Let’s call out the elephant in the room first: according to the U.S. Bureau of Labor Statistics, about 65% of small businesses fail before they’re ten years old.
As a new startup founder, does that number make you a little nervous?
If you answered yes, you wouldn’t be alone. Entrepreneurship has always required more risk exposure than your typical 9-5 grind.
But there’s good news: you have tools to significantly improve your startup’s odds of landing in the lucky 35% of businesses who survive over a decade. And in this article, you can learn about one of the most important documents in your fledgling business’s launch plan: the startup financial model.
What Is A Startup Financial Model?
A startup financial model is a set of documents that describes your company’s current finances and its likely future ones. Much of your model will likely be contained in a spreadsheet filled with equations.
These equations use both current figures (such as your startup’s cash balance) and well-informed projections (such as expected ROI on marketing) to predict your company’s future viability. As your startup grows, your financial model will transform from a profitability roadmap into a budgeting tool.
You can search “how to build a financial model for a startup” online and find plenty of free template spreadsheets. It’s important to note that the ideal financial model template can vary widely across industries. Don’t be afraid to customize a template to create your ideal financial model.
This article will describe some of the more specific components of a startup financial model in detail. But first, let’s take a closer look at why this document is so important.
Why Does Having a Startup Financial Model Matter?
From colorful presentation decks to slick networking events, startup culture involves a certain “cool” element. And it’s hard to pretend that Excel spreadsheets containing your company’s financial model are cool.
Yet these spreadsheets could make the difference between success and failure for your startup. Here's how:
Courting Savvy Investors
Your startup has to pay for personnel, equipment, and marketing before you can make money. Unless you’re lucky enough to be sitting on a massive personal fortune, you’ll need to get that money from an outside source. You need funding--and most of the time, just seeming “cool” isn’t enough to get it.
But angel investors and venture capitalists understand the sizable risk inherent to startup financing. They expect a possible high return on investment to make that risk worthwhile.
Returns can be astronomical. Venture capitalist Peter Thiel turned his $500,000 investment in a scrappy social media company called Facebook into a billion-dollar cashout eight years later.
But investors pursuing high returns must also contend with sobering tales of startup investments gone wrong. These failures can range from the embarrassing (e.g., WeWork’s IPO cancellation) to the outright criminal (e.g. Elizabeth Holmes’s Theranos).
In this high-risk, high-reward setting, investors will use your financial model to understand their risk exposure. Your model uses existing data and well-researched predictions to send a clear message.
That message? That your startup has a clear-eyed and calculated plan for success--and they don’t want to miss an opportunity to join you.
Selling the Startup-And Yourself
Your financial model likely won’t predict the future with 100% accuracy. And savvy investors understand that.
So why do they still care about financial models?
Anyone with a business idea and five minutes of market research on Google can create a back-of-the-envelope business plan. Meanwhile, creating a high-quality financial model requires research, analysis, and an in-depth understanding of your own business.
So your model isn’t just a stuffy accounting spreadsheet. It’s a marketing tool--one that demonstrates your business acumen as much as it demonstrates your company’s financial roadmap.
Investors know you can’t predict the future. But you can still show them that you have the knowledge and leadership to navigate bumps down the road.
Understanding Your Own Company
You might be surprised by the information you’ll encounter building your financial plan. You may find that your SaaS company is much more vulnerable to customer churn than you had assumed. Maybe you’ll face a big cash squeeze if you increase your manufacturing quota too quickly.
When you see a problem coming, you can make a plan to deal with it. That’s why making a financial model is important even if you’ve managed to luck into funding before making one. Creating and updating the model isn’t just a way to show off your business. It’s a way to help your business survive.
Past, Present, and Future: Your Model’s Major Components
Financial models vary significantly between businesses. But successful ones share two major components: a snapshot of the business’s current situation and its future projection.
Capturing Current Conditions
If you’re a new startup, you’re likely not very profitable yet. So how can you use your financial model to demonstrate that your business is just getting started, not about to collapse? Financial statements are key.
Financial statements are common documents in the finance world that attempt to capture a company’s overall health. Every publicly-traded company must disclose a profit and loss statement, a balance sheet, and a quarterly cash flow analysis statement. Most startup financial models follow their leads.
Profit and Loss Statements
Profit and loss (P&L) statements describe business conditions over a set period. A quarterly P&L statement might list a company’s revenue and expenses while using those figures to calculate more sophisticated benchmarks.
A single P&L may paint a grim picture of a company that’s actually on the upswing - say, if they made a big investment in inventory that they didn’t sell until later. But investors comparing recurring P&L’s can look past these fluctuations. Instead, they'll see indicators of a company’s true health compared to similar businesses in the same sector.
A P&L captures a period of time--but a balance sheet captures a single moment. This statement sums up how much of your company’s assets stem from debt your company must repay versus assets you own.
Investors use the balance sheet to see what they’d get if your company went under immediately. In this worst-case scenario, they only receive their shareholder equity after your company pays all its outstanding debts.
Cash Flow Statements
A cash flow statement shows how a company balances its outgoing payments with its incoming cash. This document explains, for example, how much you spent buying the raw materials for a product versus how much a customer paid you for it.
This statement also includes sections on finance cash flow and investing cash flow. These sections show how your company's cash situation changes as you receive funding or invest in major assets such as manufacturing equipment.
Predicting Future Conditions
You can start building your financial statements using hard data from your accounting books. It doesn't take a lot of research to look up how many units you sold last month or how much cash is in your account.
But that's not enough to impress investors. Most startups take years to become profitable. That’s why your financial model must predict how well your business will perform in the future, as well.
Giving Investors a Chance to Make a Difference
Is this the time to give pie-in-the-sky estimates about enormous future profits? Absolutely not. An irrationally optimistic model screams “I don’t know what I’m doing!” to investors.
Is this the time to make guesses about the future so safe that it seems like your company will take years to break even? Again, no. Investors get into the startup game because they want a chance at big returns.
The key is to find a balance between these perspectives.
Show investors that you understand the obstacles you’re up against. But don’t forget to show them that their help will truly make a difference. A good financial model shows investors how their funding could significantly change a company’s future, helping it through a growth spurt to become a successful startup when it would have limped along or even failed otherwise.
Balance Market Research and Short Term Plans
Market research isn’t just about looking at your existing market’s size--it’s also looking at how much of that market you can realistically expect to corner over time.
Of course, just because that market niche is available doesn’t mean you won’t need ample spending on personnel, marketing, raw materials, and so on to fill it.
Many financial models describe their short-term growth by looking at likely returns on their existing assets. Putting up the cash to hire one customer onboarding employee, for example, may help you acquire revenue from 100 new customer accounts. That growth isn’t single-handedly cornering the market, but it is predictable and quantifiable.
These calculations show investors that you have a concrete growth plan. Market research, meanwhile, shows how this growth strategy can expand to fill an entire market segment over the longterm.
It’s OK to Ask for Help
Hopefully, by now, you understand how important it is to have a good startup financial model. You may even feel a little overwhelmed - it’s essential, and it can require a lot of work.
Don’t fret! There are plenty of startup experts out there who are happy to help you out.
BaseTemplates is already an expert in helping startups put together attention-grabbing pitch decks. Entrepreneurs can now reach out to us for help building a lean startup financial model, too.
Interested in learning more? Contact us to start swaying investors and building your company!