A Financial Model That Works

Many entrepreneurs can tell a story with the best of 'em.  The words just flow, and the pictures complement the words.  When it comes to numbers, however, some start-up CEOs get lost trying to navigate a sea of Excel cells. Since most of my clients are in the Washington, DC, area, it could be that the federal government penchant for spending more than it makes is actually contagious, but, more likely, it's just that entrepreneurs would rather sell or build products than model out how they are going to generate revenues and profits.  In truth, there are few things that are more important for an entrepreneur than understanding the numbers that make the business tick.

NewPlan builds financial models for young companies all the time - usually in support of a fundraising effort.  We find that a robust financial model is important, because it shows how you plan to operate your company going forward.  It is a test of your business logic and ability to imagine scaling and growing your company.

Here are our secrets to building a useful financial model:

• Include all of the standard information.  By standard, I mean:

• Revenue calculations
• Costs calculations
• A Profit & Loss Statement
• A Balance Sheet
• A Statement of Cash Flow
• A Dashboard full of reports that cover key metrics\

• Build a monthly, 5 year model.  If it's late in the year, extend the model out an extra year.
• Create logical assumptions.  By logical assumptions, I mean things like:

• Achievable quotas for salespeople.
• Market tested salaries for employees.
• Appropriate levels of marketing spending.  For example, for software companies, marketing spending tends to be 5 to 7 percent of revenues - or slightly more - when the company exits the start-up phase.  The percentage declines some as the company gets bigger.
• Accurate projected costs for infrastructure - like data center, rent, and equipment costs.

• Whenever possible, have those assumptions calculate automatically based on revenue growth or some other key factor.
• Imagine how your organization will look in 5 years, and put that org chart in your model.  We generally build our cost models with three sections:  Go-to-Market, G&A, and Operations & Development.  Within each section, you would see a hierarchical organization that starts with the management position at the top and works downward to the most junior position.  For example, there might be:

• VP of Sales
• Director of Sales
• Senior Account Manager
• Account Manager
• Director of Pre-Sales
• Pre-Sales Specialist
• Direct of Telemarketing
• Telemarketer

• Some of those positions might not be staffed until year 4 or 5, but you'll get bonus points for realizing that you'll need that position when your company matures.
• Make sure that your model is readable.  Like a business plan or presentation, a financial model is a selling document.  If you are raising funds, an investor is going to want to review your model without you looking over his shoulder.  That means he needs to be able to figure out how it's built and change the key assumptions to see what happens

Finally, if you're not good at modeling, it's worth paying a "finance-type" to do the job for you.  More than likely, you'll be able to provide the guidance to build the model in the right way.  The mechanics of doing it are quite another matter.