There’s a classic curve that shows up in a number of financial models for early stage companies. It’s called the "classic hockey stick." It begins with a slight dip in performance. Then starts to rebound and continues on a straight line path at a sharp upward curve until the numbers get very huge a few years out.

It almost looks like you could do the graph by using a hockey stick and save you the trouble of going through the whole forecast in Excel.

The problem with these is that in almost all cases it’s not real. I’ve been blessed to be part of two ventures where we actually exceeded any forecast that might have even been done on a hockey stick basis, but those are the exception and they’re few and far between.

The fundamental issues with a hockey stick type of forecast is that it assumes many costs will stay fairly steady or just rise very modestly with the increase in sales. Among some of these costs are:

1. General and administrative expenses.

2. Marketing cost.

3. Technology cost.

4. Development cost.

5. Certain manufacturing overhead.

With sales growing rapidly and significant expenses being held fixed, the numbers get pretty rosy within a short period of time.

The problem is in most cases it’s just not sustainable. You might have some of those improvements in the short-term, but eventually the costs reach their plateau and additional spending has to be done. In other words, the cost would be increasing in more of a step fashion.

For example, let’s take some personnel costs. As the company grows people can take on more, but that can’t last forever. Sooner or later, they’re going to have to add additional people to take on work being generated from the additional volume. Another example can be facilities. Eventually, they run out of space and usually the next step up is pretty significant because you’re going to try to cover your needs for the next two to three years.

One way to check it against the hockey stick is to look at the results at the backend and see how these might compare with what others are doing in the industry or similar industries. If the best of larger firms in your business has general and administrative costs at about 10% of revenues, for example then what would make you feel that you could get it down to 5% of revenues.

A hockey stick forecast assumes everything goes well. You hit on all cylinders. Things come as planned. Unfortunately, there’s no room for error to hit those types of numbers.

The hockey stick can be pretty scary to potential investors, bankers or others that you are having to deal with. They’re likely to take what you’ve done and discount it pretty heavily.

So take a look at the profit improvement in your financial model. It’s fine to have some good profit improvement over time especially if you’re an early stage company, but just make sure you’re being realistic about it. Keep the slope down at a reasonable level and make sure the number that you’re ending up with is something attainable where you have good odds of hitting it as opposed to it being a series of homeruns along the way.