For an aspiring entrepreneur, there’s nothing more exciting than launching a startup. But, just having a unique idea is not the sole key to startup success. Instead, a startup financial modeling is essential in making your business sustainable. 

These models help you build working business plans that help with budgeting, financial planning, and informed decision-making. Drafting a financial model is connected to the startup’s business plan and budget. Thus, it aims to guide the company in its early years.

Financial analysts used it extensively when creating a budget plan. It involves calculating, forecasting, and estimating financial numbers. Established entrepreneurs believe that a financial model should be capable of telling a story about the expected growth of your company.

As a financial model outlines a road map of your yearly activities, it will eventually help your business enhance your investor confidence and raise money.

To find more about the need for a financial model for a Startup, learn the essentials and basics jot down by our expert below. It will help you start with a clear sense of strategy and directional focus to reach your goals efficiently. 

What To Consider Before Startup Financial Modeling?

If you are determined to turn your great idea into reality, mull over the following four common questions to get clarity on your vision:

Key Considerations

• What is the goal of your financial model?
• What’s your source of funding?
• Which financial projections approach you will be using?? 
• What KPIs will your business aspire to achieve?

What Is A Financial Model?

A financial model is a mathematical representation of your business’s wants and needs. It discusses how your company works and will work going forward.

The plan tells you about the expected growth of your company. Financial analysts draft it with clear input and expect robust output.

The inputs are the assumptions you made while establishing your business. They are responsible for driving your customer acquisition cost,  determining your churn rates, employee salaries, and other input elements.

However, the output contains a set of projections representing how the company will perform if the assumptions are valid. Projections and assumptions are closely related, thus enabling the business owners to make a well-informed decision on the company’s finances.

Elements Of A Financial Model

During startup financial modeling exercise,  you should be clear about what elements to include in the input sheet. Here, we have outlined a few of the factors that constitute a financial model:

1. Revenue

Here you estimated the expected revenue which you intend to generate. It will be your key metric for potential investors and a first glimpse into what the future brings.

2. Operating Expenses 

These are the ones that are incurred daily for running a business. Often, the main operating expenses of most organisations include:

• Rent
• Phone and utilities
• Equipment
• Fixtures
• Inventory
• Insurance

3. Cost Of Goods Sold 

Depending on the type of business, the cost may include products purchased for resale, raw materials, packaging, and direct labour related to producing or selling the goods.

4. Human Resource 

Here you have to plan ahead of the number of employees you intend to hire. It includes their salaries and any other incentive or benefits they will get.

5. Capital Expenditure 

The expenditure made on physical assets is known as capital expenditure. The industry and the type of business define capital expenditure. However, other expenses would be office space, software, machinery, etc.

Why should an Entrepreneur Focus on Financial Model?

Drawing a viable financial model is essential for every aspiring entrepreneur. Financial models paint a picture for startup organizations of how their business may perform in the future.

Before officially launching their dream project, entrepreneurs often ask financial analysts to help them with a robust model.

This model gives them a clear idea of the following key elements:

• Cash flow status
• Set realistic budgets
• Establish efficient business goals
• Stakeholders’ expectation
• Source of Funding 
• Enables you to anticipate profits
• Develops a comprehensive view of your company
• Predicts any expected fluctuations in business

Knowing where to start with a viable financial model is overwhelming, particularly when establishing your new business.

 Make Informed Assumptions

Before startup financial modeling, you need certain assumptions to present the proof behind your suggested numbers.  Being a startup company, it is evident that you would lack any historical data.

You can use assumptions to calculate future growth margins, rates, assets that may turnover, and projected changes in inventory. The assumptions you will define for your plan will be unique as per the kind of business you operate.

 Mostly they are related to the following factors:

• Expected revenue
• Initial investment dollars in the bank
• Operating expenses (OPEX)
• Capital expenditure (CapEX)
• Cost of sales (COS)
• Cost of goods sold (COGS)
• Customer acquisition costs (CAC)
• Working capital
• Networking capital (NWC)

Once you have these assumptions in place, you can model how changing inputs will impact metrics and make plans to prepare your startup for these scenarios.

How To Create A Financial Model For A Startup?

Financial models are a crucial part of every organization’s finance toolkit.

To create a viable financial model that works and allows you to leverage capital to work toward the company’s goals, it is pertinent to understand the essential steps involved in creating one.

Whether you are a current or aspiring entrepreneur, executive, functional lead, or manager, you can follow the steps below for creating an efficient financial model for your startup:

1. Determine your model’s primary goal (fundraising, managing cash, etc.) 
2. Choose KPIs directly related to your business goals
3. Select the most appropriate template as per your convenience and requirement 
4. Merge actual results into the template
5. Start with revenue
6. Create a dynamic headcount plan  
7. Estimate other expenses and fund resources
8. Add sensitivity analysis and scenarios
9. Stress test and audit the model
10. Review your projections

Which Financial Forecasting Model Works Best For You?

Financial models are customizable and tailored to your business needs. Business professionals suggest that forecasting your finance helps businesses plan for unexpected changes.

There are many methodologies used for preparing a financial forecast plan. However, the two of the most common are top-down and bottom-up analyses.

Top-Down Forecasting

The top-down forecasting approach predicts future market sales by estimating a company’s future performance, using high-level market data and down to revenue.

In this framework, the higher management establishes the goals and passes them down the line. As startups lack historical financial data, they primarily use this approach to create a fundamentals-based forecast.

Business professionals considered it an efficient approach because of the following potential reasons:

• It gives you a more informed idea of the demographics and audience you should be targeting
• It goes from the general to the specific.
• It assesses the potential of business growth by analyzing market data
• It performs competitor analysis
• It avoids statistical outliers common to lower-level facts and figures.
• It identifies sales patterns.
• It creates accurate models for strategizing and allocating resources.
• It enables startups to gain insight into long-term profit potential.

You can calculate the Top-down revenue through the following formula:

Revenue = Market Size x Market Share Assumption

Bottom-Up Forecasting

This forecasting method uses a micro approach to estimate future sales revenue. Here, financial experts assess the individual sales and different department performances to determine their impact on business profit.

It focuses more on the activities of the business, for instance, the final product or service, production capacity, marketing costs, hiring costs, and other factors which influence the company’s finances.

This approach allows financial experts to understand how each factor influences the bigger picture. Established businesses often use this strategic approach to look at their current situation and determine where they can reasonably expect to grow.

Also, if you plan to persuade potential investors and lenders to support your business plan, this approach is economically viable. As this framework uses actual sales and production data, you can calculate it using the following formula:

Revenue = Price x Quantity

What Should Be The Output Of Startup Financial Modelling?

As the financial model is the summary of a company’s performance, it should contain three financial statements of accounting, i.e.,

• Income Statement
• Balance Sheet
• Cash Flow Statement

It helps insiders (corporate development professionals, FP&A professionals) and outsiders (institutional investors, sell-side equity research, investment bankers, and private equity) to analyze various operational activities of the firm impacting business growth. 

Eventually, enabling the senior management of a firm to make a well-informed decision.

Where Are Financial Models Used?

Finance officers use financial models in:

• Launching a new business
• Historical analysis of a company
• Investment banking
• Equity research
• Projecting a company’s financial performance
• Project finance
• Real estate investments
• Oil & gas projects
• Banks & financial institutions
• Personal finances
• Non-profit organisations
• Government

Financial Model – Your Road Map to Future Success

Startup financial modeling is essential for founders and entrepreneurs to understand their company’s goals. It will help you answer some of the trickier questions of your angel investors, subsidy providers, and any other respective stakeholders.

Thus startup financial model. It would help them the project and forecast revenue, customers, employees, costs, etc., for the future to understand and assess the profitability and viability of the business.

At Numberly, we are committed to helping startup founders manage their ventures with the right financial wisdom and insights. We support business founders by working alongside them, helping them understand their businesses better, and providing them with a bespoke financial model tailored to their business goals and objectives.

If you are looking to build a financial model for your business,  schedule your free consultancy call and get your customized financial plan to stand out.