Is your startup ready to enter growth mode? If so, then you're going to need to raise funds — and to raise funds, you're going to need the support of investors. A good, robust financial model is important for a variety of reasons, and positioning your startup to investor interest and telling a growth story is certainly one of them. However, there are other uses for good financial models. For instance, they can help with internal decision-making and charting a growth path.
In this post, we'll take a closer look at the true value of investor-ready financial models and the key components to inspire confidence. Read on to learn more or contact Graphite Financial today.
Think of financial modeling as an operational tool rather than just a means of attracting and securing investors. Here are some benefits of a good financial model:
Several key components make up an investor-ready startup financial model. Here's a closer look at these variables:
A good investor-ready financial model is composed of three financial statements: an income statement (which is essentially a profit and loss statement), balance sheet and a cash flow statement. Together, these make up an integrated income statement.
Income statements summarize financial performance over a certain period, balance sheets list assets and liabilities, and cash flow statements track all the cash that goes in and out of the company. These three statements all interconnect and validate each other, as changes in any of them influence each of the others.
Financial model assumptions involve making educated guesses about the future performance of your startup. Some best practices for developing and presenting model assumptions include:
Revenue and financial projections are one of the most important aspects of an investor-ready financial model. Many startups create bottom-up and top-down revenue models; the former estimates future sales for each product or service, and the latter estimates the total market size and evaluates how much of it your startup can capture.
Good models also break down revenue streams by channel, product and customer segment, while factoring in other variables like sales cycles, seasonal trends and other market factors.
So, how do you build a comprehensive expense model as part of your investor-ready financial model?
Start by analyzing current expenses and working to understand how they change with output to accurately estimate future costs. This also helps project fixed and variable costs, especially as your startup scales.
It's also important to model team growth, compensation and departmental budgets. Do this by working to define clear business goals and objectives, developing a compensation plan and modeling growth. Be sure to also regularly review and adjust these models.
Graphite works to deliver models tailored to meet your startup's unique requirements and reflect the industry that you're operating in. Here's a look at industry-specific modeling considerations and how Graphite can support your startup.
Modeling is unique for SaaS startups largely due to the subscription-based business model. That said, subscription-based metrics such as MRR, ARR, churn, LTV and CAC are important to consider during modeling.
SaaS modeling must also consider cohort-based revenue retention and expansion, which is best accomplished by using cohort analysis.
eComm and CPG startups must manage inventory modeling, COGS structure and consider the supply chain. There are multi-channel sales they must account for, which have unique revenue streams and customer acquisition costs by channel. Consider incorporating metrics like AOV, repeat purchase rates and unit economics into the financial model as well.
Marketplace and two-sided models tend to be more complicated, as supply and demand have to be modeled on each side of the platform. Rate dynamics and marketplace liquidity must also be taken into consideration. Marketplace liquidity metrics and rate dynamics measure how well a specific marketplace can facilitate transactions.
Top-down financial models are market-based, whereas bottom-up financial models are operations-based. More specifically, bottom-up models project future sales for each product or service, and top-down models estimate the total market size and evaluate how much of it your startup can capture.
Top-down forecasting tends to be faster and can save time and resources, while bottom-up forecasting tends to be more tedious but also more detailed. Startups can also take a hybrid approach and combine elements from each, leveraging the strengths of each type of model.
Forecasting timeframes vary by business stage. For instance, short-term forecasts are ideal for more immediate decision-making, like cash flow and inventory, while medium-term and long-term forecasts help support staffing and resource planning as well as major investments and growth strategies.
By using a mix of forecasting methods and regularly reviewing and adjusting your startup's approach, you can balance detailed short-term forecasts with longer-term revenue projections.
Robust financial modeling isn't without its challenges. Here's a closer look at some of the common pitfalls startups should look to avoid:
There's a fine line between ambition and credibility when you're making growth projections. To avoid this, focus on building models that are grounded in data and reality. Use historical data and benchmark this data against industry standards. Also, be sure to consider external factors, like market conditions and economic shifts. Models and projections should be regularly reviewed and refined over time.
It's important to have a detailed cash flow model beyond just basic profit projections. Do this by modeling accounts receivable, accounts payable and inventory impact on cash. Capturing timing differences between revenue and cash collection is also important for accurate financial reporting and effective decision-making, as it allows you to truly understand your startup's financial health, manage cash flow and make better, more informed decisions about investments and options.
Another key challenge is incomplete expense modeling that creates unrealistic margin projections. Many startups overlook certain expenses, like customer success, infrastructure scaling and compliance costs. Scaling startups also need to account for marketing and R&D investment as a percentage of their revenue.
One effective way to make your model appeal more to investors is to create an effective visual summary of your model output. Do this by detailing essential metrics and key performance indicators (KPIs) to highlight based on your startup's current stage by using visually compelling graphs and charts. Consider structuring an executive summary dashboard for investors to make a quick assessment.
Scenario modeling is also key, as investors want to see base, upside and downside cases. Scenario analysis helps demonstrate the resilience of your startup to investors by providing a more transparent and robust evaluation of your startup's strategy and how its financial plans perform based on a range of possible future scenarios.
The models your startup creates must be accessible and easy to understand. Prioritize clarity, transparency and ease of use and understanding for all stakeholders and potential investors. Make sure any assumptions are made clearly and don't be afraid to use comments or annotations to explain certain calculations.
For more information on how to build investor-ready models and to partner with a financial expert who can help optimize your approach and improve your chances of attracting investors, contact Graphite today. Graphite's models differ from typical startup financial model templates and DIY models and really zero in on your startup's unique structure to create more effective and impactful models. Contact us today for more information and to schedule a consultation.
It should be high-level, but not overcomplicated. For early-stage seed round funding, keep projections month-to-month.
Consider updating your strong financial model anytime your outlook changes. When outlook changes, so should your forecasting assumptions.
Most early-stage companies model three to five years from the point of investment to align with long-term business plans.
Balance optimism with credibility by relying on market data and other dynamics when developing your model.
While all models should largely contain the same information, consider creating different versions to more specifically cater to the audience.
Model CAC by dividing total marketing and sales expenses by the number of new customers acquired over a specific period and use this historical data for future projections. Marketing efficiency is best assessed by looking at the return on investment of different marketing channels and strategies.
Investors look for metrics such as ARR, MRR, net income, gross profit margin, cash flow, CAC, churn and LTV.
Aside from providing the right data and metrics that investors are looking for, make sure your model is investor-friendly. Include dashboard and summary visualizations, scenario analysis and present information in an easy-to-understand way.