As a founder, a great financial model is the single most valuable asset you have to understand and interpret your runway, revenue, expenses, and many other important financial metrics. It's also a crucial element for successful fundraising.
In this guide, I'll explain the components of a great financial model, how it works, and how you can use it to create a financial roadmap that drives your startup's success.
Creating a financial model may seem overwhelming at first, but it doesn't have to be. By breaking down the process into manageable steps and focusing on the key outputs you need to achieve, you can build a reliable model that will become your go-to resource for tracking and optimizing your business's financial health. Let's go!
Key takeaways:
1. A well-structured financial model is crucial for making informed business decisions, securing funding, and planning for growth.
2. Key components of a financial model include input assumptions, financial statements (income statement, balance sheet, cash flow statement), and supporting schedules, which should be linked together to create a dynamic, flexible model.
3. Avoid common pitfalls like overly optimistic projections, neglecting to track your actuals, or failing to update your model regularly.
4. When you're fundraising, use your model as a tool to answer potential investors' questions and address their concerns. Be flexible, and be prepared to adjust your model to match the investor's expectations.
A financial model is a tool that helps businesses make financial decisions by predicting future financial performance. It uses mathematical formulas and assumptions to forecast things like revenue, expenses, and cash flow.
With a solid model on your screen you appear confident, knowledgeable, and in control when you talk to investors, stakeholders, and your team. Without one, you often find yourself calculating rough estimates off the top of your head that may or may not take all of the contributing factors into account.
A model empowers you to make the best decisions for your startup every day. Even the most experienced entrepreneurs need a financial model to understand how the decisions they make today will impact their business tomorrow.
But creating a financial model can be a cumbersome and time-consuming process. When your schedule is already packed with high priorities, it’s easy for this critical task to slip away into your backlog, never to be seen again.
While it might not seem as urgent as other priorities, every day you make decisions without a model is a day you’re missing out on opportunities to improve every aspect of your business. When you look at it this way, it’s hard to justify placing any competing priority above your financial model.
We help hundreds of startups every month, and every month we see firsthand just how impactful a great model can be in helping a founder achieve their fundraising goals and realize sustainable growth.
We created this guide to help you as a founder meet those goals. We’ll guide you through the process of selecting your tools, building your model, and putting it to use to optimize your business and raise funds successfully.
Follow the recommendations below to create an amazing model that grows more powerful every time you use it.
As you’ll see, the benefits of building and maintaining a financial model are too many to list. It’s one of the few tools that touches and informs every aspect of your operation. But there are three primary reasons you should make it a priority to start modeling today. The first is fundraising.
Investors aren’t always impressed with great ideas, beautiful pitch decks, or even compelling narratives.
They’re in the business of managing risk, and as you would expect, they’ve heard a lot of promises that never came true. What an investor wants to see, more than anything else, is your capacity to lead an organization and deliver on your promises.
They want to see that you are confident, capable, and trustworthy. This is what a solid financial model gives you.
With the help of a model, you can answer investors’ questions quickly and confidently. You demonstrate a strong understanding of the factors that impact your success and the landscape in which you operate.
Your confidence and knowledge build trust with investors. They see that you’re firmly in control of your finances, team, and growth strategies. They see that you have realistic expectations based on solid data.
In the eyes of an investor, you appear capable of leading your organization to achieve your goals and deliver on your promises. In short, you make a great first impression, and as they say, you never get a second chance.
When you use it correctly, a financial model can inform every decision you make as a founder. Can you take on the expense of a new tool this month? When should you make your next key hire? When should you start raising your next round?
Whether you’re making mundane daily decisions or planning your annual growth strategy, you’re able to harness all the data that is available and make decisions with a holistic perspective.
You can still “go with your gut,” but when you have a model your “gut” is well-informed about your alternatives and their likely impact down the road.
When you consistently make data-driven decisions you achieve a compounding effect as gains in efficiency open the doors to better tools, resources, and procedures.
A U.S. Bank study found that 82% of small businesses that fail cite cash flow problems as a primary reason for their failure.
This probably comes as no surprise to you. As a founder, you’ve likely lost hours of sleep worrying about your ever-shrinking runway.
While there are an infinite number of reasons why founders struggle with cash flow management, there’s one truth you can’t deny: If you don’t know you have a cash flow problem, you won’t get an opportunity to react to it.
For many founders, this is the most powerful aspect of a financial model: You’re always aware of your cash position. When there’s a problem, you know about it, and you’re able to react before it’s too late.
It’s liberating to have this information. You’re able to proactively manage your runway, rather than passively worrying about it. Best of all, you sleep well at night!
Those are the three biggest reasons you need a financial model. But the list goes on and on. Here are some other benefits that can help your startup, and you personally as a founder:
Now that you’re familiar with the many reasons why you should be using a model, let’s briefly discuss your options for modeling tools.
There are three general options you can choose from: a spreadsheet, software, or an outsourced service.
Until recently, most financial models were created in a spreadsheet. If you’ve ever created a spreadsheet model yourself, you know this is a difficult way to go.
Spreadsheets are still a popular option, largely because Google Sheets and Microsoft Excel are tools that most founders already have. This makes it seem like a spreadsheet model is essentially free.
But the tradeoff in terms of time and effort is huge. Building a model in a spreadsheet requires you to spend a lot of time troubleshooting complex formulas and hunting down pesky bugs.
If you need a polished model quickly, this might not be the best option for you. But if cost is your top priority and you have time to spare, it might be a good fit.
If you decide to build your model in a spreadsheet, try using one of the financial modeling templates we’ve put together. You can get them for free, and we have a template to match any business model.
Modeling software is still a relatively new segment, but there are already several fully-featured options to choose from.
Software gives you a convenient way to build your model. The interface is purpose-built for modeling, and most options come with some level of support. For most early-stage startups, software is the best option.
Instead of fumbling through complicated formulas for hours on end, you simply choose a template and start inputting your data and assumptions. It’s much faster than using a spreadsheet, and you get a nice set of features you wouldn’t otherwise have.
Software gives you user-friendly dashboards instead of endless rows of raw data. It gives you the ability to integrate with your accounting system instead of entering data manually. And it gives you a polished presentation that’s easy to share with investors and stakeholders.
If you have a lot of money to spend and you need a model quickly, hiring a contractor or service provider may be a good option for you.
When you outsource, you’ll typically get a spreadsheet model that’s polished and presentable. But there’s one big risk you should be aware of, especially if you’re going to share your model with investors.
Investors expect you to know your model inside and out. As we discussed above, mastery of your model impresses investors and builds their confidence in your ability to deliver on your promises.
If you’re not intimately familiar with your model, it can have the opposite effect. When investors question your assumptions, you should be able to defend them and explain the underlying logic. If you can’t do that, investors might get the impression that you don’t know what you’re talking about.
If you choose to outsource your model, be sure to spend plenty of time getting familiar with every detail before you show it to anyone else.
To recap, here’s a quick overview of your options:
Most financial models include the same basic elements, and we’ll cover them in-depth below.
The exact elements for your business might be slightly different depending on your business model and your unique operating environment. For most companies, these general components are a solid starting point.
A cover page is important when you share your financial model with investors and other stakeholders. Whether you’re building a model in Excel or using the latest and greatest software, dumping your reader straight into your data without any introduction is a bad user experience.
A cover page allows you to brand your model consistently with your tear sheet, your pitch deck, and any other assets you’re presenting in the fundraising process. Incorporate your logo, your brand colors, and a brief introduction to explain what is included in your model and how it should be used.
If your model contains more than a few sections, it’s nice to include a linked table of contents to help new users easily find the information they’re looking for.
Assumptions are the inputs that drive the calculations in your financial model.
As an example, think of your customer acquisition channels. For each channel, the assumptions might include the number of prospects in the channel, the conversion rate of those prospects, and the length of time it takes them to convert.
Assumptions change from month to month, and your financial model should show your projection for each month in your forecast period. Some assumptions should use a calculated change based on a projected rate of increase (or decrease), and others should be adjusted manually based on your strategies and plans.
Because there will be many assumptions included in your model, it’s helpful to group similar assumptions into sections for easy navigation.
Again, the exact assumptions in your model will depend on your business, but these section groupings are a good starting point:
The financial element includes your three financial statements, projected for every month in the forecast period.
A financial model should include periodic projections for all of your assumptions and financials. Each of these numbers is typically projected on a monthly schedule several years into the future.
Because financial projections need to reflect changing assumptions throughout the projection period, maintaining projections in a spreadsheet model can become quite complicated. Forecastr allows you to project every metric, every month, up to 60 months into the future.
When you’re building a financial model, just like when you’re building a SaaS tool, it’s critically important to keep the end user in mind. This has two big implications.
First, you’re going to share this model with investors and other people who have very little context for the data in the model. Make sure the model is easy and intuitive for them to use, and supports the narrative you’re telling them during fundraising and later through your investor updates.
Secondly, the model needs to be intuitive and useful for you, your board of directors, and the decision-makers on your team. Make sure the model shows actionable data you can use to make better decisions efficiently.
Here are three guidelines that will help keep you on the right track:
Start your model with your actual data, and build your projections from there based on your current growth rates and realistic assumptions about the future.
Avoid making top-down assumptions. An example would be, “The total addressable market is X, and we can capture Y percent of it.” This is a big turn-off for many investors.
A bottom-up approach might be, “Our current sales per month are X. We’re growing by Y% each month. Calculating our compound growth, we get future monthly sales of Z.”
Active investors look at financial models every day. They’re good at judging the quality and completeness of a model. So you would be wise to deliver a good model that exceeds their expectations.
Follow industry standards for color-coding your model:
Color-coding your text is optional, but it does help to make the model easier to read. You can use black text for everything. If you do decide to use colors, stick with these standards to avoid confusing investors.
Including navigational elements helps users quickly find the information they’re seeking. At a minimum, you should include a clean cover page with a linked table of contents. Check out our templates if you need an example.
Any dashboards you add should focus on a few high-level metrics to avoid overwhelming the reader.
We’ll talk more about this below. To summarize, a financial model needs to be kept up to date. We recommend updating your model every month and we do this religiously.
When you keep your model up to date with your actual accounting data, it becomes more and more accurate with each passing month.
When your model is stagnant, it decays. Over time, it gets out of sync with your actual performance and growth rates. With each passing month, it becomes more difficult to bring it up to date.
Because building a model is a time-consuming process, it’s better to keep your existing model current rather than build an entirely new model every time you need to raise funds.
A financial model is indispensable in the fundraising process. There’s no better tool to communicate your vision to investors.
But a solid model is much more than eye candy for the fundraising process. Used correctly, a financial model provides insight and clarity into every aspect of your operation.
For this post, we’ll break it down into five sections: growth plan, revenue plan, expense budget, hiring plan, and capitalization plan.
A growth plan details the strategy you will use to acquire new customers. A good growth plan should include separate projections for every acquisition channel in your strategy.
By breaking your growth plan down into individual channels, you gain the ability to analyze the conversion rate and cost of acquisition for each channel. This exposes your best and worst channels and allows you to allocate your resources accordingly.
While a growth plan details your strategy for acquiring customers, a revenue plan details your strategy for monetizing those customers. A good revenue plan should show which products or services your customers buy and should include a churn rate or retention rate for each product or service.
By setting monthly targets for each channel and each offering, and then reviewing your actual performance against those targets, you continually reveal problem areas within your operation, as well as areas where you are outperforming and may want to invest more resources to feed the fire.
An expense budget details everything you plan to spend money on for the forecasted period. This includes recurring expenses like salaries, benefits, rent, and supplies, as well one-time expenses like new equipment, promotional events, and acquisitions.
A good expense budget accounts for every penny you plan to spend, and breaks those expenses down into relevant categories. At the end of each period, you can compare your actual expenses against your targets to reveal and take action on overspending issues.
A hiring plan details your plan and schedule for bringing new players onto your team. A good hiring plan should include each position you might hire within the projected period, along with a target date when you expect the hire to take place.
If your hiring plan includes existing positions, you can also use it to show the timing and impact of pay raises and promotions. When you carefully plan and execute your hiring strategy, you avoid unintended cash flow issues and ensure that your salaries and employment expenses are always in line with industry standards.
A capitalization plan details your strategy to provide capital for your business and avoid running out of money. A good capitalization plan should include a calendar with target dates for raising capital before your existing money runs out.
No other part of your financial plan is more important to update and review on a regular basis. The most common reason early-stage startups fail is that they simply run out of money. Your financial model is your best defense. Track your capital closely, and keep your projections tight so that you have a good estimate of the date when you need to start your next raise.
Fundraising – when some founders think of a financial model, this is all they think about. A financial model is a huge asset in this regard. If you’re talking to VCs, you might be hearing that a financial model isn’t just an asset – it’s a requirement.
The biggest thing to know about fundraising with a financial model is when to break your model out. If you make your move too soon, you can leave a lot on the table.
Your first task is to hook the investor. This is best done with a killer pitch deck and a compelling narrative. If you successfully get the investor on the hook, they’ll have plenty of questions. Those questions are where your financial model comes in. Tell the investor you want to walk through your model in depth, and use it as a teaser to get a second meeting on the books.
Avoid sending the model before the meeting, if possible. Even if you have a great model, it’s too much information for an outsider to digest without context. A good rule of thumb is to never let your model stand alone.
When you do dive into your financial model with your investor, there are 2 basic strategies. The first is, “you and your model vs. the investor.” You act as adversaries as the investor challenges your model and you try to defend it. This usually isn’t the best approach.
The second strategy is “you and the investor vs. the model.” You sit on the same side of the table with the investor, and the model sits on the other side, alone. You treat the meeting as a working session where you and the investor challenge the model together and look for ways to improve your plan. This lets the investor know that you’ll be a good partner to work with, and most importantly, it builds trust.
A financial model is great to have during fundraising. But if you keep your model up to date, over time it becomes an indispensable resource to help you succeed as a founder. It helps you make better decisions, it lets you see which strategies are working, and it helps you avoid running out of cash.
We recommend all our founders update their models every month, and we practice what we preach. As we mentioned above, when you let your model get stale, it gets further and further from reality with each passing month.
But if you regularly compare your results against your forecast, and update your assumptions accordingly, your model becomes more accurate and more useful. Because you’re identifying and addressing gaps every month, you create a continuous improvement loop where your model and your performance both improve with each cycle.
A financial model helps you raise money, improve your business, and avoid running out of cash. It’s hard to justify operating a startup without one.
If you’re an early-stage founder without a financial model, go ahead and get started on one. If you need to go the spreadsheet route, for now, consider using a pre-built template to get it done with as little pain as possible. We’ve got free templates to match most business models.
If you want some help, Forecastr is a convenient tool that makes it easier than ever to get a great model. When you work with Forecastr, our dedicated analysts work alongside you to build and maintain a model that’s easy to use and easy to share. Reach out today to learn more.