Ahh, yes, the exhilaration of being an early-stage startup. And by “exhilaration,” we mean terror. Just total, complete, absolute, abject terror.
Look, we get it. We’ve been there. Being a founder can sometimes feel like you’re herding cats with one hand and shoveling the ocean with the other.
So many things are thrown at you simultaneously – research and development, marketing, fundraising, technology, accounting, and humans – it just feels like the weight of the world bearing down on your shoulders.
And the worst part? Managing these disparate and unrelenting streams of information feels next to impossible.
We have good news. With the right toolset, you can get your arms around the challenges you face as a founder and begin to make confident decisions about every aspect of your budding business. It all starts with your financial model.
5 Critical Answers a Financial Model Provides
- How Much Money Should You Raise?
- How Should You Spend the Money?
- What Should Your Hiring Plan Look Like? (Who can you afford?)
- What Acquisition Channels Should You Focus On?
- How Many Customers Do You Need to Hit $1M in Annual Revenue?
What Is a Financial Model?
Your financial model should be more than just a spreadsheet. Done correctly, a model allows you to track and forecast your expenses, compare alternate scenarios, and analyze your return on different revenue streams.
How it works is relatively simple: You gather up all of your available financial data and put it into a format that allows you to project your growth rates into the future. You get a clear picture of your financial future that you haven’t seen before, and your runway comes into sharp focus.
If you use a software solution like Forecastr, you can model different scenarios to evaluate the future impact of decisions you make today – like new hires, new marketing strategies, or new office space. You can experiment to see the impact of increasing your conversion rate on one traffic funnel while cutting your spending on another.
Simple charts and graphs show your historic performance, your current trajectory, and your future projections – all in one dashboard. But the proof is in the pudding, so let’s take a look at 5 critical questions that are answered by a good financial model.
How Much Money Should You Raise?
Let’s say you’re in a meeting with a potential investor, and they say, “You say you need $X. Why? What do you need that amount for?”
This is a make-it-or-break-it moment. If you hesitate, you could lose the deal.
With a financial model in your corner, you can answer this question with confidence, knowing that you have sound data to back up your ask. Rather than a stack of receipts and spreadsheets, you can share a compound graph that shows your categorized expenses with the cost of scaling built-in.
A good model also lets you plan for environmental changes, so you can be prepared for cost increases, supply chain issues, upstart competitors, and more. Show your investor that you don’t just have a great plan, you also have a backup plan that accounts for their objections.
How Should You Spend the Money?
As we’ve discussed, financial modeling is about much more than simply forecasting your current revenue and expenses.
When you understand the cost, volume, and return on each of your revenue streams, you can make better decisions about how to allocate your budget for marketing and sales.
When you can visualize the production impact of a new piece of equipment or a new manufacturing process, you can ensure that you invest at the optimum time.
Decisions like these are critical for early-stage startups with limited resources. Sometimes you simply don’t have the luxury of learning a lesson the hard way and you need to get it right the first time because a second chance may never come.
A financial model lets you plan for success. You take everything into account, including time, and you spend your money wisely at the right moment. Having a plan like this instills great confidence in your investors, your team, and most importantly – you as a founder and fundraiser.
What Should Your Hiring Plan Look Like? (Who can you afford?)
Even in the topsy-turvy world of an early-stage startup, people are a unique challenge. Culture fit, development methodologies, working styles, variable compensation plans, dietary restrictions – it’s never easy to manage humans.
Gauging when and where to invest in talent is one of the most consequential calls a founder makes. Which positions require the most expertise and leadership? Which positions can be postponed for a while? Which positions can be eliminated?
A financial model shows you the impact of every position. You can see the significance of each position in terms of its cost and its return in revenue or production.
This lets you build an optimal hiring plan, within your existing budget, with a clear understanding of how each hire impacts your runway and your time to profitability.
Investors know that these details are often overlooked by early-stage founders. If you can demonstrate that you have optimized your hiring plan to emphasize the most impactful positions and hire them at the right time, you will be the exception.
You’ll be exceptional!
What Acquisition Channels Should You Focus On?
Marketing does not come naturally to some founders, and that’s OK. Talk to a professional marketer and they’ll tell you that marketing doesn’t come naturally to anyone. Good marketing requires measurement, iteration, and tons of creative thought. Good marketing is not a deliverable, it’s a learning process.
But when you’re just getting started with a limited budget, it can be very hard to determine which acquisition channels you should invest in. A financial model takes the guesswork out of these decisions and gives you a clear understanding of your return on each channel.
Sometimes your highest volume channel is not your most profitable channel. Sometimes there’s a uniquely profitable channel that you’re overlooking. A financial model takes into account each channel’s cost of acquisition, churn rate, and long-term profitability, allowing you to optimize your spending across the board.
This information will have any investor licking their lips. But it’s also useful to you in your day-to-day role as a founder. When a given channel isn’t performing well you can start to isolate the cause, or just cut it off entirely to focus resources on another funnel.
How Many Customers Do You Need to Hit $1M in Annual Revenue?
It’s the million-dollar question. And it’s not just a random benchmark – it’s a question you’re very likely to hear from investors as they gauge the timing of your opportunity.
When will you hit $1M?
Expectations are everything here, and a solid financial model lets you set expectations as accurately as possible.
Obviously, no one can predict exactly what will happen. As we say here at Forecastr, 100% of financial models are wrong. But without a crystal ball or a divine oracle, a living financial model gives you the most accurate information about when you’ll reach $1M in annual revenue.
Your model gives you realistic expectations about your revenue, churn, and growth rate over time. You simply pass that information along to your investors. Explain the assumptions behind your projections and show them that it’s all backed up by reliable data.
You’ll rest easy knowing that you’ve given your investors realistic expectations. If a cash injection would help you reach that magic number faster, you’ll make a great case for them to provide that cash.
How To Get Started
As you can see, a solid financial model can be the difference between your startup locking in its next funding round or running out of cash. For you as a founder, it can be the difference between nailing your growth targets or struggling just to keep your numbers positive.
You can get started with a new financial model today. We have a set of free spreadsheet templates any founder can use to create an instant financial model. Just add your historical financials, calculate your current growth rates, and plug in your assumptions about future growth.
This is a guest post from our partner Forecastr. If you want a great financial model, and you want help building it, our online service gives you a purpose-built interface and a team of dedicated analysts to help you succeed. Reach out to Forecastr now to learn more.
