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Content Outline
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This section is by far the most advanced content contained in this curriculum. Financial modeling is a skill that will serve you well throughout your career as an entrepreneur, but it takes time to learn properly.
The guide below will walk you through the basic steps of building a financial model, providing examples and sample formulas along the way. Additionally, there is a sample financial model linked in the worksheets, so that you can see many of these steps in action. But largely, most of the work for this section will be up to you to complete.
You should never just copy a template when building a financial model. One core purpose of this exercise is to allow you to understand how the different aspects of your business financially interact with each other, which is key knowledge to have in order to be successful, and knowledge you only truly get if you build your model from the ground up.
Take this section step-by-step, writing down your thoughts in the Financial Model Basics worksheet or on a scrap sheet of paper. Only when you have a firm grasp on all of the different sections, assumptions, and equations should you translate it into a spreadsheet. It might help to go through the curriculum again when you get to that point.
There are additional resources - including other templates - linked at the bottom of this section. If you need help at any time, don't hesitate to ask a strategic advisor or accelerator mentor.
This section is the most dense and complicated part of this curriculum. Correctly building a financial model is going to take many hours, and a ton of trial and error. So why deal with it?
Financial models serve three purposes:
What's the difference between financial models and financial projections?
Financial projections are typically just guesses. Most people approach financial projections by starting with an arbitrary revenue or cost number, and then multiplying it by some % growth rate to get the numbers for next year. This is not how business works, and startups making financial projections in this manner is largely why no one takes projections seriously.
Financial models produce financial projections, but do so in a more robust and rigorous way. By breaking down your business into a series of assumptions, you can more accurately predict how different decisions will impact your bottom line. Many people still disregard financial models because it's hard to get any of the assumptions right, but at least you have the infrastructure to make accurate projections in place. As you mature, you begin to fill in unknown assumptions with known values, and your model gets more accurate.
At the very least, making a financial model will help you understand how business works. Commerce is a complex interplay of revenue, costs, and unexpected variables - building a financial model will at least get you to appreciate - and anticipate - those nuances.
Since financial models are complicated, we're going to be using a single example company through this entire section.
Introducing: ShakeU - the world's first direct to consumer milkshake company.
ShakeU has revolutionized the milkshake industry by inventing a shake that doesn't melt - no matter how long it festers in the sun. This allows them to send milkshakes to anyone who wants them, anywhere.
Even though ShakeU is just getting started, the founders are super excited about the potential of their technology. Here's their planned lineup:
Even though the written examples will be ShakeU based, many screenshots come from the financial model of a sample software company, so you can see how the items vary between different company types. This sample financial model is linked in the worksheet for your reference. All external references are cited, otherwise assume they are created internally.
The end goal of a financial model is often a simple 5-year income statement. All of the formulas that we build will be based around calculating values in an income statement, so it's important that you know what an income statement is - if you're already familiar, skip this section. Re
Income statements show the activity of a business over a period of time. That time can be one year, one month, or one minute. The purpose of an income statement is to calculate net income.
Income statements start with sales, or all of the money you brought in over that period. The combined sales from all verticals is net revenue. Immediately, cost of goods sold is subtracted away, to get gross profit.
Then, you tally up all of your operating expenses, and subtract those from gross profit in order to get your operating income.
Then, you tally gains and losses, also called non-operating items. Gains are money coming in that are not related to your core business - like earning interest revenue. Losses are money going out that are not related to your core business - like the cost of a one-off lawsuit. At this stage, you likely won't have many non-operating items.
By subtracting your non-operating gains/losses from your operating income, you get earnings before tax (not shown). Then, after subtracting taxes, you get net income.
If this isn't totally clear, read this primer.
Understanding the Income Statement
Financial projections are 5-year income statements. Financial models help you make these projections. The numbers that you put in your slide deck to summarize your revenue are just the numbers spit out by your 5-year income statement projections.
Sidenote:
With high-growth startups, the focus of financial projections is often net revenue, instead of gross profit. This is only looking at the money coming in, and not taking into account any of the expenses.
This helps explain why you often hear companies like Uber are not profitable. They are bringing in a ton of revenue, but are spending a ton more on COGS and operating expenses. That's the entire point of the high-growth startup model: at any cost, just grow.
Financial Modeling, Citation 1 (Link)
Financial Modeling, Citation 2 (Link)
Ideally, eventually you capture enough of the market that you can stop spending so much on operating (where marketing, customer acquisition, R&D costs go), and then you become profitable. Very often, this doesn't happen, and the startup fails. This is often why traditional finance snubs the startup and VC world - in traditional finance, profitability matters.