What are examples of assumptions in financial modeling?
In today’s newsletter edition, I want to discuss why investors consistently seek clarity on the assumptions behind financial forecasts.
Why providing transparent and well-grounded assumptions can set your business apart, and help you effectively communicate your financial assumptions.
So let’s jump right in:
1. Assumptions mastery
A thorough understanding of the assumptions behind your forecasts is crucial.
These assumptions often include market growth rates, customer acquisition costs, revenue streams, and other vital metrics.
2. Be specific and transparent
Investors appreciate specificity and transparency.
Clearly detail the sources of your data, the rationale behind your assumptions, and how these factors translate into your financial forecasts.
Example: “We’ve projected a 10% annual growth rate based on comprehensive market research reports from [specific sources] and our own historical growth over the past two years.”
3. Conduct a solid research
To build investor confidence, ensure your assumptions are supported by reliable data.
Reference industry reports, market studies, and other relevant data to substantiate your forecasts.
Example:
“Our customer acquisition assumptions are based on current industry benchmarks and our marketing campaign performance, which has shown a steady 8% increase in new customers per quarter.”
4. Address risks and uncertainties
Acknowledge the risks and uncertainties inherent in your assumptions.
Explain the steps you’ve taken to mitigate these risks, demonstrating that you are proactive and prepared for potential challenges.
Example:
“While our revenue projections assume a stable regulatory environment, we have contingency plans in place to adapt to any changes, including a dedicated compliance team to navigate new regulations.”
5. Align assumptions with business strategy
Ensure that your assumptions are not just isolated figures but are integrated into your broader business strategy.
This linkage shows investors that your financial projections are part of a cohesive and strategic plan.
Example:
“Our operational scaling assumption of a 15% reduction in COGS over the next three years is part of our strategy to optimize our supply chain and achieve economies of scale.”
6. Be ready for deep dives
Investors may want to explore specific assumptions in greater detail.
Be prepared to provide in-depth explanations and data to back up your forecasts.
7. Avoid using jargon and overly complex terminology
Clear, concise language ensures that investors can easily understand and trust your projections, regardless of their background.
By following these guidelines, you can confidently address investor inquiries about your forecast assumptions.