Bursts of Color - Financial Modeling 101
Last week I appreciated reading Making a financial model for your early-stage startup?, a post from Roy Bahat at Bloomberg Beta. Lots of good advice in here, especially for those at the pre-seed or seed stage.
I too have spent much time with models over the years, and am a big believer in their importance for every startup. Here are ten suggestions for what to do (and not) with your model:
Recognize that the model (which is forward-looking and high-level) is separate from your accounting statements (which are backward-looking and detailed).
The CEO should generally own the model, or at least understand its workings intimately. Do not outsource the model to an outside accountant (see point #1).
Focus the model on major drivers of revenue and expense. 20-30 rows of a spreadsheet are usually plenty in the early days; don't lose the plot by trying to detail every $15 expense.
Always include cash balance as the last row. Cash is oxygen to a startup, so hiding the balance from ourselves or others is a red flag.
Clearly label the input (assumption) cells differently from the output (calculated) cells to avoid confusion going forward.
Think carefully about what drives revenue, and select those assumptions accordingly... avoiding shortcuts like standard monthly growth rates, which are usually unrealistic and imply that we don't really understand what drives the business.
Ask a friend or investor to help you apply the "smell test" to both inputs and outputs to avoid things that look unlikely (e.g., Eng team grows from 3 to 10 in one month).
Allow the model to live and breath: update it each month with the actual results, and then learn from any items where your forecast was wrong.
Be prepared to share the same model with insiders and potential investors; by refreshing it monthly, you ensure that it's always relevant.
As the company grows and becomes more complex, the model should too. Once you get to significant revenue, you may even wish to have a second, different model (and modeler) to provide a sort of "second opinion" forecast.