Over many years, I’ve attempted to build a simple model to help me consider growth or budget decisions for example.  Invariably, my best endeavors ran into trouble when I came to use my creation.  As a generalist, I had a good idea of what I needed and why, but creating it accurately and more importantly simply was something I couldn’t ever quite land, which in hindsight is no surprise.  Financial model building is a highly technical skill.  Sharing my model with my team and my thoughts derived from its data only to find out that it was all flawed was not only personally embarrassing, but also a waste of valuable time.  It took me a few painful landings to grasp this and having a great modeler on the team to do this important work became part of my SOP.

When creating financial models, startups often make common mistakes that jeopardize the model’s accuracy and usefulness. It’s imperative to leave no room for error, especially when preparing a financial model for an investor pitch.

In this guide, we’ll go over nine not-to-dos of financial modeling. We also explain how to avoid them.

9 Mistakes Startups Make In Financial Modeling

Startups are on a learning journey in every aspect of business, and financial modeling is no different. Here are some common mistakes startups make and tips on how you can avoid them.

1. Too Much Guesswork

While assumptions are a necessary part of financial modeling, there’s a fine line between making assumptions and making guesses. If your model is based on too many guesses, it will be less reliable and accurate.

When you make assumptions, back them up with data. For example, if you’re assuming a certain percentage of people will sign up for your product, explain why. Maybe there has been a recent increase in consumer interest in that product or similar products. Or, you may have conducted market research that shows there’s a demand for your product.

Don’t merely say, “I think XYZ number of people will sign up for our service.” That’s not an assumption; it’s a guess.

How to avoid it:

Doing your research is the best way to avoid making too many guesses. Gather data and use it to support your assumptions.  Use benchmarks that are reliable rather than what you may think you can do.  Naive optimism is not far away from having ambitious goals!

2. Outdated or Missing Spreadsheet

When working with a plethora of spreadsheets, it’s not uncommon to accidentally use an outdated version or misplace one entirely. If the data in your spreadsheet is outdated, it will throw off all your calculations and projections.

Likewise, if you’re missing a critical spreadsheet, it will prevent you from completing your financial model. Even worse, you may lose the one spreadsheet that links everything together.

How to avoid it:

Keep all your spreadsheets in one central location, such as Google Drive or Dropbox. When people collaborate on spreadsheets, they save different versions (i.e., project1_v1, project1_v2). It creates confusion and makes it difficult to know which is the most recent version.

To avoid this problem, use a naming convention that includes the date. For example, project1_20190101. This way, you’ll always know which is the most recent version.

3. Single-Scenario Planning

The odds of things going exactly according to plan are slim. That’s why building different scenarios into your financial model is essential. What if there’s a delay in funding? What if you have to spend more on marketing than you anticipated? What if your product doesn’t sell as well as you thought?

Unfortunately, startups often build financial models that only consider the best-case scenario. They don’t plan for any roadblocks or setbacks. As a result, they’re caught off guard when things don’t go as planned.

How to avoid it:

At a minimum, you should create scenarios for three situations:

• Base scenario
• Upside scenario (i.e., things go better than expected)
• Downside scenario (i.e., things go worse than expected)

Ideally, you should build more than three scenarios. The more scenarios you consider, the better prepared you’ll be for anything that comes your way. It will also show investors that you’re thinking about the risks and have a plan to address them.

4. Inconsistent Format

Does one spreadsheet in your financial model have a different font, font size, and cell color than the others? Do the column widths and row heights vary from sheet to sheet?

While it may not seem a big deal, inconsistent formatting makes financial models challenging to read and follow. It’s also a red flag for investors.

How to avoid it:

Before building your financial model, decide on the format you will use. Then, apply that format to all the sheets in your model.

Make sure everyone working on the model uses the same format. It will prevent the model from becoming a hodgepodge of different formats.

5. Not understanding the major drivers

In any business, there will always be some metrics that have a bigger impact than others and so are more important.  Knowing these is often overlooked as being very important.  In a B2C startup with a large addressable market, a fraction of a percentage point can mean a huge difference to the business performance, so appreciating the sensitivity of each metric is vital.

How to avoid it:

Understand what your model is doing and how it works.  Look at the results and question yourself about the feasibility of achieving it. Often common sense is overlooked!

6. Too much detail or not enough detail

A model has to have enough detail to meet the objectives a founder has for it, and ideally no more.  Often founders may have an urge to include lots of detail that possibly is not necessary at best and irrelevant at worst.  If you are a pre rev, pre MVP SaaS business for example, then gaining traction, acquiring users, and finding initial PMF are likely to be your objectives.  Having a model that deals with multiple user types, lots of product variants, many pricing options is a waste of time right now.  That time may come, but its not today.

How to avoid:

Focus on what you need to achieve over your next few milestones first.  That may be enough in itself to prove your business model.  If you have questions you’re itching to answer, capture them and sit on them.  Of course it’s important they’re not forgotten about or dismissed, but its likely that it’s impractical to answer them now and even if you did, you may well be guessing – either way it’s not a good use of your time.  

7. Hard-Coded Projections

Hard coding projections and assumptions into your financial model is a bad idea for two reasons. First, it is difficult to adjust the assumptions and see how they impact the rest of the model. Second, it makes the model less flexible and less adaptable to changes.

How to avoid it:

Use dynamic assumptions to build your financial model. They will make your model flexible enough to incorporate and account for changes.

8. Using a Generic Financial Model Template

Too many startups make the mistake of using a generic financial model template. While templates can be helpful, they should only be used as a starting point.

Your startup is unique, so your financial model should be too. A generic template won’t consider your specific business, industry, or market. As a result, it may have too many features you don’t need or may lack the features you actually need.

9. An Unbalanced Balance Sheet

The balance sheet is one of the three fundamental financial statements. It reports a company’s assets, liabilities, and shareholder’s equity at a given time. A balance sheet that doesn’t balance is a huge red flag.

The discrepancy could be due to many reasons. For instance, you might have forgotten to include a liability or an asset. It could be a typing error too. For example, you may have written a positive value as a negative value or applied the wrong formula to the wrong cell.

How to avoid it:

To ensure your balance sheet is balanced, ensure the total of all assets equals the sum of all liabilities and shareholder’s equity. You should also double-check your formulas and ensure all the cells are correctly populated.

How to avoid it:

The solution lies in custom-made financial models. That’s where Numberly saves the day.

By creating tailored templates that factor in your specific needs, circumstances, financial standing, and business maturity, Numberly ensures that your financial model is perfectly equipped for your business and to share with your potential investors as well as your team.  Numberly models give your audience a simple, clear picture of your business minus the background noise that irrelevant features create in generic templates. So book a quick call to learn more.

Conclusion

Financial modeling mistakes can be grave, especially if you’re a startup seeking investment. The good news is they’re avoidable. If you avoid the mistakes highlighted in this article, you’ll be well on your way to building a reliable financial model.