So you have aspirations of establishing a startup, and you find yourself pondering the crucial question of how much funding you require? Alternatively, perhaps you have already taken the leap, engaged with potential investors, and want to be prepared for the inevitable query - “could you please provide your financial plan?” In this article, we will explore a few key considerations to help you navigate this process.
Determining the Level of Detail in your Financial Model
Before delving into the realm of spreadsheets and combing through a mountain of data, it is important to pause and reflect on what you hope to accomplish with your financial model.
There is a common inclination to dive straight in and start listing every possible element - anticipated revenue streams, personnel costs, contractor expenses, IT subscriptions, travel, and the list goes on. But do you truly need to delve that deep into the minutiae? Most likely not. Here's an alternative approach to consider!
Begin with a high-level plan based on sensible assumptions.
How can you achieve this? In most cases, a high-level assumption-based model will serve you well. By inputting a few straightforward assumptions, you can obtain a reasonably accurate estimate. This method often proves more accurate than a bottom-up approach (where you compile a list of every expenditure item and tally them up). The bottom-up approach tends to overlook certain expenses, sometimes significant ones, rendering our meticulously crafted plan outdated almost as soon as we complete it. So, what's the next step?
This is precisely what accomplished Chief Financial Officers (CFOs) do - they possess a deep understanding of typical metrics and ratios and employ benchmarks to determine if things are generally on the right track. However, as a startup, what if you lack a CFO?
Fear not, for we have devised an excellent high-level plan tailored to your needs.
The Importance of Financial Modelling for Startups
Financial modelling serves as a vital component for ensuring the success of your business. But what exactly is it? A financial model encompasses past performance variables, such as expenses and profits, to aid in predicting your business's future financial performance.
Typically, small businesses and early-stage startups lack the resources to employ a financial team for this purpose. Consequently, they resort to using spreadsheets, which can be convoluted, messy, and time-consuming when creating their models. Is there an alternative?
Fortunately there are a number of financial modelling programmes designed to empower ambitious leaders like yourself. Some are big complex ‘Connected Planning’ tools built for and used by enterprise organisations, such as Anaplan and Planful, whereas others are built with startups, SMEs, and simplicity in mind. Financial planning platforms such as Blox eliminate the need for spreadsheets, providing a space for detailed, yet straightforward, financial planning and analysis. With these tools you can confidently plan for the future, make informed decisions, and free yourself from stress.
Understanding the Need for a Financial Model
A financial model is not merely a tool; it is an essential tool that assists you in making intelligent, informed decisions, ensuring the viability of your business's future.
By developing a financial model, you gain the ability to determine future revenue, profits, expenses, and other crucial variables. This knowledge enables you to make necessary adjustments as required.
When Should I Create a Financial Model?
A financial model is of utmost importance, not only for your personal benefit but also for your business's financial prospects. Whether dealing with investors, banks, or loan companies, they will all request your financial model to assess whether they should invest in your venture.
Furthermore, your financial model allows for accurate forecasting and effective budgeting. It plays a pivotal role in valuing your business and can assist in raising capital. Therefore, a robust financial model is vital, and that's where specialist software comes in.
Key Elements to Include in Your Financial Model
Let us explore the essential components to incorporate in your financial model, along with a brief explanation of their significance:
- R&D Burn Rate
The Research & Development (R&D) burn rate reflects how quickly your business depletes its available capital. It provides insights into your cash flow and determines whether your business is self-sustaining.
Including the burn rate in your financial model is vital for attracting investors, banks, and lenders. Additionally, it enables your business to effectively manage cash flow.
- Customer/User Acquisition Assumptions
Customer acquisition encompasses the process of attracting new customers and fostering loyalty. Understanding this data is crucial for establishing and sustaining a successful business.
Incorporating customer/user acquisition assumptions into your financial model helps identify trends and areas requiring improvement or further investment.
- Revenue Forecast
A revenue forecast entails educated predictions of your business's future income over a specific period. It draws upon historical and present sales data, providing insights into your business's revenue potential.
Investors take particular interest in this aspect of your financial model as it demonstrates your business's profit-making potential. Moreover, it helps you gauge the impact of present decisions on future revenue, thereby creating a more secure and certain future for your business.
- General Expenses
Understanding your business's general expenditure is essential for effective financial management. Tracking where your money goes and evaluating its effectiveness can make a significant difference.
Incorporating general expenses into your financial model facilitates effective budgeting, ensuring you do not overspend.
In conclusion, a financial model serves as an invaluable tool for any business. It enables informed decision-making regarding finances, revenue and expense forecasting, cash flow monitoring, and identification of areas for financial performance improvement. While the specific content of your financial model may vary based on your unique business requirements, some fundamental elements should be included. These encompass a revenue forecast, expense forecast, cash flow forecast, balance sheet, and profit and loss statement. Regularly reviewing and adjusting your financial model is crucial to ensure your business remains on track towards achieving its financial goals.