5 min read

Why You Should Update Your Financial Model (and How To Do It)

Picture of Evan Diaz de Arce Evan Diaz de Arce March 31, 2022

Financial modeling Fractional CFO services Financial hygiene Know your numbers

Your research is complete, and you have built a financial model that tells a great story about your startup. You’ve shared the model with investors, and it’s helping with your fundraising.

So what do you do with your model now? Can you just toss all your paperwork and notes in a drawer and forget about them until your next funding round?

The short answer is: no. Your financial model is a model of your business, and you’re missing out on some of the biggest benefits if you don’t use it every month to make more informed business decisions.

To get the most out of your model, you’ll need to update it monthly. This post will tell you why, and, most importantly – how – to update your financial model.

The #1 Benefit of Updating Your Financial Model
Aligning Projections with Performance
Finding Your Rhythm
How To Update Your Financial Model

The #1 Benefit of Updating Your Financial Model

When you look at the data, it’s clear that any startup can quickly fall flat without a solid financial model. 82% of small businesses that fail do so because of cash flow problems.

Although there may be many different factors that contribute to these problems, one thing is clear: If you’re not aware of a cash flow problem when it’s happening, you don’t get an opportunity to take action.

Being aware of hidden cash flow problems is the most powerful benefit of keeping your financial model updated.

When you initially create your model, it forces you to plan how your business will generate revenue, how you will acquire customers, and how these processes impact your cash flow and runway. It’s a powerful exercise, and it’s one that you can repeat indefinitely if you want to.

As soon as you let your model go stale, however, you lose this advantage. You might know how much money is in the bank, but you probably don’t know exactly how long it will last.

Not knowing this information can take a huge toll on your startup, and on you as a founder. It costs you sleepless nights, bad decisions, and a loss of confidence.

From here on out, you should commit to updating your model every month.

Aligning Projections with Performance

You may have put hours upon hours into your financial model when you built it. As you quickly discovered, it was never 100% accurate. That’s OK. No model is ever 100% correct – that’s why they’re called models.

A well-maintained model does provide you with a reasonably accurate picture of what’s going on in your business. But the key phrase here is “well-maintained.”

When you update your model regularly, you can conduct a forecast versus actual analysis. This allows you to compare your expectations against the numbers in your accounting software and other data sources.

Knowing the difference between those two numbers is your opportunity to take corrective action.

You can update your assumptions to reflect your reality. And you can update your processes to address inefficiencies and operational issues.

When you do this consistently, you begin to close the gap. As the variance between your projected numbers and your actual numbers grows smaller, your ability to make informed decisions grows stronger.

With each revision, you get closer to having a model that will predict what will happen. This lets you make better decisions concerning a wide range of tasks and objectives, such as:

When to make key hires
When to trim expenses
When to start fundraising

Finding Your Rhythm

As you know, circumstances can change quickly in the life of a startup. The fresher your information is, the better – especially when it comes to your cash position.

Dave Lishego, a Senior Financial Analyst from Carnegie Mellon University, provided some great advice concerning the frequency of reviewing your performance:

“Maintain a rolling twelve-month forecast so that with each passing month, you extend your forecast by one month. You always want to be able to look twelve months in advance. So, in March 2022, your model should extend to April 2023. At the beginning of the year, create a “gold standard” copy to reference throughout the year. Do not alter this “budget” model. Save a second copy and call it your ‘working’ model to update each month. Always save a new copy and label them accordingly so that you can reference previous months.

Compare your actual numbers with your predicted figures at the end of each month. Now is the time to dive deeper to understand why they differ. Always compare your projected cash balance with your actual cash balance to ensure enough runway.”

As a company that helps hundreds of startups with their financial modeling needs, we have seen the power of regular updates help push many companies over the edge to achieve their fundraising goals and amazing growth.

We recommend that all of our clients update their models every month. And we practice what we preach. We update our model every month with no exceptions.

However, what suits us may not suit you. The schedule that will work best is the schedule that works for you. If you can only update your model every other month, or even once a quarter, that’s much better than not updating it at all.

What’s most important is that you develop a repeatable system that allows you to review your performance and compare it to your forecast, and stick to it. Consistency is key.

How To Update Your Financial Model

The exact process you should follow to update your financial model will depend on several variables, and you’ll need to iron out your flow as you do your updates.

We do have some guidelines to help you get started, and we’ll share them below. These guidelines assume a monthly cadence, but you can easily adjust these to fit any schedule you choose.

Step #1: Record Your Forecasted Numbers from Your Model

You’ll need to know your projected revenue, whether it’s the total revenue or your revenue broken down into individual streams.

You’ll need to know your projected expenses like salaries, payroll, operating expenses, and cost of goods sold.

From there, it’s up to you. Whatever the most important metrics are for your business, record your forecasted numbers for those metrics every month.

Step #2: Record Your Actual Performance Numbers

Pull your accounting data along with data from any other relevant sources. If Hubspot is your single source of truth for customer acquisition data, use Hubspot for this analysis. For each metric you want to analyze, collect your performance data from the most accurate source.

Use this performance data to update your financial model. Also enter it into your spreadsheet, or whichever tool you’re using to do your forecast versus actual analysis.

Step #3: Run Your Forecast Versus Actual Analysis

Calculate the difference between your forecasted numbers and what actually happened.

Some founders are content to simply review the percentage differences between the two numbers and take action as they see fit. Others prefer to establish acceptable tolerances for each metric and flag any differences that fall outside their set limits.

Step #4: Adjust Your Assumptions

Adjust the assumptions in your financial model based on your forecast versus actual analysis. Your updated forecast will better align with your current reality.

Step #5: Address Operational Issues

If you identify areas where your performance differs significantly from your expectations, this is your opportunity to shift resources, adjust priorities, or as they say, “crack the whip.”

Step #6: Rinse and Repeat

Continue to follow these steps every month to keep your financial model updated and on track. Optimize your process to make it more efficient as you go, and commit yourself to completing it each month on a regular schedule.

With each iteration, your financial model will become more closely aligned with your actual conditions. You will be able to make more informed decisions, and most importantly, you’ll sleep better knowing how long your current funding will last.