Projections Are Never Right

When people do projections of finances, they are almost never right.  Startups pitch us all the time and show us the five year projections.  They always look like the famous hockey stick global warming graph.  The first two years the company loses money.  The third year is roughly break even.  The fourth year is huge momentum followed by the fifth year when we make so much money we won’t know where to bury it all.

I have never seen one pan out ever.

The important thing is the assumptions behind the projections.  It gives you a glimpse into how the entrepreneur thinks.  Where are they allocating their resources?  Where are they reinvesting cash if there is a chance to reinvest it?  What hiring decisions are they making and what are the projected costs?  What are they looking at doing if the business is wildly successful and scales?

That’s what you want to know and have a conversation about.

It occurred to me that politicians do this all the time and their projections are never right either.  Remember the projections on costs of health care with Obamacare.  They wildly missed the mark by so much that they weren’t even realistic or grounded in good economic fact.  That means the assumptions they used were so pie in the sky it rendered everything else meaningless.  It turns out, forecasting human behavior is hard.

New York landed Amazon and they used a lot of tax breaks to do it.  Here is what their mayor said yesterday in an opinion piece.

New York City alone will net $13.5 billion in tax revenue from the new headquarters, and the state another $14 billion. That’s a nine-fold return on our investment

I can almost guarantee that this estimate will be wrong.  The answer is no one knows and it all depends on how you calculate the $27.5 billion in tax revenue.  In my home state of Illinois they are going to legalize marijuana and they will project a tax revenue from legalization.  I guarantee you it will be wrong and in the case of Illinois probably overstated given our financial condition.  They are also going to increase taxes on just about everything else and in the past all those projections have been wrong so why should we have confidence they will get it right this time?

An aside, some New York politicians took to Twitter etc and moaned about how the state/city were giving away a huge subsidy to a multibillion dollar corporation. Funny thing, when their pet projects get subsidies they always find the money.

Instead of looking at headline numbers, ask questions about assumptions.  How are they getting to that number?  That’s when you find how the thought process truly works.