Before getting too deep into a business, it’s critical to analyze your financial model for startup growth. Building a successful business can be challenging, so you’ve got to know what you’re getting into and what you need to do to succeed.
But how can you best build a model that reflects this? Read on to learn how to use your startup’s financial model to drive growth.
What is Financial Modeling?
A financial model is an abstract representation of a potential real-world situation. It’s a mathematical model designed to provide a simplified view of the future performance of financial assets. Those assets could be a business (or portfolio of businesses), projects within a company, or other investments.
The most effective approaches to financial modeling are a combination of top-down and bottom-up forecasting.
With top-down forecasting, you start with the total market size and estimate how much of that market your company can capture. Essentially, you’re beginning with a significant number and then shrinking it down.
The first step requires deciding on the significant number you’ll use as a basis, i.e., annual revenue. Then divide that number into smaller and smaller pieces until you reach a sufficient level of detail, monthly revenue, for example.
A top-down forecast is conducive for newer companies with little historical data to use as a basis.
This approach generally begins with your current sales figures and projects future sales based on historical growth rates and other factors specific to your business. This type of modeling can be pretty accurate when done correctly, but it requires you have enough historical data.
Bottom-up forecasting also allows you to create multiple scenarios to reflect general economic conditions and how widely your products are adopted. It can be beneficial when negotiating deals with customers and investors because it shows different growth possibilities for your company.
Financial Modeling is Essential for Startup Growth
Financial modeling helps you plan, adapt to market changes, and make better decisions. Startups tend to have a limited cash flow, so getting your model correct is essential for growth.
Financial Modeling Helps Build a Financially Strong Business
Before raising money, it’s essential to understand the financial side of your business, whether you are early stage and raising capital or a seasoned CEO who has been in business for a while.
A robust financial model will help you forecast and track different metrics related to your company’s growth. It provides a data-driven way to decide how much capital you need, what it will be spent on, and when you can expect to generate profit.
A good financial model quantifies and validates your business plan. To help you build a financially strong business, you need to understand the difference between profit and cash flow.
Financial Models are Instrumental in Raising Funds
A thorough yet concise financial model is a crucial aspect of raising funding. Internally, models give insight into how much capital you need to raise and what you should plan on doing with the funds.
But they also give potential investors a look at your company’s performance. A solid financial model shows that you have analyzed all future growth aspects, and investors generally like details.
Financial Models Help You Measure Progress
The goal for most startups is to grow as quickly as possible. Although it’s difficult to make progress toward an unknown destination, a well-developed financial model will give you something concrete to work toward.
A financial model for your startup can help you constantly measure that growth to ensure you’re always either on track or making necessary adjustments.
Financial Models Help You Leverage Growth
Decisions you make in business matter. From different marketing campaigns to new product releases, modeling various business choices will show how your choices could affect your company’s finances.
For a lot of startups, growing means securing outside investment. Presenting your startup’s financial model to investors gives them a good idea of where your business currently stands.
Investors are typically looking for startups that already have some traction and are poised for growth. Your model is also a great way to demonstrate how you plan to spend new funding.
It’s easy to see what is and isn’t working. If something isn’t working or isn’t going to work, it will show up on your financial model. Catching problems quickly and making adjustments early on can help you continue to grow where you didn’t initially see success.
Ace Your Financial Modeling with the Help of an Experienced Financial Partner
The heart of your business plan is your financial model for startup growth. Understanding your startup’s financial model, what makes it work and what could potentially derail your plans is a critical step for entrepreneurs.
A solid model can ensure that you know how much it costs to run your business, what revenue streams you can rely on, and how fast you grow. It can also help you test various scenarios before investing actual funds.
At Founder’s CPA, we can help you ensure your startup’s financial model reflects your business realities and future challenges. Contact our startup finance experts now to get started.