Creating a financial model might seem daunting at first, but getting a handle on your startup’s financial health is a game-changer. It helps you make informed decisions and, just as importantly, demonstrates to investors that you know your business inside and out.
In this guide, we’ll take you through the essentials of building a financial model—covering revenue projections, costs, and profitability—so you can set your startup on a solid path to growth.
What is a Financial Model?
A financial model is a powerful tool that helps you understand your business’s financial future. At its core, it’s a spreadsheet—typically built in Microsoft Excel—that allows you to project how your business might perform financially based on certain assumptions. It combines accounting, finance, and key business metrics to create a forecast that answers critical questions about profitability, growth, and sustainability.
Think of a financial model as your business’s blueprint for financial health. It starts with preparing essential reports like the income statement, balance sheet, and cash flow statement—together known as the three-statement model.
The real value lies in how these models help you anticipate challenges, make strategic decisions, and demonstrate to investors that your plans are built on solid financial logic. Whether you’re forecasting sales for a new product or assessing the impact of a market shift, a financial model helps turn your ideas into a reliable plan for the future.
How to Build a Financial Model in 6 Steps
Building a financial model is an essential skill for founders, CFOs, investors, and anyone managing a company’s financial operations. A well-constructed financial model is your blueprint for projecting the future, evaluating company value, and making informed decisions.
Here are six easy steps to build a reliable financial model:
1. Gather Historical Data
A solid financial model starts with accurate historical data. Gather at least three years of financial records, including income statements, balance sheets, and cash flow statements. This data forms the backbone of your model, helping you understand past performance and establish a reliable basis for forecasting future outcomes.
2. Calculate Ratios and Metrics
With historical data in hand, calculate key financial ratios and metrics. Focus on profitability ratios like gross margins, growth rates, and asset turnover ratios, as well as operational metrics like inventory changes. These calculations are crucial—they reveal performance patterns that will guide your future projections.
3. Make Informed Assumptions
Next, use your historical data and metrics to make well-grounded assumptions about future performance. This includes growth rates, cost trends, asset usage, and market conditions. For instance, you might forecast revenue growth based on past trends or maintain consistent asset turnover ratios if efficiency is expected to stay steady. These assumptions are the heart of your model—they shape how you project financial performance going forward.
4. Create a Forecast
Now, use these assumptions to forecast key financial statements, including the income statement, balance sheet, and cash flow statement. Apply the historical relationships and ratios to your forecasts, always aligning them with the assumptions you’ve developed. Your goal here is to create realistic projections that reflect the company’s expected performance, allowing for adjustments as needed.
5. Value the Company
With your forecast in place, it’s time to value the company. One widely used approach is the Discounted Cash Flow (DCF) analysis, where you estimate the present value of future cash flows. Discount these cash flows back to today’s value using a discount rate that represents the company’s cost of capital. This step helps you understand the company’s intrinsic value based on its projected future performance.
6. Review and Refine
Finally, review your financial model for accuracy and consistency. Put your model through its paces by running different scenarios—best case, worst case, and most likely outcomes. This helps you understand how changes in key assumptions affect results and highlights potential risks. Refine your model as needed to ensure it remains a realistic and dependable tool for decision-making.
A solid financial model is a strategic tool for understanding a company’s potential. By following these steps, you’ll create a model that drives smart decisions, supports business strategies, and gives stakeholders clear insights into opportunities and challenges.
Is Your Startup Profitable Yet?
Once you’ve mapped out your revenue, the next step is to determine whether your startup is profitable. Start by listing all your costs, both fixed and variable.
Fixed Costs
These are your ongoing expenses, like rent, salaries, and software tools. These costs are steady, no matter how much product you sell. Think office rent, employee wages, insurance, and subscriptions—expenses that don’t fluctuate much as your business scales.
Variable Costs
These are costs that change depending on your sales volume, like production costs, shipping, and transaction fees. The more you sell, the higher these costs go. They’re directly tied to each product or service sold, so they’ll scale as your business grows.
→ To calculate profitability, subtract both your fixed and variable costs from your projected revenue.
This gives you an idea of whether you’re making a profit or running at a loss. If you’re in profit, you’re on the right track to scale up. If not, here are some strategies to get you there:
- Cut Unnecessary Expenses: Take a hard look at your fixed and variable costs. Are there any tools or services you can do without? Can you renegotiate contracts with suppliers to get better rates?
- Increase Your Prices: If your market research supports it, a slight price increase could help boost your profitability. Just be careful—ensure your pricing stays competitive and delivers value for your customers.
- Boost Sales Volume: Bringing in more customers or getting existing customers to buy more can help you cover fixed costs faster. Think about new marketing campaigns, promotions, or loyalty programs that can help increase sales.
- Refine Your Business Model: Is there a different approach that might make more sense for your business? Maybe a subscription model or additional revenue streams could make your startup more resilient and profitable in the long run.
Profitability is all about balancing expenses and income while keeping growth goals in focus. It’s completely normal for early-stage startups to need time to reach profitability. The important thing is to know your numbers and have a steady plan to get there.
Venture Backed’s Quick Tips for Your Financial Model
At Venture Backed, we’ve worked with countless startups, and we know the challenges you face. Here’s our advice for getting your financial model off to a great start:
Start Small, Think Big
We know it can be tempting to overcomplicate things immediately, but trust us—start with the essentials. Keep it simple when you’re just starting out, and focus on what matters most: revenue, costs, and basic profitability. The idea is to lay a strong foundation and then build upon it as your business evolves. Remember, your model will grow with you as your startup scales up. Start with what you know and make sure it’s rock solid before adding layers of complexity.
Adapt as You Grow
Your startup will evolve, and so should your financial model. Don’t be afraid to update your projections as your business changes. Flexibility is key. Don’t be afraid to make changes—it’s a sign that you’re responding to real-world feedback and adjusting your course. Whether you’re adding a new product line, seeing unexpected growth, or facing challenges, adapting your financial model keeps your plans relevant and grounded in reality.
Show Your Work
Investors want to see that you’ve thought things through. A clear, compelling financial model demonstrates your understanding of the business. Make it data-driven, but make it easy for anyone to follow. Show your work, and make your numbers tell your story.
Curious to Learn More?
Building a financial model is an essential step in understanding your startup’s path to success. At Venture Backed, we’re here to help founders like you take control of your business’s financial future.
Ready to get the support your startup needs? Join our Pre-Launch Founder Community today. You’ll have access to helpful resources tailored just for startups working on their financial models. Plus, connect with experienced mentors and like-minded founders who understand what you’re going through.
Get exclusive perks from our partners like HubSpot, Zendesk, QuickBooks, and together, let’s help you hit that next big milestone. Be part of something bigger—join today and start scaling.
