Anshul Sharan Co-Founder & CEO Elever An IIT & IIM alumnus having 14+ years of diversified experience in strategy, product, risk, and operations, Anshul leads the Elever team towards its vision of improving a customer’s lifestyle by creating an affordable and personalized goal-based investment app. Anshul loves to work on solutions that impact the masses both directly and indirectly. From his personal life experiences and also going through experiences of his friends/family and peers, he realized that there are no affordable, unbiased, and personalized advisory services available to help people achieve their financial goals and improve their lifestyle. This realization acted as a catalyst to start his latest venture – Elever.
We have heard stories of start-ups getting funding based on an idea, but a start-up receives funding based on how well they communicate their story. There are various ways to communicate, and the financial model is one of the important ones. The best part of a financial model is that you can use it to share your story even without having significant operational history. A case in point is early-stage start-ups.
A section of people says that these financial models are excel-based plans that are far from reality. I agree with it because it depends on the purpose of building one. So, unless and until there is a clearly defined purpose like fundraising, customer acquisition, organic/inorganic growth, etc., these plans will be like a castle in the air. But the short answer to the question is, “Yes, the financial model does matter.”
Importance
There are fundamentally 3 important reasons for having a financial model. They are:
- Fundraising: As discussed earlier, financial models play a key role in raising funds. Every investor looks at a start-up’s financial model from a different perspective. It can be to understand the founders/executive team’s thought process, the company’s objective to build a financial model, its growth strategy, its hiring plan, its financial health, etc. But the bottom line is that for most investors, the financial model plays a significant role in decision making.
- Hiring plan: A good financial model helps strategize a hiring plan based on both the short-term and long-term objectives of both organization and individual functions. Without a financial model, an organization may not be able to prioritize various positions to be filled, resulting in cost over-run, attrition, etc.
- Financial health: Financial models are important to understand a company’s potential financial health. It helps to visualize the impact of strategies on its financial health. It will support different stakeholders like the Board of Directors, Investors, Financing Institutions, etc., to make strategic decisions. Without a financial model, there won’t be any control over various operational aspects.
Factors
Having understood the importance, let’s try to understand what it takes to build a good robust financial model.
- Core Objective: Every financial model has a specific objective. It can be for raising funds, planning hiring, go-to-market strategy, organic/inorganic growth, etc. Without a core objective, financial models are considered unreliable. Even the assumptions/hypothesis one uses to build a financial model have no meaning.
- Bottom-up vs. top-down approach: Top-down approach is relatively easy to make, as one needs to have a high-level target like market share, customer growth, etc., and then create detailed projections. However, the drawback is that these targets are generally far from reality. And therefore, the projections lack reliability. On the other hand, the bottom-up approach will use assumptions from the ground reality of business and then build forecasts accordingly. It ensures that the projections are reliable. Generally, investors prefer bottom-up projections, as it indicates how much founders know about their ground reality and what they will do to achieve their overall objective.
- Assumptions: A good financial model is as good as its assumptions. Therefore, it’s critical to be extra careful to determine the assumptions/hypothesis that needs validation. One also needs to understand the ground realities before coming up with assumptions. Another important aspect is that assumptions should align with the core objective. We should not use assumptions that have no meaning to the core objective.
- Outputs: There are two must-have outputs from a financial model. They are financial statements, especially cash-flow statements, and key metrics. Financial statements go a long way in showcasing the overall health of a business. Equally important are key metrics, as it helps investors understand the key drivers that will impact your business. E.g., a good model won’t just showcase projected revenue growth; it will look at how things like customer growth, customer churn, cash burn, etc., work together to contribute to that top-line number.
- Flexibility: It’s a must to ensure that the financial model is flexible and can give outputs for a varied range of assumptions. It means that assumptions should not be hard-coded. One should create your assumptions so that you can easily change an assumption in one place, and all formulas and outputs will recalculate automatically.
Conclusion
Financial models play a crucial role in the significant discussions you have about your business with all of your key stakeholders. Therefore, a comprehensive financial model will have several different pieces relevant to different conversations within your company.
If you have taken the time to prepare your assumptions around your business’s future thoughtfully, your most important conversations will be more productive.
Without having a robust financial model, it’s like meandering in the sea without knowing the end destination. And we all know what happens next.