Financial Modelling for Startups: What Is It?

For startups, financial modelling is the process of projecting and forecasting revenue, customers, employees, costs, Etc., for the future to assess their profitability and viability. While the startup is still in its early stages, this model will assist them in preparing a budget and business plan for potential investors.

Let’s deep dive in Financial Modelling

In financial modelling, past, present, and future operations are represented in numbers. The purpose of such models is to assist in making decisions. An executive may use these models to estimate new project costs and profit potential.

The purpose of financial modelling is to help entrepreneurs and businesses understand their financial position and raise funds from investors.

Various professionals use it to assess a company’s financial viability, including bankers, accountants, valuation advisers, and research analysts.

Benefits of Using Financial Model for Startups

  • By doing this, you can determine whether your ideas can work as a business that operates sustainability
  • An investor and a startup need quantifiable data to decide whether to invest in a startup. Financial models provide this type of information
  • Businesses or startups can allocate money where it is needed most by using financial modelling
  • By knowing your startup’s financial situation, you can make more informed decisions about how to use your money.

Types of financial models

1. Three-Statement Model

The three-statement financial model serves as a base for other financial models and links balance sheet, income statement, and cash flow statement in a dynamic way.

2. Discounted Cash Flow (DCF) Model

The discounted cash flow model builds upon the basic three-statement model to determine a startup’s current value. As a result of DCF financial modelling, the partners and investors can determine a company’s equity by adjusting future cash flows to the time value of money.

3. Merger Model (M&A)

An acquisition occurs when one company acquires another. A merger occurs when two companies merge to form a consolidated entity. The merger model provides essential information about an acquisition or merger concerning a startup’s pro forma accretion. It is used to help people understand an acquired or merged company’s overall strengths.

4. Initial Public Offering (IPO) Model

The IPO (Initial Public Offering) is a way for privately held companies to become publicly traded. In addition to providing an overview of how much investors will pay once a company becomes public, this method can help determine whether it is worth going public.

5. Leveraged Buyout (LBO) Model

The leveraged buyout model assesses transactions involving leveraged buyouts when one business acquires another with significant debt. Using cash flow statements, revenues, and liabilities helps identify how debts correlate with cash flow.

6. Sum of the Parts Model

This model identifies a company’s net worth based on the net worth of its units. Business conglomerates use this model for various departments in their companies.

7. Consolidation Model

The consolidation model for companies begins to come together, reduces the number of individual companies, and is a critical stage in the industry life cycle.

8. Budget Model

This type of modelling incorporates a company’s income statement as a reference point and enables startups to develop their annual budgets and analyze economics.

9. Forecasting Model

By analyzing minutes of plans and economic data, a forecast model can help a startup to determine how much it will spend in the future within its budget.

10. Option Pricing Model

Black-Scholes and binomial trees are two examples of option pricing models based entirely on mathematical formulas rather than subjective criteria, making them more or less Excel calculators.

How to build a financial model for a startup

1st Step: Defining the goal of a financial model is essential

When working on the first component of a calculation, one must consider the model’s complexity. Unless one aims to do simple calculations or market sizing, it’s best to keep it simple.

If you’re trying to ascertain how much capital the company will raise, you should include a thorough estimate in your financial model. Before developing the analysis, you must define your target market.

2nd Step: Identify the Startups KPI’s

A new business must track its performance against industry-standard KPIs (Key Performance Indicators), which are easy to track and can be used as a benchmark.

3rd Step: Create a template for your financial model

Business owners can use the many free templates available on the internet to simplify the process of creating financial models.

4th Step: Identify revenue sources and forecast them

Begin at the top of the income statement with revenue. Understand what drives the revenue you will have as you work your way down. Revenue growth depends on several factors, such as customers, salespeople, and marketing activities.

Please note that this will not make sense if your company is a hardware business or a biotech company that needs a long time to reach revenue. Instead, map out the effort you’ll need to reach the critical milestone associated with your product.

5th Step: Identify other expenses and estimate them

As the business grows, you should also add additional expenses similar to those other successful company’s face. Ensure you include expenses in your calculations, as very few companies generate profits before taxes over 50%.

6th Step: Identify the need of additional headcount

The first step to getting the model right is determining how many people will be needed to meet business goals. It would help if you also considered recruiting costs.

Watching out for Startups can be challenging, but the Easebuzz Neo – Smart Business Banking system makes it simple for business owners to manage their finances. Working with our platform, companies can keep an eye on money, deposit checks, and track profits from a single dashboard.

Financial Modelling basics

A Startup’s financial model must include the following elements:

1. Human Resources – to make financial models, determining a startup’s workforce requirements is crucial for estimating the costs associated with recruitment and salaries.

2. Estimated Revenue – to make accurate projections, it is essential to assume reasonable and realistic assumptions.

3. Financial Statements – moreover, it presents a financial picture at the end of the reporting period and a description of a startup’s assets and liabilities.

4. Statement of Income – the financial modelling process starts with determining EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortisation).

5. Cash Flow Statement– the statement clearly shows how much cash is coming in and going out at the end of a particular year.

6. Expenditure on Capital – Expenses for startups include office space, machinery, and software. Examples are software and office equipment.

7. Analysis of Sensitivity – when a company’s operating conditions or assumptions change, analysts can better understand how its values may change.

While creating a financial model, consider these important techniques

Keep these financial modelling techniques are recommended for startups:

  • An effective financial model starts with identifying the problems. For example, a Startup must determine its target audience to develop its target market.
  • It is recommended to limit the number of variables to ensure its viability.
  • It’s important to have well-structured Excel sheets for modelling. A good practice is to color-codes inputs and formulas according to their types
  • If there are complicated formulas, they should be broken apart for clarity.
  • Ask someone else to check and review the financial model to avoid inaccuracies and errors.

When making financial projections for a new business, companies should borrow from characteristics and assumptions used in financial models. It’s a crucial part of financial planning. Start-ups may not feel comfortable using massive accounting teams to deal with financial transactions. As a quick solution, taking advantage of a service with an Easebuzz Neo.

Do financial models need accounting knowledge?

Financial models are difficult to build & understand, which is why most startups prefer to outsource them to third party CA partners.

A growing business in India faces dire problems as it grows, and ends up needing to deal with banks and financial institutions at a high cost. The motive of Easebuzz Neo is to provide businesses with smart business banking and cost-effective solutions.

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The author writes about fintech, banking, and future of SAAS services. He works as an SEO analyst at Easebuzz, so if you're looking for an account that tracks India's fintech scene, you should check out his Easebuzz blog.