Financial statements are vital to investors. But how do investors use financial statements? Before your meeting, learn what they want to see and why.
October 21, 2020
Do you have visibility into how your startup’s finances will look in six months? How about two years? With a comprehensive financial model, these insights would be at your fingertips. However, if you’re like many other early-stage startup CEOs, you might not have a financial model in place yet: Some businesses assume they don’t need one in the early stages, or are put off by the time it takes to build.
A financial model uses your business’s actual revenue and expenses to predict your future financial performance. In our team’s combined decades of experience helping businesses scale, we’ve seen that a good financial model gives startups the data they need to make strategic decisions, and convince investors to back their business. The model functions like a roadmap for your startup: It shows the different milestones you have in mind, progress toward your targets, and how you can adapt your operations to stay on track.
Financial modeling includes a broad range of formats and objectives, so it can be a challenge to know how to start building a model that fits your business and delivers the data you need. To help you set up your model the right way from day one, this guide covers the best practices every startup founder should know about how to create a financial model for your own company.
Before you can project your future performance, your financial model starts as a set of assumptions. The data you input and use to calculate financial projections should be educated guesses informed by financial trends, contracts you’ve signed, and customers that are in your pipeline. For example, you can assume the number of customers that will churn each month based on the number of customers that have churned over the previous months, or your current churn rate.
All assumptions should be recorded in a single tab in your spreadsheet and kept separate from the tabs where you calculate your projections. Rather than manually inputting these figures for each calculation, you can pull the data from this tab using the spreadsheet formulas. This setup allows you to quickly make updates that are automatically applied to all your calculations, and clearly sets out the figures behind your projections for easy auditing.
Your assumptions tab should include (but not be limited to) the following sections:
Once you have these assumptions in place, you can start projecting how key financial statements like your Profit & Loss Statement (or Income Statement), Cash Flow Statement, and Balance Sheet may look in the coming months and years. You can model how changing inputs—such as increasing your payroll costs or a major customer not renewing their subscription—will impact key metrics like your cash zero date and net income, and make plans to prepare your startup for these scenarios.
Scenario modeling projects how your company is likely to perform under various conditions, and offers some of the most important insights from a startup’s financial model. Seeing these possibilities in advance allows you to develop strategies that will make the most of growth periods and give extra support if the business runs into financial difficulty.
To build alternative scenarios into your financial model, include a prediction for your baseline, best case, and worst case scenarios for each assumption you list. For example, if you usually gain 10 new customers each month under normal (or baseline) conditions, you might predict 15 new customers in a best case scenario and only 5 in a worst case scenario.
If you incorporate these different scenarios in your assumptions tab, you’ll be able to automatically generate a baseline, best case, and worst case scenario version of the three key financial statements and see the impact on your key business metrics. For example, you could see how significantly your worst case acquisition of new customers would reduce your margins or runway, and make plans to deal with this eventuality.
There are two main reasons your business will need a financial model: If you’re planning to scale, or you’re raising venture capital (VC) funds.
For small businesses that don’t have plans for significant expansion, a full financial model may not be necessary. But if you want to scale your business, you’ll need a financial model to get visibility into your main growth drivers and the actions that will affect key performance metrics.
If you plan on raising capital, you’ll need to have a financial model in place before you start meeting with investors: It shows the amount of funding you need, when you need it, and the rate at which your business will be able to scale. Your startup financial model also helps you communicate the potential of your business idea to VC firms, and demonstrates your potential revenue growth over the coming months and years.
If you don’t have enough data points from your actuals yet to predict your future trajectory, you can still start building a financial model using data from existing companies in your industry as a benchmark. Some businesses publish financial data as part of their annual reports, or you may have experts in your network who can share market intelligence.
The general structure of a financial model will be the same for any business: Your model will have an assumptions tab that forms the basis of a Profit & Loss Statement, Cash Flow Statement, and Balance Sheet. However, because you’ll have distinct ways of revenue modeling and will incur different expenses, the finished financial model and the exact types of data included will be different for every business.
As you’re researching how to build a financial model for your startup, you may come across resources including ready-to-use financial model templates, some of which are already populated with revenue and expense fields. It may seem like you just need to enter your data and they’ll generate a full financial model, but be aware that any template you use needs to be customized in order to suit your business and deliver reliable projections.
If you’re using a traditional business model—for example, if you’re a retailer buying and selling inventory at a markup—you may be able to find and download a financial model template that is designed to suit your type of business and doesn’t need too much customization. However, for the majority of startups, this isn’t the case. Most startups build unique business models that set them apart from traditional companies, so you’ll likely struggle to find a template that will be able to give you more than the bare bones of the structure.
For busy entrepreneurs, it can be hard to find the time to build an effective financial model from scratch, particularly since your model needs to be highly customized if you expect it to be a valuable tool for your business. If you don’t have the time to create your own custom model, Zeni could be just the solution you need.
Zeni is a full-service finance firm that combines artificial intelligence and human expertise to deliver accurate and efficient bookkeeping, accounting, and CFO services for startups and small businesses. When you sign up to the Zeni CFO plan, you’ll be assigned an industry expert CFO adviser and a Financial Planning and Analysis specialist that will help you build comprehensive projections, identify key trends, and make strategic plans for your business’s future.
Our team can support every step of your financial planning, including building a financial model that is customized to suit your business and to deliver the projections you need—without you spending hours entering formulas and formatting spreadsheets. Zeni syncs all your input data directly from the source, including payroll and accounting data, marketing pipeline figures, and sales data, so there’s no need to manually search for data to complete your model. Your CFO adviser will translate the data from your model into analytics that are ready to present and use graphical representations to show financial trends at a glance. Zeni can set up and maintain your financial model with minimal founder involvement, freeing you up to focus on using the financial insights to grow your business.
All Zeni plans include daily bookkeeping, a 24/7 finance concierge, and instant access to your startup’s metrics via the Zeni Dashboard. When you enrol in the Zeni CFO Plan, you’ll get all the accounting support of our Full Service plan—including customer invoicing, vendor bill pay, and employee reimbursements—plus you’ll also benefit from the following services: