A financial model to a small business is what engineering is to a rocketship.
Based on incoming data, it doesn’t just ensure smooth flight but predicts how a business will react in complicated situations. A financial model also helps add “fuel” when necessary, so you don’t ever get stuck in the middle of nowhere. And it’s a business owner’s best radar for avoiding financial meteors.
In 2020, small business has already been bombarded with its share of trouble. The businesses that had the upper hand are the lucky ones who had a solid backup plan.
Ahead of 2021, everyone needs a good plan.
And when it comes to finance and sales, this can be done with a simple financial model for small business. Here’s how.
Navigate:
- What type of business needs a financial model
- What makes a good financial model, according to experts
- What are the popular types of financial models
- How to build a financial model with no experience
What type of business needs a financial model?
Every business that is serious about growing roots in the entrepreneurship world needs a financial model as its safety harness. It is particularly important for up and coming businesses, startups, and businesses facing economic challenges.
Patrick Bolanos, owner of Trailer King Builders and former CFO of a $20MM restaurant group, explains the priorities of a valid financial model:
Financial models are used to determine if what you are projecting will be profitable, [will have] a good return on investment, [and will show] how you intend to pay back investors. It will be the benchmark of the business.
Most often, financial modeling is used for:
- Starting a business with financial security
- Growing your business
- Raising capital
- Attracting investors
- Understanding which new projects to invest in
If you have a new business, you absolutely need a financial model. If you’re already past the launch process and are focusing on growth, you need one too. Going into business totally without a financial plan possible, but it’s like climbing a mountain without a safety harness. You’re basically leaving things up to luck.
What makes a good financial model, according to experts
Simplicity
For beginner entrepreneurs, a good model focuses on the foundational aspects without going into unnecessary detail. The details can be added later on when you’re familiar with the priorities of financial modeling.
Paw Vej, Country Manager and Team Leader at leading financial comparison website Financer.com, says that beginner entrepreneurs often skip the fundamental questions you should be asking while bringing too much attention to advanced aspects.
For first-time business owners, the most useful things to figure out are, ‘How will I bring in sales?’ [and] ‘What are my costs?’. [On the other hand] equity, liabilities, short-term debt […] distract first-time business owners from the things that really make a difference, for example, sales, strategy and hiring.
Clear cashflows
A financial model’s primary aim is to demonstrate all finances in one place, allowing you to make assumptions and to highlight the “cause and effect” of your business journey.
Jacob Wedderburn-Day, Co-Founder / CEO of Stasher, notes the importance of clear cashflows
A good model gives you a birds-eye view of the company’s finance. This means you can see a breakdown of your income and a breakdown of your expenditure. Most importantly, you can see your cashflows. Cash is like blood to a business – if it stops flowing, or you lose too much, you will die.
You can make a basic budget by just remembering it’s about income vs expenditure. You can start adding simple assumptions like % above/below baseline income and add that in accordingly.
Flexibility
As you plan your model, remember that it’s not something you create once and sit on. A good financial model is all about flexibility.
Jason Cherubini, entrepreneur, academic, and co-founder/CFO of Dawn’s Light Media, points out the two aspects that all worthy financial models share:
[All good financial models] are flexible and able to be adjusted as new information comes in. This is especially true when financial models are used for startups or new products. The realities of business will rarely perfectly match with what has been originally modeled, so adjusting the model to better reflect reality is a must.
Usability
Financial modeling isn’t a theoretical study that you’re doing for investors or for your accountant. It should be focused on usability. In other words, it must be a blueprint you come back to again and again over the course of the years.
As Cherubini further comments:
Financial models are all about forecasting the future based on cause and effect relationships. The ‘effect’ we are most often interested in is the financial effects that will be shown on pro forma financial statements. And while much of the ‘cause’ of these financial effects will be the customers (and the revenue they generate), some of the costs will be driven by other factors.
[…] A financial model, like a budget is useless if it is not used for planning and then as an evaluation tool when looking at results. Part of the financial model’s development should be a plan on how and when it will be used and evaluated.
What are the most popular types of financial models?
Financial models come in many shapes and sizes. This may seem complicated if you are just learning about financial modeling but comes down to a few fundamental things. Before getting started with a template or building one from scratch, it’s necessary to know which one is right for your type of business, experience, and goals.
Carol Tompkins, Business Development Consultant for online accounting software AccountsPortal.com, and Arnold Chapman, Founder of ELD Focus fill us in on the 3 most popular types of financial models and their uses:
- The 3 Statement model — the most basic type of financial modeling. In this model, the income, cash flow, and the balance sheet statements are all linked using accounting/Excel formulas, and assumptions are fed into the model to drive changes in it.
- The Discounted Cash Flow Model (DCF) — based on the 3 statement model. It’s used to value your company according to the Net Present Value of your business’ future cash flow. It takes the cash flows from the 3-statement model and creates adjustments. The DCF, then, uses the XNPV function to subtract them back to your organization’s current Weighted Average Cost of Capital.
- The Comparable Company Analysis Model (CCA) — helps identify your company’s value with the help of other businesses’ metrics. It acts under the presumption that the same companies have the same valuation multiples.
How to build a financial model with no experience
As a rule, financial models are generated as Excel tables. To build one from scratch, you’ll need programming and/or accounting knowledge. Since many entrepreneurs don’t possess the necessary skills to tackle Excel formulas, we suggest looking into options for creating a financial model without experience.
Option 1: Learn Excel basics
Most entrepreneurs suggest that you learn the basics of financial modeling sometime during the business journey. Today, this is easily available through online courses, such as Coursera.
Brack Nelson, Marketing Manager at Incrementors SEO Services, suggests learning basic Excel or brushing up your skills before building a model from scratch.
There are several [Excel] formulas and functions you must use such as Index, Match, Offset, Choose, Xnpv, Xirr, and If. By knowing how to use those 7 functions you’ll be off to a great start and you’ll see the usability and effectiveness of your models start to take off.
If you want to make sure you have the fundamentals down, take a Free Excel Crash Course to learn everything you need to know.
Even if you plan on using a financial model template or outsourcing the job, personal knowledge of how financial modeling works will help you tackle the job faster and gain more ROI.
Option 2: Use a financial model template
To build a model by yourself but skip the abracadabra of formulas, using a financial model template is your best bet. All you’ll need to do is input your financial data into the template. The financial documents will vary based on the type of chosen financial model type. Basically, you’ll need your income statement, balance sheet, and cash flows.
Resources:
- Find and download a free 3 Statement Financial Model Template here.
- If you’re looking for more templates, or those specifically tailored to your business, services like Slidebean Financial Model Templates offer templates for different businesses such as SaaS businesses, eCommerce, Marketplaces, Social media websites and apps, and more.
Option 3: Outsource the job
If you want all the benefits of a professional model or want to dig deeper than the 3 statement model but don’t have the time or option to learn, we suggest outsourcing the job. There are a lot of freelance financial accountants on Fiverr who’d be happy to help you out for a very reasonable price.
Even though you have to pay more for a personal helper than for a template, you get the benefits of a professional to create, explain, and work together with you on building the foundation of your business.
Summary:
- Startups and established businesses alike should have at least one financial model to rely on
- Your model should focus on cause/effect relationships in order to predict your business’s future
- If you don’t know where to start, try the classic 3-statement model. Download it online for free.
- Templates for different types of businesses are available online for a moderate price. They don’t require any programming or coding knowledge.
- If you need help, consult a finance professional or enroll in an online course. Remember that the time and effort you put in today will double your ROI tomorrow.
