Choosing the right type of financial model is the first step in seeking investment for your startup. Your model will show potential investors how your business is structured, how it plans to generate revenue, and what kind of return they can expect on their investment.

Since startups are still in the early stages of development, their financial models are often highly dynamic, changing as the business grows and adapts to new markets. Therefore, a dynamic financial model is often the best approach for startups because it can be easily adapted to changing circumstances.

Here’s an overview of how this model works. Plus, we explain its benefits and implementation for early-stage startups.

What Is a Dynamic Financial Model?

As the name indicates, a dynamic financial model is a flexible tool that can simulate changes in a company’s financial statement values over time. The model is built using historical data and can be used to generate future scenarios based on different assumptions.

A dynamic financial model can be used for a variety of purposes, including:

• Forecasting
• What-if analysis
• Budgeting and planning
• Financial analysis

Dynamic financial modeling is a complex process requiring a deep understanding of accounting and finance. The modeler must understand the drivers of financial statement values and how they interact with each other.

All dynamic financial models have some underlying assumptions. These include:

• Customer Growth Assumptions: The model must assume customer growth from marketing campaigns and other initiatives. 
• Cost-Driven Assumptions: A dynamic financial model should also have cost-driven assumptions, such as those due to increased orders. For instance, an e-commerce store that sees an increase in order volume will also experience a hike in costs for storage and order fulfillment. 
• Market-Sizing Assumptions: To generate projections, the model must make market-sizing assumptions. In other words, it needs to estimate the total addressable market (TAM) for the product or service. For example, a Saas company that provides software to small businesses might assume that there are a certain number of small businesses in the region, and a certain percentage will be willing to pay for their product.

Often, stock returns are also an assumption in a dynamic financial model. However, this does not apply to startups since they are not publicly traded.

Outputs of a Dynamic Financial Model

The company uses the model’s outputs to determine its financial condition, including:

• Profitability: The model can assess whether a company is profitable and how that profitability changes over time. For example, a company may be profitable in the short term but not in the long term.
• Liquidity: The model can also show how much cash a company has on hand and whether it will have enough to cover its expenses. It’s important for businesses that have a lot of inventory or other short-term assets to have enough cash on hand to pay their bills.

Startups can use a dynamic financial model to raise capital by showing potential investors how the business will perform over time. The model can also be used to get a loan from a bank.

Benefits of a Dynamic Financial Model for Startups

A dynamic financial model can be good for any company. However, it has some notable advantages for startups in particular.

Accounts for Changes

Getting a startup off the ground is a rocky journey with a lot of moving parts. A dynamic financial model is a key to understanding how all these pieces fit together and how changes in one area will impact other areas of the business.

It can help a startup track its progress, assess new opportunities, and make course corrections as needed along the way. For instance, a retail startup might use a dynamic financial model to track inventory levels and customer demand in real-time, so they can make changes to their product mix or pricing.

Likewise, a SaaS startup may use it to track subscription churn and customer lifetime value. They can use this data to tweak their market efforts.

Investor-Friendly

Investors want to see a financial model that conveys the company’s story and growth potential. A well-built dynamic financial model will do just that.

It will show how the company plans to generate revenue and profit, how quickly it is growing, and how much capital it will need to get there.

A dynamic financial model can also show different what-if scenarios. It will help the investor see how the company will navigate multiple scenarios, such as:

• Inflation
• Change in consumer behavior
• New competitors
• Regulatory changes

Easier to Use

A dynamic financial model is easy to use because it is built on a spreadsheet. That makes it easy to plug in different assumptions and see how they will impact the company’s bottom line.

How Startups Can Implement a Dynamic Financial Model

When implementing a dynamic financial model for your startup, there are a few key things to keep in mind. Here are some helpful tips:

• Don’t use hard-coded values. When you’re updating your financial model, you don’t want to have to manually update hard-coded values every time. Instead, use dynamic links that automatically update based on changes in your data.
• Keep your model as simple as possible. The more complex your model, the more difficult it will be to maintain and update.
• Make sure your assumptions are clear. When making assumptions in your model, be sure to document them clearly so that anyone reviewing the model understands where you’re coming from.
• Update your model regularly. The whole point of having a dynamic financial model is that it can change as your business changes. Update your model regularly so that it reflects the most current information.

While this seems easy to do in writing, it’s actually much harder to implement in an early-stage startup. As a startup, you might not have the personnel or expertise to perfect a dynamic financial model. That’s where a helping hand comes in.

Get a Customized Financial Model For Your Early-Stage Startup

What better way to tell your story and get the attention of investors than with a customized financial model? Generic models often contain features irrelevant to startups.

At Numberly, we create pitch deck-ready financial models for early-stage founders. Our models match your company’s growth trajectory, being flexible enough to allow the inclusion of new data points and assumptions as your business develops.

From financial statements to market competition, you can include everything in your model to answer your investors’ questions and get just the right snapshot of your company. Book a call with us to learn more.