Financial modelling is the process of creating a mathematical representation of a company’s financial situation. It involves combining accounting, finance, and business metrics to create a forecast of a company’s future results. Financial models are used for various purposes such as raising capital, making acquisitions, growing the business, or valuing a business.
A financial model can be used to estimate a company’s future cash flows, which can be used to determine the company’s value. Financial models can also be used to analyze the impact of different scenarios on a company’s financial performance.
Component of A financial model
Distribution channel and User Acquisition
This section aims to segregate the different user acquisition channels. It should clearly demonstrate how many user customer can be won relative to the amount spent across them.
It covers both organic and paid user acquisition. This section should clearly map out user acquisition channel and exactly what you expect the spending done to convert user or customer. Every assumption in this should be justified and every number should be derived logically
Active user and Revenue
This section calculates the projected revenues the startup expects from different streams. Ensure to include revenue from all possible streams and calculate net revenue only after accounting all transactional charges.
Unit Economics, Gross Margin and Contribution margin
The purpose of this section is to clearly show the margin you make on every sale done. A high unit economics positivity is one of the most sought after signal for Investor to consider a startup for investment. It indicates that when the business scale it is having potential to be highly profitable and worth an investment today
Fixed cost and overhead
In this section you list down all the non-operational fixed cost that the startup incurs and expect to incur employee rent overhead tech subscription and any other fixed cost you could think of. This will help the investor to understand the true extent of investment needed. even if the unit economics are excellent a very high fixed cost would plant seed of doubt in investors mind. higher the fixed cost longer the road to profitability.
Cashflow and P&L
This section presents a summary of business projection for the next two years or higher periods. It should be noted that figures in this section are result of calculation in subsequent section. It serves the purpose of providing quick information on the revenue a startup expect and the expense it will incur. The total net burn also give an idea of the funding that business may looking for
Dashboard with Investor Summary
Objective of this section is to help investor understand the business performance using broader most relevant metrics without overwhelming them with details. This is recommended for startups with more nuance business processes, complex stream of revenue, cost item etc.
Insights and Points to remember
1. Define the model’s end goal
Clearly define the purpose of the model to determine its optimal layout, structure, and end-outputs.
2. Understand the company’s business and financial positions
Before building the model, it’s important to have a good understanding of the company’s business and financial positions.
3. Be mindful of potential projections
Remember to accurately reflect potential projections in the model.
4. Organize the model
Make sure the model is organized, well-structured, and easy to read. Be mindful of potential mistakes such as logic errors, typos, and incorrect formulas.
5. Use appropriate assumptions
Use appropriate assumptions when building the model. Be mindful of optimistic assumptions and ignore the risks presented by uncertain variables.
6. Validate the model
Validate the model by comparing its outputs to actual results. This will help identify any errors or inaccuracies in the model.
Common mistakes to avoid when creating a financial model include:
1. Incorrect formulas
Even the smallest mistake in a formula can cascade through the model to significantly impact its accuracy. Double-check all formulas and calculations before finalizing and sharing your model.
2. Data errors
Even a small error in your data will have some impact on your metrics and projections. Continually review the data you’ve entered and verify that it’s accurate, complete, and entered in the correct format.
3. Overcomplicating the model
Avoid overcomplicating the model by keeping it simple and easy to read while also carefully avoiding potential mistakes such as logic errors, typos, and incorrect formulas.
4. Ignoring key assumptions
Use assumptions appropriately when building the model. Be mindful of optimistic assumptions and ignore the risks presented by uncertain variables.
5. Failing to test the model
Validate the model by comparing its outputs to actual results. This will help identify any errors or inaccuracies in the model.
