Integral to starting a new business – especially when you’re looking to outside investors – is coming up with a convincing model to illustrate the where, when, how and how much of profits. Excel spreadsheets with numbers and formulas can work too.
Forecasting the future is hard enough as it is. Forecasting the success of a mobile video game? Well that’s nearly impossible. Successful mobile video games benefit from viral momentum. But as everyone knows, viral hits are notoriously unpredictable. We thus found ourselves stuck on how to build a financial model that could reflect this reality. How could we forecast very unknown future earnings to gain a clearer picture of the underlying fundamentals and soundness of our business?
The standard approach to financial modeling revolves around applying growth rate and future margin assumptions to historical data. Unfortunately as a startup, the standard approach hardly applies. In addition, we felt that basing all future sales forecasts on a still to-be-determined initial market reception was very subjective and left an incredible margin of error. Instead, we started at the end and worked our way back.
Our solution was to construct a logical argument based on conservative assumptions rooted in quantifiable industry dynamics and create something that shows relationships, how money flows through the company and where profitability comes from. As the first step, we modeled user adoption using the standard innovation adoption lifecycle. We then applied these adoption rates to various levels of aggregate user downloads over a defined period of time. Based on this assumed pattern of adoption – as well as user retention rates – we were able to model monthly unit sales and the total installed user base available for in-app purchases.
No matter how thoroughly researched, detailed and constructed, the one constant with all financial modeling is that it will be wrong. Accuracy is a phantom goal. Instead of taking advantage of this inherent subjectivity and creating expectations that may or may not turn out to be justifiable, sometimes it’s best to build something that’s coherent, conservative and, above all else, defendable.