For pre-revenue companies, forecasting demand is very challenging because there is no financial history.
To overcome that problem, some startup founders use random number generation as a tool to “logically generate” demand for their product or service. In their minds, this strategy is their best bet because they have no idea how to estimate demand otherwise.
However, this is wrong. In this article and the corresponding video, we discuss specific situations when using random number generation is appropriate and why it is never correct to use it in financial forecasting.
Can my actions affect the outcome?
A random number generation strategy is appropriate when your actions cannot change the outcome, For example, when you project the returns on financial assets, you have no control over how the prices of these assets move. Thus, in this case, you should use random number generation to simulate daily price changes. In this case, it is your best bet to predict the outcome, because from your perspective the result is random.
Asset allocation and financial goals are not determined randomly
On the other hand, your asset allocation strategy, or how you allocate your money among different asset classes, is not random, and your actions do affect how much risk you take and how much reward you can expect to get for a given level of risk.
Similarly, your financial goals should not be determined randomly either because your strategy affects what happens with the company, and you decide on what your strategy should be. When you build a financial model for your company, you put together a quantitative plan based on that strategy.
To learn more about The Startup Station’s four-step framework you can use to properly estimate demand for pre-revenue companies, read our blog.
To learn more about how to create assumptions for and model various business models, check out our Financial Modeling course.
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