What Is A Financial Model

Today a financial model consisting of a simple income statement is unacceptable. Cash management is essential from the onset and an investor needs to see evidence that the company has built a fully integrated financial model before investing. This should be a fully integrated income statement, balance sheet and cash flow statement, extending out 3-5 years. It should be dynamic, that is, if certain variables are changed, the effect flows through the entire model so that it does not have to be rebuilt each time the assumptions are changed. Very early stage companies may not need a fully integrated model but all companies will eventually require one, not just to evaluate the investment proposal, but to manage and plan for the company’s cash needs going forward.

“Your financial model has to be dynamic.” 

Cash planning is very important – It may sound hard to believe, but companies have gone out of business because they were too successful and could not meet the working capital needs of the business. A good financial model that is developed to raise capital can be adapted to forecast the cash needs of the business going forward, and enable it to see when it will need to raise the next round of funding.

Who should do the financial modeling? Later stage companies should have a CFO or competent controller able to model. Early stage companies may not have such a financial executive and may want to hire someone to do this. Accounting firms offer this service but expect to pay $15,000 or more, and it may take 2-3 months before it is fully functioning. There are a handful of capable consultants that specialize in doing this, quickly and competently, for $5,000-7,000. If you can possibly contract it out to a consultant, do so, because they know how to incorporate the bells and whistles that go well beyond what you thought you knew about Excel, and it will look more professional and not contain the circular references and other errors that you could spend hours trying to resolve. We use a consultant and can recommend him. He is fast, reasonably priced, and creates models that can be used for fundraising and then used to forecast the cash needs of the business on an ongoing basis.

A venture investor will typically build their own financial model for the company or they may use yours and vary the assumptions. For starters they will ratchet down your sales forecast to a level they believe achievable. This Forecast may drive their own valuation model from which they will calculate how much of a return they expect to receive if they make a certain investment.