6 Tips To Build Your Startup Financial Model Effectively
By Lior_Ronen | Founder, Finro Financial Consulting
Building a startup financial model is tricky. You try to boil down something complicated, like a business, into a spreadsheet that's easy to understand.
You want to show all your assumptions, but the reader will be overwhelmed if you go overboard. How can you do it effectively?
In this article, I offer tips for making your financial model more effective by simplifying it. Following these tips will improve your chances of success and help you secure funding from investors.
Viewing the Model from the Reader's Perspective
You're the number 1 expert on your business. You know your business inside and out. But that may not be true for the readers. The biggest challenge in financial modeling is to make your startup financial model easy to understand for potential investors who don't know the business as well as you.
To do that, it's crucial to view the financial model from the reader's perspective.
There are two primary ways to do that:
Review and challenge every aspect.
Seek feedback from a financial professional.
Let's say you choose the first alternative to review and update the model yourself. You should look at every calculation and element in the model and challenge it. The main questions you should ask are:
What is the point of this table or calculation?
Should you add data you have elsewhere into a table just to clarify it?
If you break it down into smaller pieces, does it become clearer?
Can you instantly see where this calculation fits into the larger puzzle of the financial model?
Now let's say you choose the second alternative and contact a financial professional like myself. There are two great benefits to seeking feedback from a financial professional:
Experience: This professional has seen hundreds of businesses and models in their careers and can recognize strengths and weaknesses instantly.
True external POV: This professional doesn't know your business as well as you do. If the advisor is good, they should be able to offer actionable suggestions to improve your model and make it easier to understand.
Adding Value Through Visuals Aids
Startups can make it easier to understand their financial plans by using visual aids. Using charts, summary tables, color coding, and explanatory text boxes can help achieve this objective.
Visual aids help to bring the reader up to speed quickly and effectively:
Charts can help to visualize trends over time, fluctuations in specific categories, and connections between different variables.
Summary tables can provide a snapshot of key metrics.
Color coding can highlight critical information or differences between scenarios.
Explanatory text boxes can provide additional context for assumptions or calculations.
Using visual aids is super helpful in every startup's financial model. But, you need to choose carefully the data you visualize and highlight.
Usually, it's most valuable to visualize topics that are relevant to the business's most important to potential investors:
Financial projections highlights from the income statement or cash flow statement. For example, you can show how the gross margin or operating margin fluctuates over time. You can also add to this chart the ratio between operating expenses to revenues to highlight the improvement in margins while the burn rate declines compared to revenues.
Businesses should highlight topics that are relevant to their niche. For example, SaaS businesses could highlight an improvement trend in conversion rate compared to the churn rate, KPIs or even ratios between KPIs like LTV to CAC, for example.
Businesses with actual results should compare actual numbers to projected numbers to build a comprehensive story that connects the past, present, and future.
Early-stage startups with no historical data should highlight projected growth rates, conversion rates, and estimated retention rates of new customers.
Businesses whose core business involves debt, credit, capital expenditures (CapEx), or long sales cycles can visualize how their balance sheet looks like and how working capital (current assets - current liabilities) will fluctuate.
After you find the relevant information you want to visualize, make sure your visual aids are simple and easy to understand. Don't clutter the model with too many elements or use complicated graphics that may confuse the reader.
I worked with Lior and with Finro to build a financial model for our seed round.
Lior meticulously led the forecasting process, analyzing our activity, mapping all aspects of our business, and immaculately creating our 5-years all-around financial model that fits our needs.
The Finro team quickly understood the technology, details of the business, and the primary growth factors, successfully implementing them in the model.
Overall a high-quality and seamless experience that I recommend to every startup founder!
Isaac Litman
Founder and CEO, Neteera Technologies
Lior is a machine.
He took our substantial but unwieldy financial model and turned it into a dynamic tool we can adjust and refine without constant manual input.
It amends the projected balance sheet and the KPIs and valuation as we accumulate and refine the data. He did it all in a very reasonable timeframe and is quick to respond to changes and additions.
His experience and advice also contributed to a great (ongoing) result.
Michael McCabe
CEO, OxyCarbon
Building Adjustable Assumptions
The core of a good financial model is its assumptions. Whether you have a dedicated assumptions tab or assumptions sections in each topic, they are super helpful for the reader.
Using as many assumptions as possible and reasonable can create an adjustable model that the reader can play with.
This is super helpful during the fundraising process, as both you and investors can experiment quickly with different scenarios based on changes to the model. They can judge down assumptions if they think you're being too optimistic and see what happens if you generate less revenue than expected.
They can also test certain hurdles in the user acquisition and sales process to see how the business will perform if sales are more difficult than anticipated.
The hidden gem in using many manual input assumptions in your financial model is that you can instantly create new scenarios and add them to your pitch deck to add value during pitch meetings with venture capital investors.
Using Simple Formulas
Excel formulas are the backbone of the model. They shape the outcome and are used to track and follow the calculations behind the business's financial performance.
However, complex formulas can make it impossible for the reader to understand what is happening.
So it's crucial to use simple formulas that are easy to understand and follow. Startups should aim to use straightforward and logical formulas, making it easy for the reader to follow the calculations.
One way to make formulas easier to understand is by breaking down more complicated calculations into smaller parts. For example, instead of using a single formula to calculate revenue, startups can break it down into individual components such as price per unit and units sold. By doing so, the formula becomes easier to understand and follow.
Using Plain Language
Even experienced investors can get lost in the abbreviations and jargon commonly used in financial models. So startups should use plain language to explain their financial model, assumptions, and calculations.
One way to use plain language is by using brackets or comments to explain the meaning of abbreviations and jargon. For example, instead of using "COGS" without explanation, startups can use "cost of goods sold (COGS)" to make it clear to the reader what the abbreviation means.
Another way to use plain language is using text boxes or comments to provide additional context or explanations for assumptions or calculations. For instance, if a startup uses a specific rate in its financial model, it can include a text box explaining the rationale or source behind it.
Adding Value Through Focus
Focus? That sounds pretty basic, no?
But, the fact is that many financial models that we review are packed with information that hides the most important topics a company wants to highlight.
While it's essential to include all the relevant information in a financial model, it's equally important to keep it simple and avoid adding unnecessary elements. Startups should resist the urge to add more and more elements to their model as it can quickly become overwhelming and confusing for the reader.
Instead, startups should challenge every new element and ask if it adds value to the reader. It should be removed from the financial model if it doesn't add value. This helps to streamline the model and make it easier to understand.
Moreover, startups should prioritize the most critical elements of their financial model and present them clearly and concisely. This includes revenue and expense projections, cash flow forecasts, and critical assumptions.
By keeping the financial model simple, startups can make it easier for investors and other stakeholders to understand the business and its financial performance. This can also help startups to identify areas where they need to improve their financial performance, make strategic decisions, and grow their business.
Wrapping Up
Building a financial model is a crucial step in the startup journey, and it's essential to get it right. A well-constructed financial model can help startups secure funding, make strategic decisions, and grow their business.
However, building a financial model is not an easy task. It requires startups to boil down something complicated, like a business, into a spreadsheet that's easy to understand. It's essential to strike the right balance between providing enough information without overwhelming the reader with unnecessary complexity.
To create a practical financial model, startups should put themselves in the reader's shoes and use plain language, visual aids, and simple formulas to explain their assumptions and calculations. Startups should also resist the urge to add more elements than necessary to the financial model and challenge every new element to ensure it adds value to the reader.
Ultimately, a financial model aims to provide investors and other stakeholders with a clear and concise picture of the business's financial performance and potential. These six tips can help you create an easy-to-understand, informative, and actionable financial model.
