Understanding Your Model with Sensitivity Analysis
While I love the fact entrepreneurs don’t have to waste time writing long business plans that are out of date before they are finished, I do still encourage the entrepreneurs we work with at Birchmere and my students at Carnegie Mellon to spend time thinking through their financial model.
I understand that often the business is really embryonic and therefore the projections are absolutely going to be wrong. However, it’s very helpful to have the discipline to really think through the underlying financial assumptions.
As you think through those underlying assumptions, it’s helpful to delineate principled choices from those that are really plugs for a range of possibilities.
For example, in a SaaS business, if you project your ARPU (Average [Monthly] Revenue Per User) to be $140 from early experiments you’ve run it’s tempting to just plug that in. However, it’s probably more accurately estimating it being somewhere between $110 and $150 (entrepreneurs tend to use plugs toward the optimistic end of the range). Similarly, you may expect your CAC (Customer Acquisition Costs) to be $275 but really project it to be between $250 and $320 looking at a few experiments you’ve run in a couple different channels.
While my recommendation for your summary projections would be to just use $140 and $275, I’d encourage entrepreneurs to iterate through the numbers (probably in the above example in $10 increments) and look at key metrics in this case this might include: total MRR 6, 12 and 18 months out or minimum cash balance based on holding all other values in the financial model constant. For each of these key values, you can do a nice table showing the specific metrics value in the cells with rows & columns being the different options as illustrated below.