Building your financial model is more important than most people think. It isn’t just an exercise to make your board, investors or advisers happy. The model should be directly correlated with your strategy and reflect well thought out assumptions backed by data. It will go through several iterations as the company evolves and gains traction in the market.
An effective financial model should be used as a tool and roadmap to assist in making decisions that are focused around hitting your goals (model assumptions). Whether you need to revamp your current model or build one from scratch, here are a few basic things to keep in mind when doing so.
Don’t Rely Solely on Templates You Find Online: Reviewing other models is fine, but keep in mind that your company will not be an exact match with any model you find online. The one size fits all approach does not apply here. Your revenue and cost of goods drivers will almost always be different (even if you are a SaaS company working off of a SaaS financial model you found on google). It is good to understand how others are building models and get some ideas, but never solely rely on these templates to build a model for your specific company.
Side note: I review a ton of financial models each month, and if you do happen to use a template, make sure you at least change the prior company’s name. I’ve seen several models where the company never even changed the name of the prior company in one of the tabs or summary sheet. Most of the time when I see this, they are complex templates with a ton of tabs and headers and they usually just forget to change the name on one or two headers.
Color Format Your Model: Your financial model is going to go through many iterations and may need input from other people. It is important for them to know what is hard coded, what is a formula and what is cross referenced from another tab/sheet. This keeps the financial model clean and easy to understand. You don’t want someone hardcoding into a formula and causing an error that may become difficult to find once it gets back to you.
Standard Color Codes:
Blue = Hard Coded Numbers
Black = Formulas
Green = References to other tabs/sheets
Present Your Assumption on a Single Tab: If your first tab is a summary, make your second tab your assumptions. Try to put all the assumptions that will drive the model in that one tab. Assumptions that will drive revenue, COGS, OpEx, balance sheet drivers, D&A, etc. Having a model with a single assumptions tab makes it easy to transfer to others and allows the model to flow from a centralize point in the spreadsheet. Having a simple flowing dynamic financial model is the key point here.
Don’t Forget the Balance Sheet & Statement of Cash Flows: The balance sheet and statement of cash flows are an important part of how you operate your business and how you project the inflows and outflows of capital. If you are a technology start-up or early stage company, your B/S and C/F statement may have minimal components, but it is a crucial aspect for you and your investors to understand how much capital you need to raise and how you are best utilizing that capital.
Don’t Over Complicate the Model: Financial models aren’t judged by how many tabs you have or how complex your formulas are. Keep it simple and easy to understand, but thorough enough to accurately tell your company's story with numbers. Quality over quantity. If you send your financial model to an investor they should be able to understand what is driving the model and if it makes sense. This will allow them to understand if the projections are realistic or just smoke and mirrors.
Spoiler Alert: Investors can see through the smoke and mirrors and going from $0 to $50M overnight isn't realistic. As much as it may seem so "easy" from your analysis, you aren't going to go from zero to unicorn overnight.