Perhaps, you’ve heard stories about entrepreneurs getting funding after writing a few lines on a napkin. Of course, if such a sketch is as promising and impressive as Twitter’s or Amazon’s, this may work for you. However, not everyone has the ability to make investors excited by just describing the idea of a business and a few key points of the business strategy.
You should tell an engaging story and persuade investors that you’re worth their money and time. When talking to potential investors, as well as to your team members, storytelling just changes its context and means. A financial model is one of the necessary persuasive means that can help you tell a story about your company and explain in what direction your business will move.
Many experienced investors want to evaluate not only possible direction in what their stocks may move but also the business as a whole and its quality. When making a financial model, your goal is the same. You have to understand what should be the main accomplishments of your organization before you plan how each part of your business will develop.
The Meaning and Importance of a Financial Model for Startups
Plans cannot help you predict future. Any plan is just your expectations. Therefore, it should consider different possibilities. When you have an early-stage startup, it means that your business is extremely volatile and it will go through many changes. When you create a financial model, you demonstrate your understanding of all the complexities you may face and your readiness to solve some of the possible problems.
Your team should be ready to update your business plan and to keep developing it. Any healthy business has clear goals and expectations which are based on the existing performance data. As your business grows, you can analyze more data and make better predictions regarding the future of your company.
Your financial model is one of the first documents you should create because it will show your investors numbers, not just ideas and assumptions. One spreadsheet with a proper analysis of financial data can determine the success of your business. Thus, let’s see how to build a proper financial model for your startup.
How to Build a Long-Term Financial Model for Your Startup
- Define the needs of your potential investors
Advantages of building a financial model for the owner are obvious — you can quantify the operations of your startup. But what do your investors need from your financial model? Its main function is to demonstrate the profitability of your business. They should know your IRR and other important figures.
However, investors are not the only people who will see your financial model. You will also show it to your creditors who will want to see whether or not you will be able to repay your loans on time. They will also want to compare your profits to your obligations. We suggest planning a structure for your financial model by writing down a list of questions that your audience may ask.
- Write down your assumptions
You should provide a complete list of assumptions your financial model is based on. The main thing about this section is that your assumptions should be realistic. Take into account the market demand and business requirements. Make a table of your revenue/sales assumptions and another table with your investment assumptions. Your investment assumptions should include short-term and long-term goals, as well as initial investments. You should also compose a list of payroll assumptions and operating expenses, and provide a list of other possible expenses: an increase in operating costs or payroll, taxes, etc.
- Evaluate your revenues
Your expected revenues depend on your average number of customers for a certain period of time. Keep in mind that your figures may change dramatically depending on the chosen period of time. You should also be careful if you have a multi-level price structure.
- Cash flow and profit/loss statements
Your cash flow statement should include the beginning cash balance and the ending cash balance, as well as cash flow from investing, operations, etc. The profit and loss statements must include net income, liabilities, revenue, and other important information. These numbers should be based on your assumptions, which is also a reason why the latter should be realistic.
- Compose your balance sheet
This is another section that should be based on your assumptions. The balance sheet is aimed to give your investors a general idea of how your company is functioning. The best way to present the balance sheet is to connect it to your profit/loss statements and to write a report.
Your financial model is a very important part of your discussions with potential investors, creditors, and even with your team. A proper financial model will help you present your startup in the best light possible. In addition, you can use numbers from it when creating a hiring plan. Assumptions described in the financial model can be used when discussing changes to a distribution strategy. The main thing is to have realistic expectations and to provide information that is interesting for people who will see your financial model.
About the Author
Berta Melder is an experienced brand manager and creative writer. Currently associated with Masterra Writers as a content marketing strategist. She cooperates with different education courses covering a broad range of digital topics as a guest lecturer. Follow her on Twitter.
The views, positions, and opinions expressed by the guest writer are those of the writer alone and do not reflect those of the iHub or any employee thereof. The accuracy and validity of the information supplied by the guest writer are not guaranteed by the iHub. The copyright of this content belongs to the author and any liability with regards to infringement or intellectual property rights remains with them.