Financial Model: The Basics
In this article, the financial model – The Basics, we provide an introduction to the start-up. Here, the goal is to highlight one of the biggest issues when preparing to fundraise. The main key question to answer is what content should be included in the model and why that content is needed.
We will provide a complete insight into some templates and tools that we have to offer. Hence, helping the user in his start-up. Concerning what investors want, there is a benefit to this exercise. Since it enables you to think clearly about all assumptions, pricing models, growth, and churn rates. Besides, modeling shows you are targeting a specific market which can help you to draft a business plan and how much investment you need.
An introduction of a company is the critical component of any business or a start-up, therefore, the financial model is an extension of that introduction. As it allows the reader to judge what is achievable and is to expect from the business. It paints a picture of the potential size of the market and allows the reader about the ambition of the company. Moreover, it demonstrates whether or not the business has realistic assumptions.
What should your start-up financial model look like?
There are many templates available online on different platforms and there is a lot of inconsistent advice out there too. Since most templates are prepared from the company’s point of view not taking into consideration what the investor is looking for. Like for example, Return on Investment (ROI) is a very important metric in terms of seeking investment or a loan. So, any investor or funds provider will want the business to ensure the project or business has the potential to return money at a good percentage.
In any case, below are some important points that investors are looking for:
- The model should include monthly information
- The model should focus on cash flow, balance sheet, and income statement
- Cashflow should be as detailed as possible with the support of graphs
- It is better to have a separate sheet for Dashboards
- Inputs should be understandable
- Sensitivity Analysis which allows the investor to insert the different number to check how company profit will react in case costs are high
- Use of formula which is linked to inputs
- Ensure numbers in Financial Mode are in agreement with the Pitch Deck
- Include Diagnostic Tools
- Business Ratios that are linked with Income Statement, Cash flow, and Balance Sheet
Revenue Build Up
The model should include what key drivers of your revenue are:
- Highlight Clients
- Show all revenue model types – e.g Registration fee, Yearly subscription, etc
- Show revenue per client
Cost and Expenditure
You model should breakdown all expenses and cost associated with the business:
- Make a separate table for the cost of goods sold and general expenses
- All expenses and cost of goods sold should be made as inputs to make changes in future
- Expenses should not be fixed. Make them semi-fixed
- A separate analysis of marketing expenses must be included in the model.
- Make sure all expenses are included. Expenses like bad debts, provision for taxes are often forgotten
- Expenses should also be linked with the growth rate. For example, if sales increase 10% each year the expense numbers should also reflect this in statements.
- Identify all accruals and prepayments
In other words, the model is all about cash. Therefore, make sure financial statements resolve to the all-cash line:
- Opening Cash
- Net Cashflow
- Ending Cash balance
Sources of cash should also be included. Such as cash flow from financing, investing, and operating activities.
What Investor look for?
Every investor is different from the other. However, there are some common points the investors are looking for:
- Whether you are accurate revenue drivers
- Whether all cost and expenses are linked with the growth rate
- A realistic growth rate
- Sources provided for growth rate
- Graphs in the model
- How funding going to be used
- Utilization of investment
- Financial Ratios
- Input cells for sales units
The most important factor for an investor is the return and whether the model has the potential to generate the return. Yes, of course, it is a bit difficult. The model will not only demonstrate the outcome. Also, it has to be credible enough to compete in its presentation of the return ratio included in the model.
It is a test for the creator of the model and tests the requirements of the target audience. But most importantly the financial model is the test of understanding its method and credibility which will be used in Business Plan and Pitch Decks.