3 basic financial models you need for your startup
I have been building financial models for global, blue-chip organisations for over 15 years.
These large companies see great value and have invested large amounts of money in building accurate models to help them make their daily decisions.
Often entrepreneurs focus heavily on starting their business and neglect to fully explore the commercials. You might feel that until you are generating big money there’s no need for financial modelling like the ‘big’ companies. However, building a solid financial model is absolutely one of the best things you can do for your startup. Why?
Provides you with a financial sense check
My clients often dream up many fantastic ideas, and I always help them ‘run the numbers’. One client came to me with an idea of a bespoke cereal where consumers can pick their own ingredients and it gets delivered directly to your door. Being ‘bespoke’ this cereal could then be priced at a premium.
I then went through a simple cost model with them; a break-even analysis to just give an idea of how many boxes he would need to sell to break-even based on this ‘bespoke’ process. The answer was a lot more than they expected, when I showed them the spreadsheet exposing the real economics of the business, I crushed their dream slightly.
The purpose of this model isn’t to say it’s impossible, because we know anything is possible. The purpose of this model is to give you the economic scale of the business needed in order to generate a sustainable income and to see if you’re ready to take on the amount of work to make it happen. People often dream about the amount of money they can make and underestimate the cost required to actually generate that income.
I’ve heard many stories where would-be entrepreneurs launch into it, without a sound model and end up killing their business the hard and expensive way.
Cash, cash and cash!
This is a very important model, and often startups do not dedicate enough time to it until it’s too late. Its important for startups to build an in-depth, solid cashflow model because one of the biggest reasons why startups fail is running out of money before they even finish producing a marketable product.
This model should be built with a lot of effort, thought and at the most granular level, it should be in logical order with lots of research, setting key milestones when investment is needed, tracking progress. Revisit the model as often as you need. For startups if there is one absolute model you need to concentrate on, this is the one, as nothing is more crucial at this early stage than cash!
Once you can see your business running a cash flow positive without getting a massive injection of investors cash, you have a business!
Last but not least, what if…
Scenario modelling is a great way to build all your assumptions, using market research, industry expertise, risks and experience to predict various trends and the business outcome depending on the scenarios. You should look at doing worst, likely and best case scenarios, and within these justify why you have used these assumptions.
Most companies will use the profit and loss statement to build their scenario modelling, varying key assumptions to see the how it impacts the gross revenue to EBITDA. This is a good process for you to really question your business at all angles, especially at an early stage, and help prepare for the investor’s pitch as this will show you understand what drives growth, where the risks are and be prepared to answer all their ‘what if’ scenarios…
These are my three simple models I would start off with any new business. If you would like me to help with your startup’s accounting or finances, drop me a line at email@example.com.