What is a financial model?
It’s a tool you can use to understand and plan for your startup’s financial future. It gives you insight into how much capital you need to raise, and how long it will take you to become profitable. This gives you the power to make informed decisions when you’re raising capital and evaluating growth opportunities.
Investors love to see a well-structured model that shows your startup’s trajectory in their native language – numbers. They get a clear picture of your expected financial outcomes, and the information they need to accurately assess the risk associated with the investment.
A financial model also gives you valuable insight into your risks as a founder. You can evaluate the impact of your decisions in a simulation, before you invest resources in the real world. You can test potential strategies to see how your outcomes change when you deploy resources differently across departments and projects.
The beginning of the year is a great time to start a new financial model. When you plan your year in advance, you’ll have data-driven insights to make informed decisions to accurately gauge your progress.
New Year, New Habits
As we welcome in the new year, it’s customary to reflect on past habits and consider what changes we can make to achieve better results. Many of us do this on a personal level, but neglect the opportunity to improve the habits and processes of our businesses.
Are you spending valuable resources on projects that aren’t producing their desired results?
Will you be hiring new positions at the optimal time?
Are you capturing the most important metrics from each of your operational systems and storing it in a way that gives you clear insight into your progress over time?
All of these questions factor into something that we refer to as financial hygiene. Good financial hygiene means efficient spending, timely new hires, and understanding how you measure up to projections.
How do you get started with good financial hygiene?
A great way to begin is to simply take stock of where you are now. Which of your financial goals are you on track to achieve, and which areas need improvement? This assessment will give you a good idea about where you have significant gaps or problems.
Next, you’ll need to set up a few tools. At a minimum, you’ll want a well-structured annual budget and a solid financial model. The other resource you might consider is a professional consultant. Whether you need help from others depends on the size of your problems and the confidence you feel solving them.
If you’ve never built a financial model before, getting started can be a little overwhelming. The best solution to overcome the obstacle is by utilizing a template or employing a comprehensive software for financial modeling. If you need a good template, you can find one to match your business model here.
However you decide to build your model, try to get started soon if possible. The coming year will be full of challenges and obstacles that demand your attention. It is important to strike while the iron is hot and get your model up and running now.
Benefits of Using a Financial Model
A financial model lets you harness all the data that is available from across your business. You get crystal-clear insight into your risks and opportunities, and make better decisions on a day-to-day basis. You are able to see the likely impact of each decision before you make it.
This level of insight can be transformational for early-stage startups. Many founders say that their financial model quickly paid for itself by improving their operational efficiency. This opened the door for them to raise capital from outside sources.
When you have a clean visual representation of your financial performance across every aspect of your business, the opportunities for improvement come into focus right away. There are endless uses for a good financial model, but we’ll focus on three of the biggest benefits here.
1. Creating a Hiring Plan
It’s crucial to understand how every hire you make will impact your burn rate and runway. Some hires will start generating revenue right away, others will be focused on infrastructure and will have more of a delayed impact. All of them will increase your expenses on day one.
A financial model helps you maximize your success in hiring by allowing you to build a strategic hiring plan. Every hire is made when the time is right, and their impact on your burn rate and runway are acceptable. This allows you to be proactive about planning your hiring schedule.
2. Making a Great Impression on Potential Investors
Investors understand the importance of a solid financial model that is rooted in the organization’s current data and performance metrics. They know that your data is the best indicator of how quickly you will grow, and they generally aren’t shy about digging into it.
A comprehensive model shows potential investors your exact trajectory and lets them analyze the risks and rewards associated with their investment. If your model is detailed and accurate, and you can defend the growth assumptions in it, it goes a long way towards building trust between you and your investors. It’s an opportunity for you to showcase your performance and your vision, while building credibility in the eyes of investors.
3. Knowing Your Cash Runway
Having a deep understanding of your cash flow is critical. Running out of money is the most common reason startups fail, and when you don’t know how long your cash will last, it can be hard to get a good night’s sleep.
When you know exactly how much cash you have and how quickly you’re burning through it, you can estimate the date when the money will run out with a fair degree of certainty. This lets you plan ahead so that you can raise more capital before it becomes an emergency. And it lets you stop worrying about unexpected cash emergencies that might be lurking just around the corner.
The New Year Is a Great Time To Get Started
The new year is a time when you’re likely focused on your finances already, due to your annual budgeting process. You can take advantage of that process, which requires you to gather information from many different sources (accounting, CRM, payment processors, etc.) to fast track your financial model. As long as you’re taking the time to gather that data, you may as well capitalize on the opportunity to use it for more than one purpose.
If you plan to fundraise at any point this year, don’t pass up this opportunity to get a jump on your model and put it into active use for a few months before you have to show it to potential investors. If you build now, you’ll be well-prepared to defend your model and your assumptions when the time comes. Not to mention, you’ll be able to focus your time and attention on the raise, rather than scrambling to build a last-minute model.
Starting off the new year with a thorough review of your finances and your cash runway is a great way to set yourself, your team, and your investors up for success in the coming months. There’s no more efficient, or effective time to bite the bullet and start building a financial model.
OCEAN understands that financial models play an essential role in helping startups succeed. We’ve helped launch more than 300 small businesses and more than 60 high-tech startups through our Genesis Entrepreneurship Training and OCEAN Accelerator. We help founders learn the skills they need to navigate the early stages of growth, and you can reach out to us for help at any point in your journey as a founder.
Written by forecastr
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