If you think that financial modeling for a new business is arcane magic, limited in value to financial wizards and professional investors, then you have been listening to the wrong advisors. In reality, a simple Excel spreadsheet model customized around your assumptions can save you hours and avoid a wasted expense in validating alternative vendor and marketing decisions.
The way to start is with a sample financial model, freely available from many sources on the Internet, such as this one from Entrepreneur. Another alternative is to build one,starting with a few formulas to extrapolate early revenues and expenses into the five-year projections, normally requested by banks and investors.
Don’t try to build the “ultimate” business model for all possible alternatives in multiple business domains. For maximum value, with the least effort, focus on only the “what ifs” that are the highest priority in your mind for your own startup. In my experience, the top candidates will include the following:
- What if you have to cut your targeted price? Pricing is always a tricky issue. Vendor costs are subject to change, customers are fickle, competitors come out of the woodwork and the economy can take a downturn. You need to quickly calculate the long-term impact on profitability of pricing and business model changes.
- What if you need to change your market size and volume projections? The manual calculations to translate market assumptions into costs, volumes, expenses and net return are massive. They can be done by a simple financial model in a few milliseconds. Investors will test your savvy by asking where your business breaks.
- What if your growth and scaling projections are too aggressive? Most entrepreneurs realize that doubling their revenue each year puts them in a premium category with investors, so that may be your first target. But targets need to be adjusted as the reality of early returns sets in. Projections you know to be wrong won’t help you.
- What if investors offer you only half, or double, what you ask for? With a financial model, it’s relatively easy to apply these amounts to your marketing, manufacturing and administrative costs, as well as business volumes, to predict the impact. Your credibility with investors and your confidence in any request depends on these answers.
- What if your customer acquisition cost assumptions have to change? The cost to acquire a customeror traffic to conversion ratios is critical to the success of most startups. This can be projected top down from market share assumptions or bottom up from actual costs and sales results.
The time to start building your model is even before you incorporate the business and spend real money on building products. Just like planning a long trip with your car, you need to know where you are going before your start, or you probably won’t get there. If you are not computer literate, it’s never too early to find a partner or learn to tackle this critical element of every business.
The financial model obviously has to be built in concert with the overall business and pricing model that you are implementing. The most common business models these days include the subscription model, freemium model and ecommerce. Each has a different set of variables for sales, revenue flow, marketing costs and personnel.
Creating a financial model is perhaps the only way for you to see key areas of strength and weakness in your business before the money is spent and it’s too late to recover. It’s a great learning experience and it’s not rocket science so you can do it yourself. But don’t hesitate to ask for help from a professional if you need it.
You may be surprised how clear the relationship appears between product pricing, cost and customer count. You will quickly understand the old adage that if you lose money on every customer, it’s hard to make it up in volume.
Image credit: CC by FryskLab