FI.co: How to Create a Basic Financial Model: An Entrepreneur’s Guide


Creating a Financial Model forces an entrepreneur to plan very specifically how their business will work, how users and customers find and use their products, and how those processes create revenues and costs.

As tempting as it might be to outsource this project, it is important to create your own model in order to organize your thoughts, and quickly take action. Constructing your own model will help you predict potential obstacles, make calculated decisions, and see how the business will perform with a given set of assumptions.

In a talk from the Denver Founder Institute, Jim Franklin, former CEO of SendGrid and active startup advisor and board memberexplains the step by step process in planning your company’s financial model. He advises founders to only take investor cash if necessary, and to always think about business as a long term entity. Those who do seek investor financing should use a financial model to prove credibility.

To help you grasp the concept, we listed the basic components and techniques of modeling, highlighting the problems you should solve with data in each section. 

How Do You Begin?

 

Intermediate Modeling - Less Detailed Dashboard

Models always start with a dashboard. The basic components that make up the most simplified dashboards include graphs for: Revenue vs Expenses, Revenue/Headcount, Accumulated Loss, and Active Users. Make sure the following questions are answered within the data you provide in each section.

Revenue vs Expenses                                                               

You don’t know what your revenue is going to be, it’s all estimates. But you do know what your cost is going to be, making expenses very predictable. Do your math with curves, not numbers, and be broad. With curves you can tell the probability of any value. Make sure your data answers these questions:

 

Revenue/Headcount

Revenue per employee is calculated by dividing a firm's revenue by its total number of workers (Revenue/Number of Employees). Increase headcount and add this to your monthly expense.

 

Accumulated Loss

Determine how much money you need to raise for your project.

 

Active Users

You're doing pretty well if you have five to ten thousand users in the first year. Build realism in your model, and have no surprises. When you have no surprises, you increase your credibility, helping you tell your story better. Make sure your data answers these questions:

 

 Separate Your Assumptions

Any good financial model lives and dies by assumptions. Create a separate assumptions tab and plan for them to change overtime. Create a bulk of assumptions, listing out revenue, loss, Cost of Goods Sold (COOGS), etc., all laid out and organized in clear formatting. Start thinking about your business and how it will pan out.

Input on one sheet, and the rest of your tabs/financial statements are driven off of these assumptions.


Advanced Modeling - Financial Statements Based on History and Assumptions.

Creating a more advanced dashboard includes using formulas to converge your financial statements and assumptions. The three statements include your income statement, balance sheet, and cash flow statement, used to predict future finances going forward. All financial statements are linked together. In an advanced model this information can be in separate tabs or visible through one tab in excel, establishing a one-stop shop of information. This one tab can drive founder, mentor, or investor discussions. Listed below are the most improtant aspects of your model that will tie together.

Get a more detailed explanation from the Three Statement Financial Modeling, from the Street of Walls.

There are various templates for constructing your financial model, but this information sums up the basic elements.

Watch Jim Franklin's entire video on Financial Planning to learn about the hidden costs you should plan within your model.

(Business accounting image by Shutterstock)

How to Create a Basic Financial Model: An Entrepreneur’s Guide

By Nailah Morgan

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