5 Tips for Building a Killer Startup Financial Model
By Lior_Ronen | Founder, Finro Financial Consulting
In the startup world, having a solid financial model is super important for attracting investors, making smart choices, and finding your way to success. But let's face it, creating a financial model that's both detailed and easy to grasp can be pretty tough for entrepreneurs. The real challenge is taking all the ins and outs of a business and putting them into a spreadsheet that makes sense without drowning potential investors in a sea of information.
This article aims to provide valuable insights and practical tips on mastering the art of startup financial models by focusing on these 5 areas:
Adopting the Readers' Point of View
Striking the Right Balance Between Complexity and Value
Utilizing Visual Aids for Better Understanding
Emphasizing Simple Formulas
Employing Plain Language and Explaining Jargon
So whether you are a seasoned entrepreneur or a first-time founder, these guidelines will help you navigate the complexities of financial modeling, ensuring that your startup's financial story is compelling, coherent, and accessible to a wide range of stakeholders.
Adopting the Readers' Point of View
Building a good financial model is not only about adding the right KPIs and accurately estimating what the next 5 years of your company will look like but also about allowing the readers to understand your business model and future potential from the model. That's why understanding and catering to the reader's perspective is critical to creating a successful financial model.
As a founder, you may be intimately familiar with every detail of your business, which can sometimes lead to the assumption that others will easily grasp the financial model. However, it's important to remember that your audience, which may include potential investors, partners, and advisors, may not have the same level of understanding or prior knowledge about your business.
To adopt the readers' point of view, consider the following tips:
Start with the basics.
Clearly outline the key components of your business, such as revenue streams, expenses, and growth drivers. This will help readers grasp the overall structure of your financial model and provide them with a solid foundation to build upon.
Logical flow.
Organize your financial model in a logical sequence, making it easy for readers to follow along and understand the connections between different elements. One possible way to do it is by starting by showing the summary of the income statement and cash flow statement, then a detailed summary of these financial statements that provide some more information, and then drilling to revenue projections, headcount projections, payroll cost assumptions, and then move on to cash flow analysis, KPIs, etc.
Clearly label assumptions.
Being open about the assumptions you've incorporated into your model is important. Make sure to highlight all the manual input assumptions, not just the ones that are easy to share. This way, venture capitalists and other stakeholders can examine the conversion rates, churn rates for SaaS businesses, retention rates, and other key factors you've assumed. Maintaining this level of transparency allows readers to quickly identify, assess, and understand the assumptions you've made and the outcomes they generate.
Use consistent formatting.
Ensure that your financial model is visually coherent by using consistent formatting, such as font styles, colors, and column widths. This will make it easier for readers to navigate your model and focus on the content.
Provide context.
Offer explanations or notes to clarify any complex elements or industry-specific terms that may not be immediately obvious to readers. This will help them better understand your business and its financial dynamics.
By keeping the readers' perspective in mind and making your financial model as clear and accessible as possible, you can effectively communicate your business's potential, financial projections, and overall strategy to a wide range of stakeholders.
Striking the Right Balance Between Complexity and Value
An effective financial model should capture the essential elements of your business without becoming overly complicated. Including every detail and potential scenario can be tempting, but doing so may result in a more confusing than an informative model. Striking the right balance between complexity and value is crucial for creating a financial model that effectively communicates your business's potential and financial projections.
To achieve this balance, consider the following strategies:
Focus on the most important factors.
Pinpoint the key drivers and components that significantly impact your business's financial performance. In your financial model, emphasize these factors rather than attempting to address every possible detail. For instance, consider an e-commerce startup with 124 products. Analyzing each product's costs, prices, and marketing channels could make the model unmanageable and offer little value to the reader. Remember that we're aiming to create a financial forecast rather than an operating model, so it might make more sense to group products into a few categories in most cases. Concentrating on the essential factors makes your financial model clear and informative without becoming unnecessarily complex.
Question each new element.
Before incorporating a new element into your model, consider whether it genuinely enhances the reader's comprehension of your business and financial plan. If the answer is no, consider whether it's necessary to include that element. For example, a balance sheet may not add much value to the financial model for many startups, especially early-stage and SaaS companies. Nonetheless, in certain situations, it could prove helpful. Always weigh the benefits of adding new elements to ensure your financial model remains focused and valuable to the reader.
Opt for simplicity over precision.
While accuracy is important, avoid getting caught up in overly precise calculations or forecasts that may ultimately create confusion. Instead, aim for simplicity and transparency, presenting reasonable estimates and assumptions that are easy for readers to understand and evaluate.
Use a modular approach.
Divide your financial model into smaller, interconnected sections, which makes the information more digestible and easier to analyze for readers. This method enables you to present complex data more organized and comprehensibly. For instance, a SaaS startup, illustrates the step-by-step process of acquiring new customers by breaking down the various marketing channels. Demonstrate how many users engage with your initial interaction and how many sign up or schedule a demo, etc. This approach helps readers better understand the intricacies of your business model.
Regularly review and revise.
Continuously assess your financial model to ensure it remains relevant, accurate, and focused on providing value to readers. Be prepared to remove or modify elements that no longer serve a purpose or add unnecessary complexity. Additionally, add actual results or historical data if you have any. It helps bridge the knowledge gap between the business's past, present, and future.
By carefully considering the complexity and value of each element within your financial model, you can create a more accessible and effective tool for communicating your business's financial story to potential investors, partners, and other stakeholders.
Utilizing Visual Aids for Better Understanding
Financial modeling is not just how numbers are in Excel or Google Sheets. We're trying to deliver a message and tell a story about the potential of a business. There is no better way to do it than with visual aids.
Visual aids are crucial in making complex financial data more digestible and engaging for readers. By incorporating charts, summary tables, color coding, and explanatory text boxes, you can enhance the clarity of your financial model and help readers quickly grasp the most important aspects of your business's financial performance.
Consider the following tips for incorporating visual aids into your financial model:
Choose the right charts.
Select chart types that best represent the data you want to convey. For example, use bar charts to display revenue and expenses over time, pie charts to show the distribution of revenue sources, and line charts to illustrate trends or growth rates.
Simplify data presentation.
Avoid overcrowding your charts with too much information. Instead, focus on presenting the most relevant data points and using clear labels, legends, and titles to help readers interpret the visuals easily. Think of this part of your financial model as you would about a chart to your pitch deck.
Use colors strategically.
Employ color coding to highlight critical data points, differentiate between various elements, or draw attention to specific areas of your financial model. Be consistent in your color choices and ensure your selections are easy on the eyes.
Create summary tables.
Develop summary tables that consolidate key financial data, such as revenues, operating expenses, and cash flow, into an easily digestible format. This will allow readers to quickly review the most important figures without navigating through the entire model.
Add explanatory text boxes.
Use text boxes to provide context or explanations for specific elements in your financial model. This can be particularly helpful for clarifying complex calculations, assumptions, or industry-specific terminology.
Incorporating visual aids into your financial model enhances the overall presentation and makes it easier for readers to understand and engage with your business's financial story. By utilizing these visual elements effectively, you can create a more accessible and appealing financial model that communicates your business's potential and financial projections to various stakeholders.
Emphasizing Simple Formulas
Keeping your financial model's formulas simple and easy to follow is essential for ensuring that readers can fully comprehend how your business operates and how different elements of your model are connected. Complex formulas can be hard to decipher and may create confusion, making it difficult for potential investors and other stakeholders to accurately evaluate your business's financial performance.
To emphasize simple formulas in your financial model, consider these tips:
Break down complex calculations.
Instead of using a single, intricate formula, break it down into smaller, more manageable steps. This approach makes it easier for readers to follow the logic behind the calculations and understand their significance.
Use named ranges and cell references.
Improve the readability of your formulas by using named ranges and clear cell references. This practice allows readers to identify the source of data used in a calculation quickly and makes your formulas more transparent.
Avoid nested functions.
While nested functions can be powerful tools in Excel, they can also be challenging to understand for non-experts. As much as possible, simplify your formulas by separating nested functions into individual calculations.
Provide clear explanations.
If a formula is complex or requires specific knowledge to understand, add comments or explanatory text boxes that clarify the calculation's purpose and the logic behind it. This will help readers follow along and better understand your financial model's inner workings.
Test and validate your formulas.
Regularly check them for accuracy and consistency, ensuring that they produce the desired results and align with your business's overall financial strategy. This practice will help you identify and correct any issues before they cause confusion for readers.
By focusing on simple formulas and clear explanations, you can create a financial model that is more accessible and understandable for potential investors, partners, and other stakeholders. This transparency will enable them to evaluate your business's financial performance with greater confidence and insight.
Employing Plain Language and Explaining Jargon
Using plain language and explaining industry-specific jargon or abbreviations are essential to creating an accessible and effective financial model. Even experienced investors can get lost in unfamiliar terms, making it crucial to ensure that your financial model is easy to understand for a diverse audience.
To employ plain language and explain the jargon in your financial model, follow these tips:
Be concise and clear
Write in a straightforward manner, avoiding overly complex language or sentence structures. Aim for clarity and simplicity, ensuring that readers with varying levels of expertise easily understand your message.
Explain abbreviations and acronyms.
While it may be tempting to use abbreviations and acronyms to save space or time, doing so can create confusion for readers who may not be familiar with these terms. Make sure to explain any abbreviations or acronyms in brackets, comments, or text boxes.
Provide context for industry-specific terms.
If your financial model includes terminology specific to your industry, take the time to provide context or explanations for these terms. This will help readers unfamiliar with your industry understand your business and its financial dynamics.
Use consistent terminology.
To avoid confusion, be consistent in your use of terms and phrases throughout your financial model. This will make it easier for readers to follow along and understand the connections between different elements.
Encourage feedback and questions.
Invite potential investors, partners, or advisors to ask questions or provide feedback on your financial model. This will help you identify areas where further clarification or explanation may be needed and ensure that your model is as clear and understandable as possible.
By employing plain language and explaining jargon, you can create a financial model that is accessible and easy to understand for a wide range of stakeholders. This approach will enable them to understand better your business's financial performance and potential, ultimately increasing their confidence in your startup's success.
Wrapping Up
Creating a well-crafted financial model is an essential aspect of any startup's journey, as it attracts investors, informs decision-making, and outlines a path to success. By adopting the readers' point of view, striking the right balance between complexity and value, utilizing visual aids, emphasizing simple formulas, and employing plain language, you can develop a financial model that effectively communicates your business's potential and financial projections to a diverse audience.
With these guidelines in mind, entrepreneurs can overcome financial modeling challenges and create a compelling, coherent, and accessible financial story that resonates with potential investors, partners, and other stakeholders. In doing so, you will increase your startup's chances of securing investments and lay the foundation for informed decision-making and long-term success.
