Where To Start When Building a Financial Model?
No financial model is perfect, but these tips can give you a better direction.
Here’s some great questions to ask yourself before you begin crafting your financial model.
I was recently asked by an entrepreneur for help building a financial model because there was an investor who wanted to see their plan. Where should they start? What level of detail should they show? What is the investor looking for? I think the most important place to start is what are you trying to accomplish when building the model as that informs the best path forward.
What is the purpose and audience?
Is the financial model for internal or external use? Are you trying to manage cash burn, forecast hiring, or show margin profiles and how they scale over time? Are you just testing if an idea would make sense? Any or all of these could be viable, but it is important to know your audience and focus. That informs which inputs/outputs you should care about, how “pretty” it needs to be, how much it needs to integrate with your workflow/data, etc.
What is the outline and structure?
Once you know your objectives, I always map out the structure of what you are building. Is there a summary page with key financial metrics, an inputs/assumptions page, a detailed income statement, an operating plan, etc.? Mapping these out helps me better see the big picture of how it all comes together. Then as you build the details, always remember to make the model as dynamic as possible so you can easily change assumptions and see the impact.
What is the so-what?
So now that you have an amazing financial model built, what does it mean? I always like to have a summary page that draws out the key insights. Back to the objectives we mentioned at the beginning, what is the implication for cash runway, margins, when to hire, etc? Make sure at the end of the process, your model provides an appropriate direction on the questions you were trying to answer. Sensitivity tables are another great way to test the importance and impact of different assumptions.
Remember that every financial model I have ever built or seen is wrong, so what matters more is understanding which are the most sensitive assumptions in your model that impact your key outputs. Then based on that, how do you go deeper to test those assumptions. If you need an example of a financial model, we have a generic Startup Budgeting Template tool that is free and available for download. Then from there you can customize it to your specific business needs and purpose.