Let’s assume you have an idea for a startup that you’re ready to pursue. What’s next? How do you know if this idea will succeed and be able to bring in sustainable revenue and how much money to raise from investors?
This is when having a solid financial model is a vital component for any startup’s success. This is even more important when moving from seed to series A and B as the importance of the financial model to the investors increases.
You think you need an external business consultant or expensive and complex specialist software to construct a financial planning model? No! By no means! With just a little bit of effort, you too can create a sophisticated financial model by using the Excel software that you have on your own computer. This article describes what you need to pay attention to and which Excel template might be a great help and guide.
1.What is a financial model?
In short, a financial model is an abstract mathematical representation of how a company works. Such a model has different inputs, calculations and outputs. The inputs are the assumptions that drive the model (e.g. revenue, costs, capital expenditures, payment terms, tax rates etc.). The outputs are a set of projections and Key Performance Indicators (KPIs) (e.g. profitability, cashflow, balance sheet items, but also funding requirements, break even, customer acquisitions costs, customer lifetime value etc.) that show how your company will perform if the assumptions are true.
A smart, cheap and flexible way to prepare a financial model is to use a spreadsheet tool like Microsoft Excel.
2. Why you need a financial model
Financial models are important not only for calculating funding requirements and raise cash but to help you plan operational activities in the short-term, forecast for the mid- to long-term, and serve as a management decision tool.
By far, the biggest purpose your financial model serves is to help you to understand your cash to really know your burn. It is essential that you know how long your money is going to last and what milestones you are going to be able to achieve with that spend.
3. Skills needed to set up a financial model
Setting up an integrated financial model from scratch can be a challenging task, especially for entrepreneurs with only minimal previous experience in this area and/or without a financial background.
In principle three different skills are mandatory:
- Modeling Standards
With regard to “Finance” it is important to have at least basic knowledge in corporate accounting and finance as well as in financial analysis (understanding and setting up integrated financial statements, making adjustments, calculating ratios etc.)
Modeling is a distinct skill; don’t confuse it with “Excel”, which is just an environment for modeling. There are several international established modeling Standards (e.g. FAST). These standards and conventions provide a comprehensive and detailed set of guidelines relating to every stage of the spreadsheet model development process, but do not limit the customizability of spreadsheet-based analysis in any way. Put simply, these standards explain how to develop best practice Excel models, not what numbers to include. Adopting these conventions increases productivity reduces errors and makes a model easy to understand, review and adapt.
Last but not least basic Excel know-how is necessary. However, this skill is fairly easy to master to a sufficient level. When adopting the aforementioned modeling standards you only need to know the basic arithmetic operations and only some additional Excel formulas.
Having read this, most entrepreneurs without a financial background are inclined to abandon the essential planning task. However, when using the right Excel tool, all skill areas will be supported and only minimal knowledge is necessary to prepare highly professional and presentable projections.