2min read Building a Financial Model
Building a financial model is an important aspect of running a startup and achieving investor funding. Below, we learn how to create a quick version of the financial model, how to capture assumptions and drivers, and what mistakes to avoid in financial modeling.
Quick Version of the Financial Model
When setting up your fundraising plan at a high level, set a revenue target five years out. Then, draw a line from today to that five-year mark. Your fundraise and hiring plan will come from that.
To calculate this quick and dirty version of the financial model, follow these steps:
- Start with current revenue.
- Apply your organic growth rate and map out your top-line revenue for five years.
- Calculate your revenue per person metric.
- Apply your expenses for five years using the revenue per person metric.
- Identify the negative profit line.
- Set your fundraise to cover the negative working capital.
- If the amount is greater than one million dollars, break the fundraise into two rounds.
This will give you a rough idea of how much you need to raise and how many people you will need to hire.
Assumptions and Drivers
In building out your financial model, make explicit the assumptions you are using and identify the drivers in your business. Create a tab on your financial modeling spreadsheet for assumptions and drivers for the investor to review.
As you build out the revenue forecast, capture the assumptions behind the growth rate. For the costs, make clear which are fixed and which are variable costs. Identify the drivers within the business. Typically, this is the number of products sold or the number of customers signed up. This drives the revenue line as well as the variable costs. For example, the more customers targeted for revenue, the higher the cost of sales and sales commission.
Investors look to see if the costs align with the revenue forecast. Understanding what drives your revenue and costs will help you build out your financial model and create more accurate projections.
Mistakes to Avoid in Financial Modeling
Your financial model can be used not only for fundraising but also for running your startup. Avoid these mistakes in setting up your financial model:
- Tying your revenue to a factor that doesn’t actually drive revenue. Instead, figure out what actually drives sales and build your model around that.
- Trying to identify exact numbers for factors such as conversion rate. Instead, use a range of numbers to account for variations.
- Skipping the research into companies in your sector. Instead, spend time looking at similar companies to find out what drives their business.
- Trying to include too many drivers in your business model. Instead, focus on the top drivers that account for the majority of your sales.
- Setting up the financial model for generating financial statements only. Instead, set up the model so it also calculates key performance indicators.
Design the spreadsheet for running the business in addition to raising funding.
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Hall T. Martin is the founder and CEO of the TEN Capital Network. TEN Capital has been connecting startups with investors for over ten years. You can connect with Hall about fundraising, business growth, and emerging technologies via LinkedIn or email: firstname.lastname@example.org