10 Reasons Why You Need a Great Financial Model (Today!)
Being the founder of a startup can be both exciting and scary, particularly when raising capital from investors and managing your company’s finances. If this sounds familiar to you, a financial model is one tool you need to have in your corner.
Whether you’re a first-time founder who is hearing the term “financial model” tossed around in fundraising conversations, or a serial entrepreneur who has built models of your own in the past, this post will help explain why a solid financial model has become a requirement for fundraising and scaling your startup.
We’ll explain what a financial model is and how you can use it. And we’ll cover 10 reasons why you should start building a financial model for your startup right away.
What Is a Financial Model?
A financial model is a way to take all of the information that’s included in your three major financial statements and extrapolate that information out into the future. To put it simply, a financial model is a way of visualizing how your startup will make money.
Financial models are essential for fundraising because investors want to see your assumptions and expectations laid out clearly so they can assess whether or not they’re in on a good investment opportunity.
Financial models are also essential for you to better manage your business as a founder. A model includes a projected cash flow statement and a projected income statement, which show how much money you’re likely to have at any given point in time.
The more information you and your investors have on these fronts, the better.
Financial models use recent KPIs and historical data to give founders a birds-eye view of where they stand financially. With this valuable data, you can make more strategic decisions (such as when to add team members), foresee obstacles and risks, and pinpoint the best times to raise capital.
Instead of a one-and-done tool, financial models are like dynamic blueprints of your business—they change shape as you grow, and you consult them regularly for real-time insight into your financial health.
If you maintain a “living” financial model by updating it regularly, you create an interactive process where your data becomes clearer and more valuable as you go.
What Will a Financial Model Tell You?
When business decisions are made, there’s no room for error, and not just from a revenue-building perspective. Startup founders must also consider profitability, working capital requirements, and debt capacity.
Financial models help founders to make better decisions about their spending, revenue streams, and other variables that keep their startups on track for success.
When it comes to fundraising and financing, a financial model is one of the best tools you can have. By visualizing your burn rate, you can plan ahead to raise funds and secure financing at the optimal time.
Financing can take many forms—it isn’t always limited to just venture capital and angel investors. Accessing debt financing can be a valuable tool for you as a founder, especially if you have a high-growth potential business and insufficient collateral for a traditional loan.
You can use a financial model to help plan your big moves, such as opening a new facility, expanding into a new market, or purchasing additional equipment.
You can also use it to assist you in managing your company on an ongoing basis by monitoring trends in your spending and revenue to ensure you have enough cash flow and stay within budget.
Your financial model is like a trusted assistant who gathers and interprets your data so you can always make the best decisions.
Why Every Founder Needs a Solid Financial Model
It’s clear that a financial model is a critical component of any successful startup’s game plan, but few founders have time to agonize over the details and stare down a spreadsheet until two in the morning.
Luckily, great financial modeling tools let you manage all of the following critical tasks as you take your startup from a minimum viable product to a flourishing enterprise.
Here are 10 reasons every founder needs a great financial model:
#1: Forecast Revenue
When forecasting your company’s revenue, you’ll need to take every revenue stream into account. You’ll want to analyze each stream and project their growth rates individually rather than simply calculating revenue as a lump sum and projecting a percentage increase across the board.
A stream-oriented approach produces a more accurate forecast and allows you to analyze and share the appropriate growth assumptions for each stream.
This can be a painful task to implement in Excel, but financial modeling software makes the process relatively quick and simple.
#2: Analyze Expenses
Spending X amount of money may not seem like a big deal today, but how will it impact your plans 6 months from now? If that money is required for a future expense, do you have a way to recognize that and avoid the potential mistake?
A model lets you document and plan future expenses alongside your future cash flow so that you can justify the expenses you accept and reject on an ongoing basis.
#3: Predict Runway
If you’re like most founders, the fear of running out of money can keep you awake at night. A financial model lets you visualize your runway, understand your burn rate, and take control of your fundraising schedule.
It never hurts to plan ahead, and when you have a solid grasp of the timeline of your cash flow, you can respond confidently when you’re caught off guard by sudden or unexpected demands for cash.
When you know your burn rate like the back of your hand, you can sleep well at night knowing that you’re taking a proactive approach. As a result, your worries dissipate, and you’re better able to focus your efforts on the areas where they’re most needed today.
#4: Manage Your Hiring Plan
Hiring wisely is all about timing. Overhiring early on is a common mistake young startups make.
A good rule of thumb is to hire based on revenue growth, but even the best plans can get thrown off track when investors and stakeholders decide that an unplanned hire is an urgent need.
A financial model lets you plan out your hires, taking into account their start date and their timeline for making a meaningful impact, and offset that against the company’s financial projections.
If investors tell you to hire a role, you can show them the reasons why the role is scheduled for a future date. And if your CTO tells you he needs 5 more developers, you can confidently tell him exactly when those hires will be possible.
#5: Understand Your Key Metrics
Gaining insight into your current and projected key metrics allows you to make better decisions.
Maybe your company has seen steady growth in customer acquisition and revenue, but there is a wide variance in the lifetime value of those customers. A model lets you segment your revenue between streams and understand the long-term value of each stream. So if there’s a significant difference between streams, you can allocate resources accordingly.
If an investor asks for your average customer lifetime value, you’ll make a strong impression when you give it to them along with a breakdown showing lifetime value across segments and channels.
Being able to dig into your metrics is priceless. Every time you compare your KPIs against your forecast, you can identify opportunities to improve and weaknesses to address.
#6: Automate Metric Calculations
If your model is kept up to date, you never need to dig back into your accounting data to calculate metrics for a decision or a presentation.
All of your calculations and formulas can be taken care of automatically by your financial modeling software. The time you save on calculating metrics and troubleshooting formulas is huge.
#7: Analyze Churn
Where is your churn, why is it happening, and how can it be mitigated? You’ll likely need to evaluate churn across different products and services to look for patterns.
Churn data will let you know which channels are suffering the greatest attrition so you can put your energy into creating solutions and stop leaking revenue.
#8: Examine Your Assumptions
It’s often said that your biggest dangers as a founder are your unknown unknowns. It’s crucial to examine and challenge every assumption that factors into your growth plan.
A model lets you compare your goals against your actual performance month after month. If it turns out that your business isn’t growing as much as you expected it to, then you adjust your assumptions to reflect the reality of what’s actually happening.
When it comes time to pitch to more investors, sharing realistic estimates consistent with your performance will help them trust you and your data rather than get the sense that you are overly optimistic about your future.
#9: Compare Alternate Scenarios
What impact would adding that new product have? What if a key player leaves the company? What would happen if a major competitor moved in and swallowed up much of your market share?
One of the most daunting aspects of early-stage startups is that anything can happen at any time. A model helps you think through these possibilities and estimate the consequences so you can plan accordingly.
While you can’t predict the future perfectly, you can start to game plan your response to likely changes, which breeds confidence in investors and stakeholders.
#10: Strengthen Your Pitch Deck
A financial model powers up your pitch deck to make sure you’re making the best possible impression. You might say that the pitch deck is the alley-oop, and the financial model is the slam dunk when pitching investors.
You can borrow supporting data from your financial model as you perfect your pitch deck over time with a crystal clear business model and the perfect storyline. If the investor shows interest and starts asking questions, that’s when your financial model takes over to close the deal.
Securing the Future of Your Business
Having an accurate financial model is one of the essential steps in fundraising and gaining investor trust. Confidence equals cash.
As a founder, getting insight into your current metrics and planning for future conditions is key to scaling your business. A financial model can help you do just that by providing a clear overview of your business’s health and expected growth.
With a financial model from Forecastr, you can forecast all of these, along with many more:
Forecastr is a purpose-built financial modeling tool that helps early-stage startups create accurate revenue forecasts, manage cash flow, and track expenses.
When you sign up for Forecastr, you receive our complimentary 30-day white-glove onboarding service, where two expert analysts work side-by-side with you to create a great financial model. You get live online support as needed, and assistance from your analysts for quarterly updates and troubleshooting.
Track your KPIs against your actual performance, and stop wasting time on admin tasks so you can keep doing what you do best: raising revenue and expanding your business. Get in touch with Forecastr today to schedule a free demo and learn more about how we can help you forecast with confidence.
This article is intended for informational purposes only, and doesn't constitute tax, accounting, or legal advice. Everyone's situation is different! For advice in light of your unique circumstances, consult a tax advisor, accountant, or lawyer.