Financial modelling for startups refers to the process of making financial projections and forecasting earnings and expenses. Businesses make manual data entries in excel as this helps firms determine possible financial outcomes depending on past performances, expenses and revenue assumptions. 

Imagine running a business or a startup and not knowing the expected revenue or financial health for the upcoming months.

It can lead to taking ill-informed decisions like prioritising growth & expansion during an economic slowdown. 

This is where financial modelling comes in. It helps businesses & founders understand their financial status. It is also used by startups to attract potential investors for funding. Bankers, credit analysts, accountants, valuation advisers and research analysts use it to review the financial viability of a business.  

Top Benefits of Using Financial Model for Startups

Here are the reasons why startups need financial modelling:

  • First, financial models present quantifiable data, which is immensely useful in fundraising. 
  • It can attract investors who want to evaluate a company’s financial model before investing.
  • It provides insight into whether an organisation’s ideas are sustainable or not.
  • It also helps in understanding the cash flow needs and revenue of a business. 

8 Most Popular Financial Models Types 

financial model illustration

Now let’s understand how these models are utilised in startups in more detail: 

  • Three-Statement Model

It is the most basic type of financial modelling and links up three financial statements which are: balance sheet, income statement and cash flow statement. The three-statement model acts as a base for other financial models. 

  • Budget Model

It falls under the reporting model classification and can be used for planning a startup’s annual budget and economic analysis. This type of modelling relies heavily on a company’s income statement and uses it as a reference point. 

  • Forecasting Model

The forecast model makes cost predictions within a company’s budget with the help of minute planning and economic analysis. As a result, it can help a startup to determine its future expenses. For example, it can provide an idea about the costs associated with producing a product or service. 

  • Merger Model

When two companies collaborate to form a consolidated entity, it is known as a merger. When one company acquires another, it is known as an acquisition.

A merger model provides valuable inputs about a startup’s pro forma accretion when there are talks of an acquisition or merger. This type of financial modelling helps people understand the overall capacity of a company merging with another business. 

  • Discounted Cash Flow Model

A discounted cash flow (DCF) model helps to determine a startup’s current net value by building upon the basic three-statement model. It adjusts future cash flow to the time value of money to arrive at a company’s present value. DCF financial modelling allows the partners and investors to evaluate a business’s total equity. 

  • Sum of the Parts Model 

SOTP (Sum of the Parts) model helps to determine the net worth of individual units of a company. Business conglomerates commonly use it with various business units in different industries. 

  • Initial Public Offering Model

A privately held company becomes public when its stocks are offered on the stock exchange in the form of IPO (Initial Public Offering). A company and investors can use this method to determine its value before going public. This financial model provides an overview of how much investors will pay once it becomes public. 

  • Leveraged Buyout Model 

When one company acquires another company using significant debt, it is known as a leveraged buyout. This model is used to assess the transactions of a leveraged buyout. It utilises cash flow statements, revenue and liability to understand better the connection between a company’s debt and cash flow. 

How to create a sound Financial Model for Startups? 

Listed below are the necessary steps required to create a financial model: 

Step 1: Define the goal of the Financial Model

In the first step, one must determine how complicated their model would be. It needs to be less complicated if one aims to do back-of-the-envelope estimates or market sizing.

If the financial model aims to raise capital, it needs to be detailed enough to show that the business owner has a clear idea about the market. A detailed analysis is a prerequisite for formulating an accurate financial model.

Step 2: Understand the KPIs of the startup

New businesses need to use industry-standard KPIs (Key Performance Indicators) as a reference point. These are numerical factors that are easy to track. Therefore, businesses must regularly track their performance against these KPIs.

Step 3: Use a Financial Model template 

Creating a financial model can be time-consuming. To make financial modelling easier, businesses can choose from the many free templates available on the internet. 

Step 4: Start with revenue forecasting 

Here startups need to analyse what will drive revenue for their businesses. Business owners need to analyse the number of users, marketing activities and cost of products. Product development milestones provide a clearer picture for businesses dealing with hardware or biotech. 

Step 5: Analyse headcount needs

An important step to get the model right is to properly analyse the number of people required to meet business goals. Recruiting costs are another aspect that needs to be considered. 

Setting up a new venture is always a challenge. But RazorpayX is here to make the job of business owners easier. Our platform enables a startup to manage and control its finances from a single intuitive dashboard easily. We will explore that in a while. But first, let us look at the different elements of financial modelling

Crucial Elements of a Financial Model 

Detailed below are crucial elements of financial modelling for startups:

  • Human Resource: The costs associated with new recruitment and salaries of existing employees come under the purview of ‘human resource’. This is why figuring out the workforce requirements of a startup is essential for making financial models.
  • Revenue Assumptions: This is the money that a startup hopes to generate. Reasonable and realistic assumptions are required to drive accurate projections. 
  • Balance Sheet: It presents details of the assets and liabilities of a startup. In addition, it presents a picture of a company’s financial position at the end of the reporting period. 
  • Income Statement: It is an integral element of the financial modelling process. For accuracy, one must first determine the EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortisation). 
  • Cash Flow Statement: It helps to understand a company’s cash and bank balance at the end of a particular year. It provides a clear picture of the cash coming in and going out. 
  • Capital Expenditure: It is the expenses necessary for purchasing physical assets. Examples of expenses of a startup include software, office spaces and machinery. 
  • Sensitivity Analysis: This element helps analysts understand how the values may change if a company’s operating conditions or assumptions change.

Important pointers to keep in mind while creating Financial Model

Here are some vital points that should be kept in mind while creating a sound model for startups:

  • Determining the main problems help in building effective financial models. For example, a startup needs to first determine its target users before making any plans.
  • According to experts, limiting the number of variables helps in ensuring its viability. 
  • Excel sheets used for modelling should be well structured. Pro tip: Use mindful colour-coding for different inputs and formulas. 
  • The formulas for calculations should be as simple as possible. Also, providing the break-up of complex formulas is necessary for clarity. 
  • Recheck the formulas to avoid inaccuracies and errors. If possible, ask someone else to check and review the financial model. 

Today, financial modelling is an integral part of any new business and not without reason. It is a crucial element in making financial projections and forecasting revenue. Startups generally do not have large teams to deal with finances. So, they can consider taking help from RazorpayX, which is a one-stop banking solutions provider.

Is accounting knowledge required for Financial Modelling?

Creating & understanding a financial model is difficult and most founders find it easier to outsource this task to their CA partners.

RazorpayX was built precisely with the aim to help founders focus on scaling their businesses while we create simple, innovative & beautiful products that take care of all aspects of money movement.

RazorpayX- Banking made awesome for startups

Let us look at the key benefits of RazorpayX for startups: 

  • This neo-banking platform offers a supercharged current account that can schedule payments in single clicks, auto-read invoices and give detailed financial reports from a single intuitive dashboard. 
  • It comes with a host of benefits such as seamless integration of accounting software such as Tally, 3-click payroll processing, a corporate credit card with 3x higher limit than traditional corporate cards, bulk payouts among other services.

Explore RazorpayX

FAQs

1. Which type of data do most financial models begin with?

Financial models begin with the entry of past financial statements in a company. Generally, analysts consider the historical data of the previous 3 – 5 years.

2. How long does it take to build a financial model?

It might take more than three weeks to complete a financial model. This is because the process requires precision and double-checking.

3. What are the most popular financial modelling tools?

Financial tools are skills, elements and information that help analysts build financial models. Analysts need to make these tools using their knowledge of Microsoft Excel, decision-making skill set and colour formatting knowledge.

4. Is financial forecasting different from financial modelling?

Though there are similarities between them, there are crucial differences as well. For example, while financial modelling forecasts revenue and makes projections, financial forecasting represents a business's cash flow for a particular time frame.

5. What are the prospects after doing a financial modelling course?

After completing a financial modelling course, students can work as investment bankers, equity research analysts, financial analysts, directors and managers.

    Liked this article? Subscribe to our weekly newsletter for more.


    Avatar
    Author Kanika Singh

    Write A Comment