A startup financial model is an essential tool for successful financing success. When you’re seeking capital, it’s critical to demonstrate to potential investors that you, personally, understand the key cost and revenue drivers of your company. One of the biggest headaches new startups encounter when preparing to raise financing is the issue of financial models. The startup financial model will help to guide every decision you make throughout the life of your company and will give you a clear sense of direction. Unfortunately, not every successful business has a clearly laid out financial model.
Financial Model Startup
Many startup businesses have started out with little in the way of financial modeling or even guidance from an outside source. These companies will typically rely on their business plan to provide them with a fairly accurate idea of their revenue and expenses over the short, medium, and long term. As the company grows, these numbers will inevitably change. In order to project a realistic picture of future earnings, venture capitalists require projections of how revenues will be reaped if sales are to grow. Without this type of projection, venture capitalists cannot properly gauge the valuation of the business.
Fortunately, most good firms provide this type of startup financial model to new startups. The best firms will provide multiple financial models that will allow you to project various revenue levels based on your assumptions about demand, product demand, and marketing trends. These models can also allow you to project operating costs and allocate the right operational dollars for growth. Here are some of the common startup financial models most venture capitalists use.
How We Can Calculate Growth Model
Growth and revenue models are designed to help you project how revenue will expand over time. To calculate a growth model, you first need to estimate the revenue growth rates that you expect to experience for each year. This includes both the immediate revenue impact and a forward-looking effect such as reducing cost by 10%. These models can be very complex and time-consuming, but they are essential for potential investors. If a firm provides you with a simple growth model, it is likely that the firm has a much larger funding cap than the startup would suggest.
Many financial models show potential startup financial modelinvestors an assumption that doesn’t reflect real-world conditions. For example, assuming that the selling price of a company’s stock will continue to remain at its current level through three years may not be reasonable in light of recent volatility in the stock market. Investors must be provided with an assumption that is consistent with current market conditions. In addition, this assumption must be one that is feasible over the course of the startup’s operations.
Factors of Financial Model
One factor that is often overlooked in a startup financial model is the effect that initial sales will have on future revenue growth rates. Most financial models assume that the revenues generated from new customers will offset future losses. While revenue growth rates are most likely to continue to decline, the startup could face additional operational costs if the revenue from existing customers begins to increase faster than expected.
It’s important for a potential investor to provide the company with an assumption that will allow for this situation. For instance, assume that sales grow at a 5% annual rate through the first five years after the business is open, but assume that customer acquisition costs will grow at an annual rate of two percent through the first year.
Another important aspect of a startup’s model is its sensitivity analysis. Sensitivity analysis is used to identify areas for risk adjustment. In the past, startup businesses were considered highly speculative due to the extremely high degree of risk associated with launching a new company. Today, venture capital companies are more likely to focus on a company’s revenue growth potential and less on its attractiveness as a growth story.
By removing factors such as speculative reasons for the startup’s inception, and identifying only those factors that are of substantial importance to current and prospective investors, a startup can focus its attention on making strategic decisions that will increase its revenue and market share. The use of a sensitivity analysis model allows for the elimination of unnecessary variables and the focus on identifying the most relevant ones.
Finally, startup financial models should be aligned with realistic assumptions regarding assumptions. The purpose of this section is not to list all possible assumptions that could exist, but to discuss some of the most common assumptions made by financial models. Assumptions such as startup costs, operating overhead, revenue growth, and customer attrition are common in financial models.
Startup businesses may not realistically expect their revenue or market shares to exceed their costs and operating overhead in the first year. However, the startup may expect its gross and net profit margins to become negative during the first year. While these scenarios are unlikely to occur, they are the kinds of things that venture capitalists consider “risky,” and should be avoided during the startup development process.