Let us begin by talking a bit about the financial model. Financial modeling is the process of creating a financial analysis of the company, and it impacts the future growth of the business. Companies in all stages, such as Startups to multinational enterprises, use financial models. Financial models are built in Excel or more advanced software. Afterward, we will get into the hacks founders can use in their financial models.

The financial model summarizes a company’s expenses, income, and revenue. With the help of a financial model, you can safely calculate what a customer should/would/could pay for the product in the future. Unfortunately, people often mistake the usability of the financial model. They often obsess over the numbers calculated by the assumptions, but that is not the case.

As put by George Box, a very well-known statistician, wrote in a 1976 paper Journal of the American Statistical Association:

“All models are wrong, but some are useful,” George Box.

That is the whole point of a financial model; it is not about the numbers but the process. The financial model helps you face the questions you can’t or don’t want to answer regarding the company’s financial validity. As you move up the ladder from a startup to a well-established business, you will come across three classes of models with increasing complexity.

– Model A: Market Model

– Model B: The Investor Model

– Model C: The Operating Model

The market Model, also known as the “top-down model,” will help you understand the competition in the market and where you stand. Investor Model will help you determine if you have the right product and if you will be able to sell your product to the customers.

Flow of money coming into = Flow of money coming out.

The Operating Model is the reality guide you will need to run things smoothly. It will help you with the actual forecast, giving you a reality check from time to time.

Significance of financial modeling

There are many ways in which financial modeling helps you. First, however, we will be getting into the top two reasons.

• Managing business.
• Securing funding.

Managing business:

You need a sustainable financial plan to help your business grow and succeed. Financial modeling lets you see the big picture and test different scenarios. It’s always a good idea to give any idea a test run before executing it.

• Planning:

The financial model uses formulas to anticipate the future of the company. For example, you can analyze the company’s future from a month to a year to a decade. It works by calculating the company’s financial standing and history regarding the assumptions.

• Hiring:

With the help of allocating funds in financial models, you will be able to hire efficiently. You don’t want to lay off employees because of a lack of funds. Therefore you should hire people that you can afford and keep long-term. Hire the right people to help grow the company and help your startup succeed.

Securing funds:

With the help of a financial model, you will be able to secure funding for your business. When presenting your business to a potential investor, you must show them your financial forecast. Investors ask for a 3-5 years financial forecast, and a financial model helps with that. Therefore, the financial model is a crucial part of securing investment.

• Financial planning:

After setting assumptions for your financial model, you will know whether you have enough funds. Then, with the help of forecasting, you will learn how much investment is required and when. It also helps determine the type of investment best for your business: debt financing, entity financing, or venture capital.

Financial Modeling Tips for Founders:

There are different types of financial models, and choosing which one you need is vital. Let’s take a brief look into these models so you can start from the right foot.

There are ten types of financial models:

1. Three Statement Model
2. DCF Model
3. M&A
4. IPO Model
5. LBO Model
6. Some of the Parts Model
7. Consolidation Model
8. Budget Model
9. Forecasting Model
10. Option Pricing Model

To learn more about these models, dive into our blog on Numberly

Being perfect at financial modeling is more of an art than science. What may be right for one business isn’t necessarily suitable for you too. With the tips below, you can u Understand and achieve the financial model that works for  your business.

1. Key business drivers:

Aligning your assumptions of the financial model with your business. You should use Key Performance Indicators(KPIs) or business goals is what you should use to generate your financial model.

Key Performance Indicators such as churn rate, the average selling price per customer, etc., are the key variables that will determine the lifetime value of the customers.

It is vital to have 4 to 5 KPIs before moving to forward with the financial modeling. Don’t have too many KPIs as it will complicate the financial model.

Explain your gross margin:

Gross margin answers the question of what costs are required for your service. Therefore Gross margin indicates the cash position of your company. Your cash position will improve when the gross margin is more significant and will help you grow.

Therefore, investors are looking for Startups that have a higher gross margin. Because when a company has a higher gross margin, they have more money to spend on operating expenses, marketing, advertising, and hiring people.

2. Error-free:

To have an effective bulletproof financial model, you must add assumptions. The assumptions shouldn’t base on Imaginary data it should be on your cash flow drivers. The model should be precise, clear, and accurate. It will help you secure funding and maintain the finances. For all this, your model should have Dynamic Codes without any errors. The codes shouldn’t be hard-coded as you might need to change the assumptions, or when you show your model to an investor, they will want to test-run your model.

Here you will need an expert’s help. However, you don’t have to look any further; Numberly provides free consultation for your models.

3. Assumptions:

Financial modeling helps you look at the bigger picture, and you will need assumptions. You can’t have a complete model without Assumptions or Scenarios.

When you pitch your idea to any investor, they want to look at a 3-5 years forecast. This is where this section comes in. It might seem impossible to project five years into the future, but it isn’t with a suitable model.

When building your model, you should create a monthly forecast for 3-5 years. Afterward, you can summarise it on a quarterly or annual basis.

To prove the accuracy of the assumptions, you should cite the sources. For example, if you have done research or interviewed users, you should mention it in the document to show the accuracy of your data.

4. Don’t Complicate it:

Your financial model should be Simple and Precise. You need data in your financial model that is not complicated. You don’t need to add every last detail; it should have the correct information. Cash flow is the essential part of the model, along with assumptions. You might like a detailed model, but you must consider other people.

For example, Investors, you are presenting your model to team members or anyone. It might seem difficult or not necessary, but this will make a huge difference. As your company grows, your data will increase, and updating the financial model will become very frustrating if the model has too many details.

5. Focus on expenses:

When doing the financial modeling, you should focus on expenses. In this part, you will capture your personal, advertising, and marketing expenses, known as General & Administrative expenses(G&A) or Sales, General & Administrative expenses(SG&A). Most startups fail because they don’t manage their expenses well, such as rent, cost per headcount, etc.

Keeping an eye on the costs will help you narrow down any cash flow that isn’t necessary. You won’t be able to pinpoint each of the expenses, but you will be able to see a pattern draining your money in any way. When it comes to the business’s revenue, you can try to control it, but it can’t be in your hand as you can’t force your customer to buy a product.

Instead, you can use different strategies to expand revenue which links to expenses. It is simple math. You are losing money if you cannot cover the costs with the income. Therefore in order to have an infallible startup, you can’t veer off the expenses at any point.

6. Be pessimistic:

When you are starting a new business, you should be a pessimist because when you are starting a new project, you have high hopes for it. You want to change the world. To achieve that, you need all the tools necessary. One of these tools is testing all scenarios. It would help if you had several different assumptions for your financial model.

You are ranging from best case scenario to worst case scenario. When it comes to the Investor model, you should always base that on the pessimistic case. This will help you turn the worst-case scenario into the best-case method. Hope for the best and prepare for the worst.

7. User-friendliness & constant Updates

User-Interface is essential to any model, which is why you should make the model user-friendly. There are two groups of users, the internal team administrations, managers, etc., and the external team, such as investors. Therefore you should make the model as friendly as possible, so it is self-explanatory.

Investors get tons of models every day and they won’t waste their time on a model that is too difficult to understand or test.

Quite often founders start taking financial modeling for granted as they move forward in their business journey. This mistake can be the death of your company. If you don’t update your model and look at the numbers provided by the model objectively you won’t be able to progress.

After you have progressed and have stability you should hire financial analysts to help you with your financial model. If you can’t afford that there are multiple platforms such as Numberly to get expert advice on your Model.

Bonus tip:

Before taking any major decision regarding the expenses of the company you should always look at your Growth Margin so you know whether you can afford it or not. The same goes for when you are hiring any new employee or expanding your business. With the help of these tips, you will be able to achieve a flawless financial model which will help you build your business.

If you need some help with financial modeling or growth margin calculations,  schedule your no-obligation free consultancy session and let our experts guide you on the way forward.