Projecting financial statements.
OK so we're still in years five to six and we'll be going public soon maybe next year or the year after
it's come up soon.
You'll enjoy the process.
Goldman Sachs is going to take US public.
OK so when creating forecasts we usually project at least three to five years.
And again we always start with sales projections.
When we talk about budging we talked about sales is the most important thing you can forecast.
It's the same thing with companies forecasting for financial models.
And so you create projections which people on Wall Street call pro-forma financial statements.
I don't know why.
It's just a projection projection.
OK so what is the most important thing to assess for a potential investment in a startup.
What is it what we talked about before.
It's the management team and there's no point in creating a financial model if you don't have an incredible
management team.
So when I do my due diligence on potential venture capital investments I don't even bother making a
spreadsheet or forecasting financials.
We don't have the best financial team in place member the jockey is always more important than the horse.
And so and I love this quote from Michael Delling going to say it again and its ideas are commodities.
Execution is not OK.
So is the tanh big enough.
I always ask myself that as well before investing in the companies the total addressable market big
enough.
And we talked about this on the first day of class as well.
And so this company that's that we're going to invest in now.
It's got a tam of $50 billion.
Now bear with me for a while.
OK.
We're going to do a model and we're going to assess assess what the TAM is first in order to be able
to forecast revenue.
So we're going the model a long term model.
We're going to we're going to invest in this company because we just found out that the management team
is amazing.
Okay.
And this management team has had multiple pass exits before in the technology sector and the size of
the market is $50 billion so we're really excited about this hypothetical investment.
Okay.
And the founder of this hypothetical company that we're going to model believes that his firm can capture
10 percent of the total addressable market in 10 years so the TAM is 50 billion bucks.
And this this guy thinks he can be 10 percent of that market in 10 years so that's what is at five billion
dollars in revenue.
Okay.
Okay let's look into this.
So whenever you're creating models for private companies.
OK.
And today's session is all by private companies and later will will actually do a model on a public
company which is a lot easier because you have a lot more information.
So when you're modeling a private company you start with a total addressable market and you figure out
what percent of revenue this this company or what percent of the 10 this company could get.
So in this case we know the tamest $50.
And the founder thinks that he can capture 10 percent of the OK so this this guy is going to get $5
billion in revenue in 10 years.
OK.
So we'll create revenue.
OK we'll model it a long time 10 years maybe whatever and then we'll just assumptions and remember everything
just a percent of revenue.
I think it shows to you in action.
OK.
So we started the model building with sales.
OK.
So I'm using Microsoft Excel use whatever spreadsheet software you want.
I like Excel because I use it for every now and is actually pretty cheap if you use Microsoft Office
Online.
It's I think it's less than 10 bucks a month if you're a student and you get serious discounts too if
you're in university.
So I digress.
Here we go.
So that Tam is $50 million.
The market share your 10 is $5 billion.
And then this is to say that the average selling price the product that this company is making the average
selling price of the HSP is $100000.
And so if we take five billion dollars in revenue divided by a hundred thousand dollars per unit or
the average price the that gets you to 50000 units sold in year 10.
OK remember what we're doing now is we're figuring out revenue.
So.
Okay.
Bye.
So in year 3 This person told us that he can get the five hundred million dollars in revenue and most
people I would call B.S. on it.
But this guy is so awesome.
In the last company he founded that he actually got his last firm $350 million in revenue by the third
year of existence which is amazing.
And again most companies go public that are successful in year 7 or 8 or 9 whatever it is.
OK.
So keep modeling this in so I'm playing out the numbers here.
And usually this whole process of trying to figure out revenue takes me at least a day.
Right.
And I make a lot of assumptions and then I finish what I believe to be the perfect revenue forecast
for the next five or 10 years.
And then I go to bed.
And then I get up the next morning and I look at it again with a fresh mind.
And quite often I make minor tweaks here and there and then I'm done with the revenue and I model the
rest of the company.
So you're going to see a truncated or smaller version of this whole revenue process for me from when
it comes to forecast.
So as you can see I'm forecasting the year over year growth in the number of units.
And so by year 10 you see that they're expecting 50000 units.
And I'll just kind of walk through it until I get the right number set up and I'll always list everything
I'm thinking about as I go through this process.
So when I revisit my model I can understand the logic that was in my head at that time.
OK so I'm going to read some of the line items off my Excel spreadsheet here.
So in year 3 our guy said he can get to 500 million bucks in revenue.
This seems pretty aggressive.
Let's assume it's 400 million.
You see what I did there it's it's a little bit more of an art than a science when you're modeling right
the scientists the mathematical calculations and the percentage of the Tamie think you can get longer
term.
But there's an art side to it as well and that's why finance is a little bit more of an art art and
a science type of process or analysis process than accounting is OK.
So this growth is pretty high.
Let's assume it slows down a lot in future years just to the Law of Large Numbers.
OK so I get that 50 percent unit growth in year 10 that still seems high.
My numbers are way too big.
I'm just reading here.
OK let's haircut them a lot.
OK.
But the increase in year two year three seems nutty high.
I don't think 10 percent share in 10 years can be done.
I mean there will be a recession at some point.
And these growth rates seem too high.
OK fine let's assume that this is our uber optimistic scenario as companies don't grow a triple digit
for that many years in a row.
Ok so so here's where I'm at right now.
So 50000 units in year 10 of 51000 now in 2015 there's 20 units coming just launched then 200 the next
year then for grand that 2018.
I got eight thousand four hundred and then you can see the year of your growth there which is high it's
still way too high.
Look at that triple digit over year growth there and year 2023 to 24.
Unrealistic unrealistic.
But the reason I'm showing this slide is because I want to show you that the revenue line item is quite
simply the number of units multiplied by the average selling price of 100 grand.
And we're going to tweak that a bit but I also want to show you this slide because you can see the yellow
box there in the yellow box.
I put a comment and if you're using Windows and excel you hit shift that too which inserts a comment
and then on Mac just right click or whatever and then put in a yellow card.
In the best practice is always to put your name in the comment.
And quite often if you're working with big teams of investment bankers or M&A people whatever it is
or are mutual fund analysts what you do is you put your name in that comment as well as the date and
the time that you put that comment and why you put that card that might be based on a conversation you
have with somebody that's a sea level or executive or an investor relations professional at that point.
OK let's keep going.
So I wrote here again there must be competition at some points to get a haircut the average selling
price.
So we'll soon competition enters the market in three years and at that point the price drops from a
hundred grand down to something else.
And so I did it right here you see that actually buy by the end of the third year it ended the fourth
year.
I assume that the pricing point is no longer $100000 actually drops to $90000.
That's why I'm off by point nine.
OK.
And so price of components comes down come down as well.
And I think this company actually is making a pretty revolutionary appliance.
It's a hardware product that has some really cool software in it as well.
Correct.
Now this is just an exercise.
We're not going to go into too much detail of the qualitative background on this company.
OK.
So we took a haircut pricing wise.
Okay.
And then we come in our code or our spreadsheet I should say when I used to be a programmer at Accenture
and other tech companies back in the 90s I would program a lot.
And I'd always add comments to my code.
So when I revisit it in the future or if a colleague revisit it I could understand what the heck I was
coding about at that time.
And the same thing can be said here when it comes to excel and lots comments really important.
OK so I'm expecting a 20 percent price cut the following year here you can see that in the spreadsheet
especially since component costs are always dropping.
Can I understand what I was saying.
All right.
And so I keep playing around with the model.
Keep tweaking it's you can pause the presentation any time you want and read my comments there.
I'm not going to go into too much detail on this.
And then I assume that by year 10 or 2024 or whatever it is you get a 40 percent price cut.
So it has come down significantly from a hundred grand today to $40000.
Longer term Okay great.
And then what I'd do is I'd copy that revenue column and I want to take that column and pay special
as a rope.
OK.
So we can make her income saying remember the top of the income statement you've got revenue in that
room.
OK.
And so what you do is you right click go pay special you paste the values and then you transpose and
transpose is just an Excel term for take columns turn into rows.
Okay great.
So we did that.
So I have all my comments here.
The company said they think they can do three or 50 million bucks in three years from now based on our
revenue analysis and our revenue projections.
We think 350 million bucks is more appropriate and I basically just took a 24 hour or 18 20 hour whatever
exercise of modeling our revenue and I truncated into I don't know 10 minutes or so.
Okay great.
So we're going to move on to expenses.