A financial model defines your business goals in numerical expressions. It includes figures regarding your customers, employees and how your margins will improve. Creating a financial model helps determine the key metrics you can test as you execute your business plan. A good financial model doesn’t have to be right. However, the difference between the actual results and predicted projections can give insights into the potential of the business.
Building a financial business model
Here are some steps to create a financial model for your startup:
1. Establishing the goal of the model
The first step when starting any business project is to establish its goal. Establishing the goal of the model helps you determine the complexity of the project. If you’re making a major financial change like raising capital, you need to be detailed enough to prove that you understand the market but not too detailed to lose the interest of the investors. On the other hand, if the model is a detailed cash flow for an existing business, you can go for a highly detailed analysis.
2. Determining the KPIs
Determine the key performance indicators in the model and how to track your performance against them. As a starting point, you can use industry-standard KPIs to get a direction.
3. Using a financial model template
Work smart, not hard. Building a working Excel piece from scratch is unnecessary and time-consuming. There are many free templates available that you can use for your financial model.
4. Merging actual results into projections
It is best to start with real numbers so you set your level. If the model is for an already operating business, you can merge your actual results with the projections to see how you’re doing.
5. Starting with revenue, work your way down the income statement
It is important to understand what drives your revenue when thinking about how much revenue you can make. Consider the number of sales or marketing activities and people and customers that will help with your revenue growth.
6. Estimating significant expenses
Estimating significant expenses helps you determine the major requirements to reach your goal. Usually, for startups, the biggest expense can be headcount. Determine the number of people you need to achieve your goals and how much will it cost to employ them (consider recruitment costs, hiring, salaries and other employee benefits).
7. Estimating other expenses
After the major expenses, estimate the other expenses that contribute to reaching your goal. Keep counting the additional expenses as your company grows, including the headcount expenses.
8. Reviewing the projections
Reviewing projections is important to ensure that you’re on the right track and aligning with your goal. Measure the projections against actual results and get insights about how you can do better and what is the potential of the business.
