Financial modeling can be applicable in a wide range of scenarios for startups. Investors often look at a startup’s financial model to assess its potential for success and growth. A well-constructed financial model can also help a startup track its progress and make better-informed decisions about allocating resources.

In this guide, we discuss some of the most common use cases of financial modeling for startups. We also talk about the benefits of using financial models.

Use Cases of Financial Modeling for Startups

Startups can use financial models for several purposes. Here are some of the most common use cases:

Fundraising

An early-stage startup will often use a financial model to raise money from investors. The model can show how much money the company needs to get to the next stage of its development, how much equity investors will get in return for their investment, and what the company’s financial projections look like.

Suppose you’re a startup retail business owner looking to raise $1 million from investors. Put together a financial model that shows the following:

• Dynamic assumptions about the number of stores you plan to open in the next five years
• Three financial statements
• Best-case, worst-case, and most likely-case scenario analyses
• Your use of the funds
• The equity investors will receive in return for their investment
• Capital required

Company Valuation

Besides raising money from investors, startups also need to worry about company valuation to determine how much a company is worth. There are different methods for valuing a company, but the most common is the discounted cash flow (DCF) method.

The DCF method discounts the company’s future cash flows to present value and then sums up all of the discounted cash flows. The discount rate used in the DCF analysis is the company’s weighted average cost of capital (WACC).

Financial models for startups leverage the DCF method to value a company. The model factors the startup’s projected cash flows, discount rate, and terminal value.

Budgeting and Forecasting

The startup failure rate has been close to 90% for the past few years. While many factors contribute to startup failure, one of the main reasons is that startups run out of cash.

A financial model can be a blueprint for a startup’s budget and forecast. The model can help startups track their actual results against their budget and forecast, identify areas of concern, and make course corrections.

For instance, a startup SaaS company needs to track its monthly recurring revenue (MRR) and customer churn rate. The company can build a financial model that shows its MRR, churn rate, and cash balance on a monthly basis.

If the company sees that its MRR is below its forecast, it can take action to increase sales and reduce churn. Similarly, if the company’s cash balance is below its forecast, it can try to conserve cash or raise additional funds.

Distributing Financial Resources

For a startup to be successful, it needs to allocate its resources wisely. That’s where a financial model can be helpful.

For example, an e-commerce startup will have to allocate resources to the following departments:

• SEO and online marketing
• Product development
• Customer service
• Warehousing and shipping

But merely knowing where the money should go is not enough. The founders also have to consider the following:

• How much money should go to each department?
• What are the historical spending patterns for each department?
• What are the future spending needs for each department?
• Does the company have the necessary resources (e.g., personnel, equipment) to support the projected growth?
• What are the risks and opportunities associated with each department?

A financial model can help startups answer these questions. Instead of making decisions on a whim, a financial model allows founders to make data-driven decisions that can be measured using key performance indicators.

Benefits of Financial Models for Startups

Financial modeling helps startups translate their business plans into numbers and assess the financial viability of their operations. A good model will help a startup identify its key assumptions and track progress against them. It will also provide a framework for allocating resources and managing risks.

There are many benefits to creating a financial model for a startup. Perhaps the most important is that it forces the management team to think through all of the key components of their business and how they fit together. The process can uncover weaknesses in the business plan that might otherwise go unnoticed.

For example, a startup might assume that it will be able to grow its revenue rapidly without incurring much in the way of costs. But when they model this out, they might realize that their assumption is overly optimistic and that they will need to invest more in marketing or product development to achieve their desired growth.

Another benefit of financial modeling is that it can help a startup raise money from investors. Instead of simply presenting a deck of slides, the management team can use their model to show how their business will generate revenue and profits.

Who Builds Financial Models In a Startup?

Many financial professionals can build a financial model in an early-stage startup. However, the job is mostly left to equity research analysts, accountants, and corporate development analysts.

These people are tasked with understanding a company’s financial position and future potential and communicating that information to investors, lenders, and other stakeholders. 

However, startups don’t typically have the funds to work with investment bankers or other financial consultants, so it falls on the shoulders of in-house employees to get the job done.

In most cases, these individuals end up using generic financial models that contain unnecessary features. Most of these models also use hard-coded assumptions that are not feasible for a constantly growing startup.

A better alternative is to leave financial modeling to a third-party expert. In fact, research shows founders who use third-party expertise see a 3.5 times faster growth in their startups than their counterparts who don’t.

Numberly: The Third-Party Financial Modeling Experts You Need

Numberly is the go-to place for early-stage founders who want to create investor-friendly financial models catered to their companies’ specific needs and maturity levels. Since Numberly creates customized financial models, it helps startups tell their stories more effectively and efficiently to potential investors. Book a quick call to learn more.