“A financial model is a tool you’ll use on a regular basis to support decision making.” These are words we all know are true, but don’t necessarily want to hear. Finances certainly aren’t our strongest suit, or our favorite area of the business to focus on, or the reason why we start companies.
But having a sound financial model in place is critical to the success of your business.
That’s why we talked to Tom Gabbert, founder of mAccounting, and Santiago Jaramillo, co-founder & CEO of Emplify, in this week’s episode of the Powderkeg podcast. The two are experts in startup finances, and together they explained why it’s essential to create a detailed financial model for your startup:
Making Day-to-Day Decisions
A financial model isn’t just a collection of numbers that sit in a spreadsheet on your laptop. Used correctly, it’s a tool you should utilize on a regular basis to support decision making.
“If you’ve constructed it right, you’re going to have your variables isolated, and you’re going to be able to do some ‘what ifs’ to understand the key drivers of the business,” Gabbert said.
Maintaining a detailed account of your assets and liabilities will allow you to utilize this data to make sound fiscal decisions. Have you been cash flow positive for several months? Maybe you can start to think about hiring additional employees or acquiring debt. Running in the red? You should probably hold off on any unnecessary expenses until you can increase your profit margins.
Grounding Your Expectations in Reality
Entrepreneurs tend to be an optimistic bunch, and they can sometimes get carried away envisioning the world-changing potential of their companies. Sitting down and working out your financial model will help you develop a more realistic—and more achievable—plan for your business.
“When you really dig into the details and start laying out the team, the sales effort and the operational support it’s going to take, all of a sudden it seems like much more of a daunting task. It’s that detailed level of planning that helps you put a reasonable plan in place,” Gabbert said.
Identifying the business realities you need to address will temper unrealistic expectations of overnight success.
Predicting the Future
Your financial model will not only help you make short-term operational decisions, but it will also help you predict long term consequences of the actions you take right now.
“Say you’re thinking about going down a particular path. You can model it out and see what that future is going to look like, then compare it against another path and forecast twelve months down the road. You’re able to almost create two futures and compare them to each other,” Jaramillo said.
Maybe you have enough money to hire one new salesperson or one new marketer, but not both. If you know how much money you’ll need to pay each person and how much they’ll each earn for your company, you can project with reasonable certainty which hire will be more beneficial for your business in the long run, which will help you make the best possible decision.
Any investor who’s considering buying into your company will want to feel confident they’re betting on a winner. You can help put their mind at ease by showing that you have a detailed and well thought-out financial model.
“Making sure your financial statements are in good shape, you have financial projections, you have a dashboard with KPIs—it’s credibility building, first and foremost. It’s a big deal to [an investor] because it tells them this is a well-run company,” Gabbert said.
Investors will ask hard questions about your finances to see if you’ve considered a number of contingencies. Being familiar with your model will help you respond confidently to these kinds of questions and allow you to give accurate growth projections.
Creating and maintaining a robust financial model should be high on your list of priorities. It will empower you to make better-informed decisions with greater certainty about the outcomes and attract more people to your mission. That means you’ll be able to earn more money, serve more customers and make a bigger impact on the world.