Updated: Feb 14, 2019
A financial model is a translation of your business plan into numbers; this can represent your operating budget, your current forecast or your five year plan.
The financial model represents an understanding of your business model and the economics which drives your sales, expenses and ultimately your profits.
Your revenues are typically driven by both price and quantity - how much would you sell it for and how many.
Determine what type of business model you will use to make sales:
Determine your Customer:
Business to Business (B2B)
More willing to pay for a product or service.
The size of the order is larger than single consumer.
Making a sale is much more time consuming.
Difficulty getting in front of decision maker.
Business to Consumer (B2C)
The Market is more accessible.
The potential pool of customers is endless.
Individual people generally do not want to pay.
Consumers are much more price sensitive than businesses.
Variable Costs and Contribution Margin
For each quantity sold there is also a cost associated, this is called a variable cost. The selling price minus the variable cost is considered the contribution margin.
For Internet based businesses, there are costs associated to the amount of traffic to their site since Internet service providers will charge for additional bandwidth usage.
For manufacturing businesses, raw materials would be variable to the units they produce and sell.
Fixed Costs are costs that do not increase relative to the unit economics of the business. As the quantity of sales increases, the contribution margins will cover the fixed costs eventually surpassing the break even point and achieving a positive net profit margin.
Selling and General Administrative
Your business will also have fixed costs; these are costs that do not necessarily increase as the quantity of production increases. Fixed costs typically would include your office rent, utilities and other general and administrative costs.
Payroll is the largest cost item to most businesses. Growth in revenues cannot be achieved without growth in labor force. Ensure that your revenue forecasts align with the growth of your team.
Capital expenditures will be your the plant, properties and equipment required for your business to build and sell it's products.
The J Curve
The most popular trajectory of a startup's forecast is the "J" curve. This curve is popular because it is a realistic representation of the early life cycle of a startup business.
You have an idea for a service or product, the downward curve represents resources spent taking the idea and producing a prototype. At this point you still have not gone to market yet.
You take your prototype and test the market. This product is not fully ready for the market; it doesn't quite have the features that the people want or it may have defects at its current state.
If you aren't able to learn from this experience - this is where your business dies.
You've fallen, but you're not down for the count. This is a rebuilding phase, you take what you learned from your first go-to-market and you re-create your product.
This is the product or service re-created from your early pains, it is now a market fit and the people are using your product.
Orders are coming in fast and your business is growing. You begin to build on your organization structure, hire new people and refine your business model.
Reap the benefits of your hard work, you may find an exit here through selling your business or going public - an IPO.
This entire process would need to be mapped out in Microsoft Excel or other spreadsheet software and It would require a strong understanding of the three financial statements. We at GFT have the ability to help you prepare your startup's financial model.
Please feel free to contact us.