To forecast how the business will perform in the future, a financial model is used. Financial modeling for startups is usually done in Microsoft Excel or more specialized financial modeling tools for both small and large businesses. They use algorithms to correlate a company’s financial data to estimate future financial performance based on certain assumptions. The individual creating the model can alter the assumptions to see how they affect the company’s plans and profits.

Assumptions are informed estimates based on previous data, trends, external conditions, and industry and market data.

What Are the Benefits of Financial Modeling for Startups?

Businesses face obstacles or discover opportunities that were not anticipated, regardless of the state of the economy. It’s possible that a supplier is encountering issues. Alternatively, the company could be located in an area of the country that is prone to weather-related delays. Your most loyal clients may switch to a competitor’s product or quadruple their business with you.

You can come across a novel company model that takes off without warning. You can be better prepared to handle these and similar circumstances if you establish a financial model that allows you to examine the outcomes of occurrences like these.

You can go through how you’d handle extraordinary events if they happen by building a model that incorporates the business impact. Creating a model that explains how you would react to known changes would give you a leg up in dealing with an unexpected situation.

Your business model should, at its most basic level, assist you in determining what you would do if:

1. Revenue is stable, as it has been for the previous year or two. 
2. Demand, on the other hand, is much higher than it has been in the recent past.
3. There is a dramatic decline in demand.

Each of those possibilities’ top-line implications for cash flow and product demand will have an impact on every department of the organization, from finance to marketing. The model can assist you to figure out what steps you should take to keep consumers satisfied while managing demand spikes or drops.

While the boat is sinking, you don’t want to be counting life jackets. Similarly, if your trip becomes really popular, you don’t want to run out of accommodations.

A business plan that allows for potential changes in business conditions will not only make you more prepared, but it will also show lenders, investors, and acquirers that you’ve considered what it takes for a company to succeed in adverse or unexpected circumstances.

Small firms may find developing a financial model difficult, yet it is essential. A financial model can be used by entrepreneurs to work out how much to charge for products or services in order to generate a profit, in addition to preparing for possible future outcomes. By tracking performance against plans, financial modelling for startups can also help you create strong financial discipline.

Furthermore, if a company ever needs a loan or investment, it will need to develop a financial model in order to provide the financial projections that lenders and investors want.

How Financial Model for Startups Work?

Small businesses with a long history might construct data models by combining historical financial data with information from industry and market studies. Startups, on the other hand, frequently face the challenge of determining what data to utilize as to set the foundation of financial modeling for startups because they have little to no sales history or customer satisfaction measurements.

They can receive national averages for businesses in nearby markets by consulting industry and market research. Standard revenue costs in any industry, the proportion of revenue ascribed to the direct cost of sales, and the percentage of revenue attributed to overhead are all figures that can be used.

Three-Statement Model

The three-statement model is the most important financial model and the foundation for all other financial models. The three-statement model generates a prediction for a specific time period by combining three fundamental financial statements—income statement, balance sheet, and cash flow statement—with assumptions and Excel-based calculations. It begins with revenue and goes on to compute expenses, debtors, creditors, fixed assets, and other things.

To create a clear picture of its existing business, an employee building a financial model in Excel will create tabs for the income statement (showing revenue and expenses), balance sheet (detailing assets and liabilities), cash flow statement (money in vs. money out), capital expenses, and depreciation costs.

A finance practitioner can then utilize those historical figures to create critical assumptions, which drive projected results and see the forecasts using Excel-based calculations. What impact would a shift in product demand have on revenue growth and cost of goods sold (COGS)?

Revenue projections (average order value minus refunds/discounts), average order value, refunds as a percentage of revenue, discounts as a percentage of revenue, COGS as a percentage of revenue, and operating expenses as a percentage of revenue are all examples of assumptions on the income statement.

Other financial models can be used to forecast the effects of various assumptions after the three-statement financial model is in place.

Sensitivity or “What-If” Analysis

This model illustrates the impact of changing assumptions such as selling price, supply chain expenses, fixed costs, expected sales, delivery costs, and other variables. In most sensitivity analysis models, one variable is changed at a time, and the impact of that modification is then demonstrated. What effect does changing the packaging price or the advertising budget have on the forecast? Is it possible for the corporation to break even if the average selling price is changed?

As a result, sensitivity analysis is frequently referred to as “what-if” analysis. It forces the individual looking at the figures to think about the validity of the assumptions they’ve made. What happens if the actual findings differ significantly from those anticipated? Which variables have the greatest influence on the forecast?

Scenario Analysis

This approach to financial modeling for startups is similar to sensitivity analysis, however, it involves adjusting multiple variables at once. A scenario analysis examines what has occurred in the past and what might occur in the future, including substantial developments that would have a long-term influence on the company. A base-case, worst-case, and best-case scenario is usually included. Scenario analysis could be used to simulate the impact of a coronavirus epidemic, a natural disaster, or the loss of a key customer on a company’s total revenues, for example.

Strategic Forecast Model

Businesses utilize a strategic forecast model to assess how different initiatives they’re considering will affect long-term, strategic goals. This technique, also known as long-range forecasting, aids firms in assessing the influence of corporate projects, treasury initiatives, and marketing and analysis plans on their long-term strategy. A corporation might use the strategic forecast model to anticipate the expenses and possible revenue of developing a second manufacturing plant, opening stores in a different country, or introducing a new product line, for example. It can then decide whether or not pursuing those ideas is in the best interests of the company.

Discounted Cash Flow Analysis

A dollar now is always more valuable than a dollar in two years. You know your cash flow if you do nothing to your business and it earns a consistent amount of money each month. If you make an investment now that will generate new revenue streams in the future, that money will be worth less per dollar than the money you’re spending right now.

Instead of investing that money in your business—for example, by building a new office, purchasing new equipment, or increasing inventory—you may invest it and earn a profit. You might also put money in a savings account and receive interest. So, in order to determine the current worth of an investment, you must discount the money you expect to earn in the future, which is where discounted cash flow analysis comes into play.

The difficult element is determining what discount rate to use. Assume you have a customer who is willing to sign a five-year contract to purchase a certain amount of merchandise, and this is the foundation for your new venture. You have a sure thing if that customer has a good business—you know the company will receive a specific quantity of income for the next five years. You can invest and calculate your discounted cash flow using the interest rate on another safe asset.

If your expected return on investment has historically been 90% of what you anticipated, then your discount rate should reflect that. As a result, your discount rate represents both what you could make if you just invested the money, as well as a risk assessment based on market patterns, your own experience, or both. You’ll use that discount rate to figure out what your investment’s net present value is, and if it’s positive, you’re on to a winner.

The risk component linked with future business is one reason capital investment dried up in numerous sectors during the COVID-19 epidemic. In most situations, estimating a reasonable discount rate is extremely difficult because no one understood how the epidemic would roll out or how much it would harm business and the economy in the long run at the time.

The best way to decide whether or not an investment is a good one is to calculate its net present value. However, the accuracy of your calculations is greatly reliant on your ability to choose the appropriate discount rate.

Foundational Financial Models for Small Businesses

These are the models that will aid you in comprehending the performance of your company:

• Financial statements: The best approach to communicate a company’s financial performance to banks, investors, governments, auditors, or anybody else is to use a useful financial model that includes a projection of the financial statements.
  

• Revenue: This outlines how and when business owners will be compensated. These are the concepts that business managers must grasp in order to determine how to price it, how customers will pay for it, and how frequently customers will purchase it.

   

• Growth margin: How much of the money you charge clients in revenue will go into delivering the product or service, and how much will be left over. That will tell you if you have enough money to support and expand your firm while still making a profit.

   

• Operating expenses: How much does it cost to run a business? What does it cost in terms of support, marketing, and administrative costs, as well as services, software, and so on?

   

• Working capital: Many entrepreneurs and small company owners are unaware that starting a firm or expanding into a new area of the industry requires capital or money. After paying out the operational and gross margin, business owners must determine how much income they need to earn from customers to eventually make enough money to operate the company.

   

• Investments or capital expenditures: This is typically put together when a small business needs to acquire funds, speak with a bank about obtaining loans, or expand credit lines. Business owners must be able to demonstrate to investors how quickly their money will be repaid.

What Can a Financial Model Tell You About Your Business?

A financial model not only informs investors and lenders about the health of a company, but it may also help with decision-making and, eventually, improve business management. Financial models can help small firms answer some basic concerns about their revenue strategy.

To begin with financial modeling for startups, you can use the three-statement financial model to create a budget and track actual spending against that budget. This makes it easy to spot future cash flow slowdowns and determine whether or not to minimize costs. Financial models also assist firms in planning and estimating when and how much they will need to spend to meet particular revenue, total customer, or other KPIs targets.

A financial model also enables a company to forecast financial statements and measure key performance indicators (KPIs) such as revenue growth, gross margin, operating income, earnings before interest and taxes (EBIT), profit margin, and net profit margin.

So where do Numberly come in?

Let Numberly Automate your financial modeling which would therein have a number of advantages, including the ability to handle larger datasets and show estimates to make them easier for you to understand. We can improve your prediction accuracy while also reducing forecasting time. We also make it simple to compare actual and predicted results, consequently making your life much easier.

To get started, schedule your no-obligation free consultancy session and let our experts guide you on the best techniques of financial modeling for startups.