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8 Financial Model Best Practices for Startup Founders

Tuesday, March 1st 2022 (3 months ago)

A great financial model is critical for every startup. It allows you to get a glimpse of your future financial data. It allows you to make better decisions, and understand the impact those decisions will have over time.

Perhaps most importantly, a great financial model leaves your investors feeling impressed. Rather than wondering about high-level questions, they can dig into the details and analyze your proposition for themselves.

Investors know that most startups fail, and they understand that financial problems are one of the most common reasons for that.

When you’re in front of an investor asking for money, it’s invaluable to have a financial model that quantifies your risk and your value.

You might have an innovative product, a catchy tagline, and a great Instagram page. But at the end of the day, money talks. That’s one reason why building and maintaining an accurate financial model is essential to your fundraising success.

This post will guide you through 8 financial modeling best practices to help you get started on the right foot and make sure your model is always up to date and accurate, whether you’re fundraising or not.

Table of Contents

Illustration: A financial model

Why Does a Financial Model Matter?

A solid pitch deck is essential when you’re fundraising, but it’s only part of the story. 

Your pitch deck covers a lot of topics at a very high level. What problem are you solving? What is your value proposition? Who is your target market? What is your business model?

These are important points, and your investors need answers to all these questions before they’ll consider funding your startup. If they’re interested, they will start to ask questions. From that moment on, your financial model becomes more important than your pitch deck.

Your financial model allows you to answer investors’ questions with actual data. You can point to your actual metrics, extrapolate them by industry standards, and compare them against relevant benchmarks.

From the investor perspective, it’s no longer just you telling a story. It’s you presenting a business case with real-world metrics.

Your financial model shows investors that the story you told during your pitch is believable and realistic.

8 Financial Model Best Practices

Building a financial model from scratch can be overwhelming. There are many steps, and most founders have a lot of questions along the way.

Begin by reviewing these financial model best practices and mapping out your process. If you follow these recommendations you’ll know your model inside and out, and you’ll be able to present it in a clean, easy-to-read format.

Illustration: Building a financial model

Best Practice #1: Build from the Bottom Up

Unlike a top-down analysis, which focuses on the market as a whole, a bottom-up approach is grounded in your actual financial data. 

This approach requires you to break your business down and isolate the key components that drive revenue generation and growth. It can be a painstaking process, but the result is much more credible than a top-down approach, which can be a red flag for investors.

Never approach investors with an arbitrary growth rate or anything that could be construed as “wishful thinking.”

As an example, if you were building a revenue model for an ecommerce startup, you would start by listing all of your products and distribution channels. Document your actual sales for each product across each channel, and analyze monthly trends to determine your current rate of growth for each. Extrapolate those trends to create your forecast.

Don’t forget to factor in relevant variables like discounts, upgrades, and chargebacks.

Best Practice #2: Use a Cover Page With a Linked Table of Contents

While 10 descriptively-named tabs in a spreadsheet might make perfect sense to you, you’re building this model to share with people who have no context for your business or its jargon and abbreviations.

Give investors a soft landing by creating a visually appealing cover page with a table of contents. Include your direct contact information and a description that highlights your company and reminds them about the pitch.

If you have more than about five sheets, include links in the table of contents to make navigation easy for the reader.

Endless sheets of raw data can quickly become confusing, even for a seasoned investor. Structure the labels and headings in your model so that anyone can quickly grasp the meaning of the data.

If you’re building your model in a spreadsheet, you can use one of our free financial model templates. We’ve done the hard part for you, so you can simply plug in your data and start modeling!

Best Practice #3: Always Start With Your Real Data

Always use your actual data as the foundation for your model, even if the actual number is zero.

Short-term, for fundraising, you need to provide transparency for investors and set expectations that align with your actual performance. 

Long-term, beyond fundraising, your model becomes a powerful tool for daily decision-making and operational insight. A model with complete and accurate historical data is priceless.

Best Practice #4: Know Your Model Inside and Out

Your financial model is more than just numbers in a spreadsheet. It’s an analog for your business. 

Investors will gauge your understanding of the actual business according to your understanding of the model. You should be intimately familiar with everything in your model. You should know all your assumptions, and you should be prepared to defend the logic behind them.

Before you present your model, do a few practice rounds with a colleague or a mentor posing as the investor. Practice answering their questions with data and try to challenge every assumption before you put it in front of an actual investor. 

Best Practice #5: Tailor Your Key Metrics to Your Business Model

The key metrics you focus on in your business model will depend on your business model and your industry.

If you’re a SaaS company, your metrics will be much different from those of hardware or ecommerce companies. Focus on the metrics that investors are used to seeing for similar companies. If there’s a unique metric that’s especially relevant for your business, include it; but be sure to explain it to the investor.

Illustration: Updating a financial model

Best Practice #6: Keep Your Model Updated

The best financial models have accurate and complete historical data. The amount of data you have impacts the accuracy with which you can project growth and change.

Update your model religiously every month. You’ll gain great insights by comparing your actual performance against your forecast, and you’ll also ensure that your model doesn’t get stale.

If you stop updating your model, the usefulness of the data will begin to fade. Beyond a certain point, it becomes easier to build a whole new model from scratch rather than update your outdated model.

Avoid this double effort and keep your model in good working condition every month.

Best Practice #7: Include Scenarios to Match the Investor’s Concerns

Put yourself behind the investor’s desk and look at the investment opportunity through their eyes. What are their biggest concerns going to be? Can they clearly understand the best, worst, and most likely outcomes?

You can use your financial model to build alternate scenarios that show the likely impact of potential changes to external variables like regulations, market conditions, or the competitive landscape.

This is a great opportunity for you to strut your stuff and build trust. 

Show investors that you understand the risks your business faces and show them how you plan to respond in each likely scenario. This can go a long way towards making investors feel confident that their investment will be in good hands.

Using a financial modeling software like Forecastr is valuable here, as you can conveniently copy and paste an unlimited number of scenarios and make changes to each of them independent of the base model.

Illustration: Presenting a financial model

Best Practice #8: Make Your Model Easy to Present and Share

Even if your data is comprehensive and accurate, it won’t matter if nobody looks at it. Don’t make investors dig through endless raw data to make sense of your model. Give them easy-to-digest charts and graphs that allow them to digest information at a glance.

Think about the big picture you want your model to convey, and use your visuals to accentuate the data that supports your narrative.

Always include the standard three-statement model with an income statement, a cash flow statement, and a balance sheet. Many investors will use these as starting points to begin digging in deeper.

Always present your model in a clean and polished format. With a tool like Forecastr, you can give investors access to an interactive online model with just a click.

Summary: Financial Model Best Practices

  1. Build from the Bottom Up – Build a bottom-up model, starting with historical data. Avoid arbitrary assumptions and wishful thinking.
  2. Use a Cover Page With a Linked Table of Contents – Always include a cover page. Use a linked table of contents if your model is more than a few sheets.
  3. Always Start With Your Real Data – Never use fake numbers as a baseline. If it’s zero, use zero.
  4. Know Your Model Inside and Out – Know every data point. Be prepared to defend your assumptions and answer a lot of questions.
  5. Tailor Your Key Metrics to Your Business Model – Focus on the metrics that matter most for your business model and industry.
  6. Keep Your Model Updated – Update your model religiously every month.
  7. Include Scenarios to Match the Investor’s Concerns – Don’t underestimate the power of scenario planning. Take advantage of this opportunity to impress.
  8. Make Your Model Easy to Present and Share – Provide visually appealing charts and graphs to highlight key metrics.

Whether you’re raising funds, or just trying to manage your business better, a financial model is one of the most useful tools you can have.

Forecastr is an online tool that makes financial modeling fast and painless. We provide a convenient interface along with dedicated financial analysts to help you make the most of it.

Understand your growth, plan your expenses, and manage your runway with Forecastr. Contact us to get started today!

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