How do I create financials for my startup company?

Until the coming of the dotcom bubble, it was impossible to imagine a business that didn't have coherent financial projections, especially an early stage business. After all, if you can't visualize and plan a revenue, nay, profit stream, how can you build a business?

What's amazing though is that nowadays there are many thriving businesses that don't have any sort of revenue stream, let alone a robust one that can help the company grow and simultaneously survive lean months or seasonal lulls. For example, Twitter seems to have a pretty high overhead for its online "microblogging" service, yet there's not a nickel of revenue in sight, not even the now-banal online adverts.

Generally, though, I believe that what separates a hobby from a genuine business is a revenue stream. Whether it's through licensing, sponsorships, advertising, subscription fees, ancillary product sales, conference registration fees, affiliate payments or commissions, etc., if there's no revenue stream, it's not a business.

Given that, how do you actually come up with your financials for your business plan, that is, figure out how much money you should realistically be expecting to see as your business starts out and grows - hopefully - into a thriving venture? That's the big question, obviously.

One place to start with is what channel or channels you are going to utilize for your revenue. If you have a premium service with a subscription fee, for example, then you will have higher costs for those premium members and will also need to assume that only a percentage of your members will upgrade to premium membership.

Let's talk a little bit about numbers to make this tangible. For example, let's say that you have a dating site built around movie favorites. Free membership lets people specify their geographic region and list up to two favorite movies. Your system then tries to match them with others in their area that have one or both movies on their list too. Make sense?

Now, the premium service lets you list as many movies as you want and can even import your pre-rated movies from Netflix to make it easy. That's $9.99 / month.

On day one, you'll have zero members, but let's assume that you can sign up 10 new members each and every day. In 30 days you have 300 members, in six months you'll have 1825 members, etc. Of these members, 10% upgrade to premium membership, and the average time that they remain a premium member is four months. That means that six months in, you'll have 182 premium members paying $9.99/month, or a monthly revenue stream of $1818.18.

What you can see here are the assumptions, one of the most important facets of your financials. Our assumptions so far are that you start with zero members, that you gain 10 new members each day, that 10% upgrade, and that the average time of premium membership is four months. Each and every one of those can - and doubtless will - change, so these should all be pulled out on your spreadsheet so they can be adjusted. For example, what happens if 20% upgrade? If the average time for premium membership is actually two months? How many members will you have in 18 months? What kind of monthly income? What if you could pay $250/month for advertising and double your new member signup rate?

All of those sort of questions should be answered by your financials. Here's an insider's tip that's critical to know too: it doesn't really matter, in the end, what your actual numbers are. What investors want to see is that you have numbers and that they can mess with them to see what happens with both pessimistic and optimistic scenarios. What if you could get 1000 new members/day? Or only 1.03% of members ever upgrade? Or your Netflix import module doesn't work so no-one upgrades for three months as you thrash, looking for a new programmer?

Most investors assume your assumptions are optimistic, often idiotically optimistic, as in "year one membership: 137. year two membership: 500,000. year three membership: 1.73 million users" or projections that show the company earning hundreds of millions 12-18 months after first opening their doors to the public. I suppose it's possible, but it's very, very rare in the world of entrepreneurship, and savvy investors know that.

The key is really to be able to identify these sort of cornerstone numbers within your business, these assumptions, for your own business model, for your own venture. It might be assumptions on click thru rate on adverts coupled with an assumption of per-click value for those advertisements, for example, which makes it straightforward to calculate value per visitor or, at least, the expected value of increasing your visitor numbers 2x, 5x, 10x, 100x, and so on.

There are also a ton of books about how to write business plans, how to plan for your business and so on. I don't have any specific recommendations, but a quick visit to Amazon.com will surely be more than satisfying!

Good luck to you.