Small businesses and startups can greatly benefit from financial modeling because it provides an outlook for specific business conditions, improves decision-making processes, allows you to determine where your business can successfully scale, and maximizes opportunities and profitability.
Basically, it’s a “what if” tool to test business scenarios and take a closer look at how various factors will affect profitability, like potential product price increases or employee wage increases.
Financial modeling for startups enables them to develop scenarios and evaluate likely outcomes. Models are created and tested around specific parameters that are guided by a company’s objectives, and provides insight into financial performance, giving your business knowledge about future financial results.
Through financial modeling, startups and small businesses gain valuable predictive capabilities, allowing them to forecast what the future of their organization will look like. A good financial model can also help businesses:
- Test assumptions and verify key drivers for your business.
- Compare different business choices, like pricing models.
- Calculate the actual amount of capital you need to startup.
- Calculate your burn rate.
- Model out your user growth.
- Model out your expenses.
- Be more prepared when speaking with potential investors, and effectively communicate profitability projections.
Building a financial model isn't just a vanity exercise. When done right, it could help you better understand your business, whether it's a startup or an existing business that you're growing.
Understanding Business Scenarios with Simplistic Financial Models
Overcomplicating financial models don’t serve businesses well and can create a messy approach to predicting company performance. It’s a balance, especially because the “garbage-in, garbage out” principle of data in financial modeling applies to these scenarios.
Small businesses need a simple, concise, and uncomplicated approach to their financial modeling. For example, a startup or small business in the retail sector may want to adopt a customer-centric approach to their financial modeling to determine how many customers are in their market, what percentage of these customers can potentially be acquired, and how much profit your company will earn from these customers.
Small business owners can make smart decisions on a quantifiable basis. Before making significant financial decisions, various hypotheses can be tested through a financial model, providing businesses with an understanding of the potential best-case and worst-case scenarios.
Financial Modeling Best Practices
Small business Financial Model isn’t easy, and there are a right way and a wrong way to go about it. Professionals should rely on the best practices approach to creating models that are in tune with specific business objectives.
Firstly, there are types of financial models that are particularly helpful for achieving certain business objectives. To stay on track with retail, small business scenario, if you’re looking to evaluate how various factors like increasing your sales would impact your bottom line about your internal costs, then the following financial models might be useful:
- Three Statement Model or Pro Forma Financial Statement Comprised of three financial statements, this model links together the balance sheet, cash flow statement, and income statement to evaluate an outcome.
- Discounted Cash Flow (DCF) Model Expanding on the previous model, this model takes discounted cash flow amounts into account when evaluating the current value of your business.
- Forecasting Model This model predicts what your company’s finances will look like in the future by basing the forecasting on historical and current data, along with industry trends. This is a popular model for businesses who want to develop a budget for their company.
There’s a best practices approach to use when building a financial model:
- Assumptions (input) and calculations (output) should be distinguished from each other by using correct formatting techniques.
- The model layout should be created logically, using groupings to different segment sections, such as Assumptions and drivers, Income statement, Balance sheet, Cash flow statement, Supporting schedules, Valuation, Sensitivity analysis, and Graphs
- The model can then be built around historical assumptions and results, reverse engineering this data by measuring factors like fixed costs, gross margins, revenue growth rate, variable costs, etc.
- Then the income sheet, balance sheet, and supporting schedules can be built, followed by developing the cash flow statements.
- A DCF analysis is performed as part of business valuation, and sensitivity analysis and scenarios can be incorporated into the model.
- Graphs and charts are created to communicate results transparently, and stress tests are conducted to determine if the model acts as expected according to the results.
Measuring the Outcomes with Financial Modeling for Startups
Knowing what scenarios or events will impact your company’s profitability, sustainability, and longevity helps you plan for the coming years. Measuring your business’s health and potential is critical to projecting for financial budgeting and smart business strategy development.
Businesses can receive support from Research Optimus, a trusted international research, and analytics company with over a decade of experience providing financial modeling solutions for startups. Research Optimus (ROP) offers advanced analytics and financial modeling that helps small business models gain valuable insight into their future performance. To discuss your requirements and get started, contact us today.