The 5 Essential Elements That Every Tech Startup Financial Model Should Include

May 4

May 4 5 Essential Elements To Include In Every Startup Financial Model

By Lior Ronen (@Lior_Ronen) | Founder, Finro Financial Consulting

A startup financial model should communicate your message clearly.
Your financial model should reflect your business well and help the reader understand it too.
Many financial models submitted for due diligence are mediocre and use generalist templates found online, which does not help the company to translate its business best into a spreadsheet.
In this post, we'll review the essential elements that your startup financial model should include to up-level the model from okay to excellent.

Typically around five times a week, a startup founder contact me puzzled and lost after talking with generalist financial modeling experts. These "modeling experts" work one day on an oil and gas company model and the day after that on a SaaS startup financial model. The differences between the two are canonic. These "experts" use their one-size-fits-all templates that they created years ago and aimed to fit as many use cases and industries as possible.

Of course, there is nothing wrong with that. Many startup founders find this satisfying. However, a general model not constructed for tech business and not tailored to the business model misrepresents the company and its potential. Since Finro works with both startup founders and private equity funds, we see very often the quality of information and financial models that these funds receive from startups for due diligence. These models split into three groups:

Type 1: Poor quality models that require many adjustments

These are usually financial models that were built by one of the two. Either a generalist "modeling" expert that could work one day on a restaurant model and the other day on a SaaS model. Or, the models were built by an anonymous "expert" who made them available online.

In many cases, these models use odd naming conventions, terms, calculations, and methods that are not relevant for tech and require additional work to adjust them to the metrics investors are looking for. In some cases, these models also do not fit the company's business model, use case, or industry. These models require many adjustments to make them useable and ready to analyze and drive conclusions.

Type 2: Okay models that require some adjustments

These are financial models that were built for other business models but were adjusted to tech. They might not use the jargon and calculations that investors are looking for, but require fewer adjustments to make them useable than the type 1 above.

Type 3: Excellent models that require minimal adjustments, if any

These are custom-made models that were built to describe the business model of the particular company accurately, and capturing its revenue streams, costs, growth drivers, and KPI correctly.

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Naturally, you want your tech startup financial model to fall into the Type 3 category and to do that you need to make sure it includes these five essential elements:

1. The model reflects your business

I see it happens a lot. A founder uses a general financial modeling template that does not reflect the startup's specific business model, vision, and roadmap. In some cases, it even doesn't capture the revenues and expenses drivers correctly. It's highly essential to make sure that the financial model represents the business accurately.

That means that if the business is SaaS, the financial model should reflect that. If the company is a two-sided marketplace, the financial model should reflect that. In other words: every business is unique with a unique business model, individual growth drivers, a unique way to generate revenues, and unique ways to spend money. Make sure your model reflects that.

Learn more about Finro financial modeling services >>

2. Use Simple and Comprehensive Assumptions

There are two common mistakes that we witness in the assumptions sections of tech startups, financial models. Either the assumptions are too general, which makes it hard for an investor to play with and stress test. Or, the assumptions are also detailed and complicated to follow, which makes it hard to follow and understand promptly. If investors need to put in too much time understanding the model, they will request you to adjust and simplify it, which could consume more time and money and could drive frustration. It's not easy to find that balance, but our experience allows us to master that art.

3. Powerful Duo: Income Statement and Cash Flow

A tech startup and especially an early-stage startup should focus its efforts and energy in estimating the business performance going forward. The future business performance should be translated successfully into projected revenues and expenses. You need to wrap these into an Income Statement.

Also, to provide a complete picture of the expected financial performance, you should add a Cash Flow statement. Only from the reason that from accounting purposes, some items cannot be reflected in the Income Statement should also be taken into account in the Projected Cash Flow Statement. Together the Income Statement and Cash Flow Statement provide most of the financial information needed to make an investment decision.

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Many clients ask us about adding a Balance Sheet projection, and this is a complex topic that will require a separate blog. In general, the need for a Balance Sheet projection depends significantly on the business model and the startup stage. I don't recommend early-stage startups to invest any time in Balance Sheet projections. It's useless and a waste of time. In later-stage startups, it depends on the business model and whether it will add value to the financial model.

4. Handpick Your KPI

The KPI metrics complete the projection picture for the reader of the model. In early-stage startups, KPI projection can focus the discussion with investors and bring an essential topic to the table. In a late-stage startup, the KPI metrics can highlight strengths or difficulties in the business. Therefore, it's crucial to use the right KPIs for your business. Every industry, sector or niche has a different set of KPIs that are used to analyze businesses' growth, strength, difficulties, etc. When using a general model with general KPI metrics, you miss a valuable opportunity to show your business potential. So, make sure to research and use the right KPIs for your business.

5. Keep It Simple

Many spreadsheets online offer you "59 different ratio calculations", "more than 30 charts", "US GAAP, IFRS, and Non-GAAP Statements." These are many different ways to complicate this. The startup financial model's primary goal is to translate your business model, estimations, and projections into a spreadsheet that will allow the reader to know your business better and assess whether they want to hear more about it or invest in the company.

To communicate your business idea and potential, you need your message to be delivered clearly and easy to follow. Long, complicated Excel formulas, sophisticated financial engineering, and dozens of tabs will probably not help your message to be heard correctly. Put yourself in the reader's shoes and make sure that your message is clear and easy to follow.