What is a Startup Financial Model, and Do You Need One?

Introduction

New business owners will find out early on their entrepreneurial journey that they need to talk about money—a lot. From projecting future revenues to managing working capital to presenting to investors, finances will constantly be top of mind. That’s why startup financial models are so important.

Financial modeling for startups can be used in a variety of ways, whether a startup wants to make sure the company cash flow is healthy and sustainable or as founders prepare to pitch to investors. Further, financial models can help prepare for big expenses, from hiring new employees to paying company taxes.

Regardless of the goals, building a startup financial model could be the key to success. Read on to learn more about why a financial model is important for startups and how to create one.

What is a Startup Financial Model?

A startup financial model is a tool that tracks and projects a company’s financial health. Many financial models include three common elements: an income statement, a cash flow statement, and a balance sheet. Startup financial models are often part of the company business plan, as this model can be used to identify startup costs, key performance indicators (KPIs), and ongoing expenses, while also projecting future revenues.

Because financial models are so versatile, they can be adapted for a number of different business goals. This tool can ultimately play a role for startups looking to build their business, secure funding, and even find long-term financial success.

Why is Building a Financial Model Important for Startups?

Most startups will fail. In fact, 90% of startups fail, often because of high burn rates, poor budgeting, and other issues with cash flow. Startups can also fail because of a poorly prepared business plan that doesn’t address important factors, like market demand, competition, product pricing, and long-term costs.

Building a startup financial model can address many of these common risks to a startup. Startups can use a financial model to:

Track Goals

Whether you want to reach a certain number of sales in your first year of business, hire new employees, or improve current KPI measurements by next year, a financial model will help. This tool allows you to take a more detailed look at the business finances to determine strengths and weaknesses while also estimating future financial performance. With a financial model, you can adjust the business as needed to help the startup meet its goals.

Keep a Budget

Startups may choose to use their financial model to maintain a budget by tracking actual and anticipated expenses and revenues. About 53% of startups underestimate business costs in their first year, so taking the time to prepare a financial model can help startups better understand their costs and keep spending in check to avoid poor cash flow.

Attract Investors

Financial models aren’t just beneficial—they may be required, especially if your pursuing startup financing. Potential investors or lenders will need to see how your business is doing financially, or if it’s not running yet, how it is likely to do based on your extensive research. 

Even if a startup isn’t making sales yet, the financial model can show that the founders have a thorough understanding of their market and the costs it will take to launch a successful startup. 

A startup financial model can make a startup more attractive to potential investors by giving them more confidence in the business.

Prepare for the Future

Creating a startup financial model can also simply be part of the due diligence a business needs to take on. Startups need to understand their financial performance and estimate future financial standing in order to hire people at fair rates and avoid running out of money. Startups can use financial modeling to prepare for tax payments, a cost that can often take new companies by surprise.

How to Create a Financial Model

Clearly, financial modeling is important for startups, whether they are just getting started with a new business or they are rapidly growing and need to plan for the future. 

But where do you begin with financial modeling? While the process can vary based on the business type, size, and goals, startups can create a financial model with the following key steps.

1. Set Goals for the Model

Because a financial model can serve so many different purposes, it’s important to know your “why” for creating it. For instance, if your financial model will primarily serve as a budget and business plan for the company, it should be extremely detailed to help with tracking expenses, projecting revenue, and planning for the future. 

If you plan to present the financial model to investors, details are important, but too many can become overwhelming in a presentation. Make it clear that you understand your target market, that you’ve considered the costs of doing business, and that your business has long-term viability.

2. Establish a Model Framework

If someone on the startup team is particularly savvy with spreadsheets, you can create your own financial model. You’ll need to input the KPIs you plan to measure for the financial model as well as what goals you’ll be working toward to create the spreadsheet. Otherwise, you can also use templates to build out the bones of your financial model.

No matter how you set up the model, it will include some common elements to track, such as revenues, the costs associated with making your products or services, fixed and variable operating expenses, costs for headcount (or employees), and financing.

3. Input KPIs

Now that you know what you want to track and why, you can begin putting in data from your business to track KPIs. For instance, you may start inputting sales, current expenses, and tax costs. The KPIs are how you will track your financial performance, so it’s important to be detailed and accurate here.

The KPIs you want to track will depend on your business, market, and specific goals, but some common KPIs for startups may include average revenue per user, customer churn rate, website traffic, or leads.

4. Estimate Costs

Whether your startup is growing or it’s just getting started, there will be costs you may not be paying for yet, but will still need to account for. These estimated costs need to be included in a financial model to avoid any costly surprises in the future. For instance, you may be using software for your operations that offered a new client deal for your first year, and that cost will go up in the next year. Or you may need to consider costs for expanding to a bigger storefront or warehouse. The more detailed you can be in estimating future expenses, the better you can expect the unexpected.

5. Forecast Revenue

By tracking your business’s financial inputs and outputs in the financial model, you can begin forecasting revenue. This can help startups determine sales goals, or how many sales they’ll need to make to start turning a profit, and examine what expenses can be minimized. 

Forecasted revenue can be important for presenting to investors and setting financial goals for the company, but it can also provide some insight for startup founders. Many startup founders won’t take a salary home from the business in its early stages or until the business begins raising seed funding, so revenue projections can help determine when startup founders will be able to start paying themselves a salary.

6. Include Working Capital

Working capital is the amount of money a business has readily available for daily operations based on the difference between current liabilities and assets. Startups should keep a close eye on working capital in the financial model, since this number can make or break the business. If existing liabilities, like expenses and debts, are higher than the company assets, the startup could face bankruptcy.

7. Prep for Taxes

New businesses must consider taxes when preparing the financial model. This variable, ongoing expense can leave new business owners with sticker shock. Businesses need to prepare ahead for taxes, including income taxes, franchise taxes, employment taxes, and corporate taxes, just to name a few. The exact taxes a business needs to pay depends on the type of business, the business location, business size, and many other factors, so it’s best to consult with accounting professionals to better predict for tax expenses in the financial model.

8. Check In

Creating a financial model is only half of the battle. Companies need to review and analyze the model regularly to adjust projections and determine financial performance. Plus, over time, a business’s goals may change as the company grows. 

Startups can also analyze the model to find issues, like underperforming sales or unnecessary expenses. By finding problems early, startups can address the issue and get the finances back on track.

Reviewing and updating the financial model can help the business stay up to date on its finances, and ideally use this data to secure more funding, reach increasing sales goals, and establish a viable, long-running business.

Build to Success by Building a Startup Financial Model

For startups, creating a financial model could be the difference between launching a successful startup and securing investors or mismanaging money and filing bankruptcy.

Of course, many factors go into a successful startup, like having an innovative idea, fulfilling a need that isn’t met, or providing excellent customer service. But because financial performance is so critical to determining a startup’s long-term sustainability as a company, financial modeling can’t be overlooked.

By building a startup financial model, new businesses have an in-depth look at their financial health, and they can use this tool to project revenues, set financial goals, and even attract investors.