Financial models, or plans, are as important as business models. These two entities are the yin and the yang to solidifying a solid startup structure. In this article and the corresponding video, we discuss five of the best practices for building a robust financial model:
Best Practice #1: Be Conservative in Your Projections
Entrepreneurs are filled with wonderful characteristics that facilitate their drive to succeed. They are risk takers, critical thinkers, and problem solvers. Naturally, these traits call for a certain degree of optimism and self-confidence.
Yet, when it comes to building a financial model, there is such a thing as being too optimistic. The solution is easier said than done, though, because it involves checking the startup’s ego at the door; at least, for a little while. When building a financial plan, it is better to set expectations low. By being conservative in your predictions, it makes it easier to meet and hopefully exceed those goals.
Best Practice #2: Simplify Complex Business Scenarios
Recognizing there is a cornucopia of legs crawling out of a single portion of a startup plan, simplicity is achievable. This might not be easy but really, what part of building a business is easy? Adding too many assumptions to a financial model makes it unreliable. By identifying as few essential drivers as possible, entrepreneurs are saving themselves and their potential investors a massive headache. Remember, everything in business is an elevator pitch. That includes laying out financial models. Keeping it short and sweet will keep an investor’s attention and will a produce a plan you can easily follow.
Best Practice #3: Represent the Fundamentals of the Business Model
This best practice is where the financial and the business models meet. The financial model is a quantitative representation of the business model. This is the startup’s chance to showcase the financial impact of the monetization strategies as they relate to the business model and to estimate all the costs required to bring those strategies to fruition.
Best Practice #4: Do Not Set Your Goals Too Low
While being too optimistic is dangerous, it is equally as bad to purposefully undervalue yourself or your idea. Therefore, being realistic is key to finding that middle ground. Cheapening your vision to play safe only means that you can’t compete effectively with other startups and your company becomes an unattractive investment.
Often, women entrepreneurs are the most egregious offenders; as they often settle for what they believe is the sure thing, which ends up causing them to fail.
Best Practice #5: Keep it Logical
Creating a logical representation of a business model produces credible financials. Even if the inputs, or assumptions, to a financial model change, as long as the underlying logic is correct, it will be easy to see the financial impact of a new strategy.
Creating a thorough and credible financial model is not easy. Fortunately, these five best practices will lay the essential groundwork for success. Course # 2 on Financial Modeling of Early Stage Software and Service Startups delves deeper into this topic.
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