses have different norms for business models, and even the same type of business can employ multiple business models.  Things to consider include:

  • COGS: The Cost of Goods Sold (COGS), sometimes also called Cost of Sales (COS), is a significant consideration for hardware businesses as there is always a cost to produce and ship. For Software as a Service (SaaS) businesses this is more complex. Read an oldie but goodie from Openview Ventures on COGS for SaaS businesses here.
  • Gross Margin: The gross margin is what you get to keep after your customer pays you, and you pay your vendors to cover the COGS and other associated costs to effect this sale.
  • One-time versus recurring revenue streams: Whether there is a recurring revenue model that generates repeatable income per acquired customer over time make a big difference. In general, recurring revenue streams are awesome.  For example, SaaS models where end users pay a monthly or annual fee for access to a cloud based service has a recurring revenue model, whereas buying a bottle of laundry detergent at the grocery store is a "one and done" business model without a recurring revenue model.  Generally, businesses with recurring revenue models do much better than those with one-and-done pricing models because they can generate more life-time-value per acquired customer over time.
  • 5-year projections. How the forecast looks for the first 5 years of sales.  This is a model of the growth of unit sales and/or retained subscribers in the install base over time. To generate this forecast, you will need to come up with a solid go-to-market strategy, consider what channels you will sell your products with, and have a detailed analysis of how you will acquire your first customers in Year 1.

Download an Excel template with simple models for forecasting revenue / creating a 5-year pro-forma for businesses with common business models.

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