Most entrepreneurs pay very close attention to current cash flow; fewer have a deep understanding of the current and future financial model for their business. By building a forecast model, you can gain early and lasting insight into how your business really works – both today and for tomorrow.
Many entrepreneurs can tell a story with the best of ’em. The words just flow, and the pictures complement the words. When it comes to numbers, however, some start-up CEOs get lost trying to navigate in a sea of Excel cells. Since most of my clients are in the Washington, DC, area, it could be that the federal government penchant for spending more than it makes is actually contagious, but, more likely, it’s just that entrepreneurs would rather sell or build products than model out how they are going to generate revenues and profits. In truth, there are few things that are more important for an entrepreneur than understanding the numbers that make the business tick.
Modeling Secret Sauce
Here are our secrets to building a useful financial model:
- Include all of the standard information. By standard, I mean:
A Profit & Loss Statement
A Balance Sheet
A Statement of Cash Flow
A Dashboard full of reports that cover key metrics
- Build a long-term model – at least 3 years and more is better. If it’s late in the year, extend the model out an extra year.
- Create logical assumptions. By logical assumptions, I mean things like:
Achievable quotas for salespeople.
Market tested salaries for employees.
Appropriate levels of marketing spending. For example, for software companies, marketing spending tends to be 5 to 7 percent of revenues – or slightly more – when the company exits the start-up phase. The percentage declines some as the company gets bigger.
Accurate projected costs for infrastructure – like data center, rent, and equipment costs.
- Whenever possible, have those assumptions calculate automatically based on revenue growth or some other key factor.
- Imagine how your organization will look in 3 or 5 years, and put that org chart in your model. I like to see cost models with three sections: Go-to-Market, G&A, and Operations & Development. Within each section, you would see a hierarchical organization that starts with the management position at the top and works downward to the most junior position. Note that some of your positions might not be staffed until year 4 or 5, but you’ll get bonus points for realizing that you’ll need that position when your company matures. Here’s an example of what a fully formed sales organization might look like:
VP of Sales
Director of Sales
Senior Account Manager
Director of Pre-Sales
Direct of Telemarketing
- Make sure that your model is readable. Like a business plan or presentation, a financial model is a selling document when you hand it over to bank or outside investors. If you are raising funds, an investor is going to want to review your model without you looking over his shoulder. That means he needs to be able to figure out how it’s built and change the key assumptions to see what happens
Important Final Words
Most importantly, by building a robust forecast model, you’ll be forced to think through the business assumptions that will drive your company in the coming months and years. You’ll see potential pitfalls and opportunities much more clearly, and you’ll also have put your path to scaling into numerical form.
Finally, don’t feel blocked, because you have an allergy to Excel. if you’re not good at modeling, it’s worth paying a “finance-type” to do the job for you. More than likely, you’ll be able to provide the guidance to get the model in the right way.