What Is Financial Modeling?

A financial model is a mathematical representation of how a company works. It is used to forecast the business’ financial performance, 提供了方向, 和 give context to uncertainty, 和 creating one of these models is financial modeling. Imagine the model as a machine: We insert fuel in the form of assumptions, such as salaries 和 customer acquisition costs, which produces the output regarding projections 公司的’s performance (e.g., future revenues 和 cash flows). Deciding which assumptions to use 和 underst和ing how to project accurately can be a difficult undertaking, although it’s well worth the cost, as sophisticated models end up serving as powerful decision-making 和 forecasting tools for management. 为什么 else is modeling important? What are the different types of financial models, 和 how do we go about financial model building?

为什么 Is Financial Modeling so Important?

的 possibility of a financial model’s outputs perfectly matching reality is very low. 毕竟, financial models are based upon a narrow set of assumptions from a range of possible inputs. With so much uncertainty, why should business owners bother themselves with building a financial model? And why do 投资ors care so much about it?

Improved finance skills can lead to significantly increased opportunities of 成功 和 thus founders should 投资 in improving these skills. 的re are several reasons why founders should devote significant resources to building their model, which can be perceived as a manifestation of finance skills. Two of these reasons include:

• A financial model gives direction on where the company is going. 换句话说, it can reveal the main business drivers 和, in the case of significant deviation, provides insight on where the company should focus in order to manage or hedge risks.

• It is a strong indication to 投资ors that the founders know what they are doing 和 that they underst和 the business.  的 various assumptions 和 reasoning behind the financial model demonstrate whether the founders are reasonable thinkers or 不, meanwhile providing a necessary tool for the company’s 估值.

基于这些原因， 管理人员应该 不 just try to find a readily available financial model template to fill out. A template can provide an idea of how a model is built 和 indications of missing elements, but no more than this. 毕竟, a financial model template represents a different business with different needs 和 characteristics. Instead, a proper financial model should be built from scratch. Custom models show that founders underst和 the nuances of their business 和 should demonstrate sharp business acumen. Given that the financial model is the analytical tool driving many of the projections 和 outputs in 投资or presentations, 一个体格健美的, sophisticated financial model increases 投资or confidence 和 the possibility of receiving funding. Thus, it can be a great 投资ment to cooperate with a top financial modeling 专家 that can help you to create a robust model 和 help you manage 和 fully underst和 it.

Financial Modeling Basics

Prior to building your model, it is first important to select what type of model fits your needs most closely.

Main Financial Forecast Methods

的re are two main methods to build a startup financial model: 自顶向下 和 自底向上.

自顶向下

In a top-down approach, we start with the big picture 和 then work backwards; we define the milestones that we need to achieve in order to reach the target. 例如, if we have a mobile nutrition startup, we begin by saying that the market in 2017 is worth $27 billion 和 from starting at zero, 到第二年, we will capture 7% of it. 以这种方式, we just defined the revenue 和 then we calculated the costs associated with this target 和 so on.

自底向上

另一方面, in a bottom-up approach, we start with basic assumptions (e.g., sales people needed 和 the cost thereof, attractiveness of our business, traffic) in order to build the financial model. Subsequently, we can create scenarios in order to check how the assumptions have to change (e.g., how many more salespeople we need) in order to achieve our goals.

Which Approach Should We Take?

A top-down approach, particularly in the case of a startup, can be rather opaque 和 based upon subjective, overly-optimistic predictions or even desires. This can put more 价值 on a bottom-up approach towards leading to a better underst和ing of the model. 另一方面, the top-down approach can ignore today’s situation 和 provide useful inputs regarding milestones to be achieved.  Thus, for financial modeling purposes, the bottom-up approach can give a more structured, realistic perspective, which can be complemented from a strategic perspective with some top-down analysis.

How to Build a Financial Model 和 What We Should Be Aware of

One you have decided upon the type of model to build, you should make sure that you develop an underst和ing of all the component parts that go into constructing a fully dynamic financial model.

A financial model has two main parts; the assumptions (input) 和 the three financial statements (output), namely 损益表, 资产负债表, 和 cash flow statement. Based on the individual company’s needs, more parts can be added, such as sources 和 allocation of capital, 估值, 和 sensitivity analysis (outputs based on different scenarios). Let’s have a look at the main characteristics of each of them, along with some examples of a financial model’s components:

No. 1: Assumptions 和 Drivers

This should be the first tab in a spreadsheet 和 contain variables that will be used in the other tabs. 在理想的情况下, the rest of the tabs should have no manual input 和 every single number will be sourced 和 calculated from the assumptions tab.

的 assumptions are unique to each business 和 include relevant topics of the business such as revenues (e.g., growth rate), costs (e.g., salaries), 和 capital (e.g.，利率). 的 assumptions should be serious 和 reasonable numbers 和 thus should be a product of proper research (e.g., industry averages, 专家 opinions) but also critical thinking. 例如, a new startup has increased needs in marketing 和 thus should 不 blindly use the average spending of a few big, mature companies in the sector. In order to keep the list tidy, it would be better to have assumptions based upon the actual needs of the model 和 不 just an infinite, difficult-to-use list. When building financial models, 寻找证据, defining benchmarks, 和 creating ranges regarding certain assumptions is also a recommended approach in order to reach robust conclusions.

Lastly, we can add some supporting schedules, as part of the assumptions or as separate tabs. 例如, if the business has debt, there should be an amortization schedule showing the repayments, 利息支付, 和 the progress of the loan.

No. 2: 的 Income Statement

的 损益表 shows the revenues 和 the costs of a company 和 indicates if it has profits or losses. It is divided into two parts: operating 和 non-operating. If for instance a software company sells a property, the revenues for the transaction are non-operating, because real estate does 不 constitute its core business.

An 损益表 is quite straightforward, so why it is so useful? 好吧, an 投资or (as well as the entrepreneur) can check the forecast growth, the margin evolution, 和 the costs 和 their relative weight to the revenues.

With the assumptions in place, the 损益表 can be completed: revenues, 直接成本, 总利润, operating expenses, 息税前利润, non-operating expenses, 税前收入, 税, 净收入, 准备好了. 当然, depending upon the level of detail we want, we can create sub-categories relevant to our business. If for instance we have a startup with more than one revenue source, under the revenue line we can add each of them (e.g., revenue from subscription, revenue from advertisement). However, reading the numbers is one thing 和 interpreting them is a不her. One of the most used metrics, 息税前利润, is a good indicator of operating capabilities, but still has its own perils. 下面, there is a visual example of an 损益表. It should be 不ed that for the first year, it is better to have a monthly breakdown:

No. 3: 的 Balance Sheet

的 资产负债表 is a snapshot of the business’ assets, equity, 和 liabilities.  It is an indicator of the financial health 公司的, showing what it owns 和 owes. 的 major parts are the current 和 non-current assets, current 和 non-current liabilities, 和股票. Balance sheets for startups are very important, because startups in their early days usually are loss-making 和 operate with no cash flows. So, it is crucial to track the net working capital balance, in order to plan in advance, even with the help of an 专家. After building the 损益表 和 putting the assumptions in place, we can easily translate them to the 资产负债表. 例如, the sales/revenues will be reflected to the cash 和 accounts receivable (sales on credit) of the 资产负债表, while the net income goes to the retained earnings. 下面, there is an illustration of a simple 资产负债表, connected to the previous 损益表 with supporting comments about how each entry is generated.

No. 4: 的 Cash Flow Statement

As the saying in finance goes: “profit is an opinion, but cash is the fact.” This phrase illustrates how significant the cash flow statement is. 此外, 投资ors want to see what a startup does with its money, but also that it can pay what it owes, 投资, 和成长. Thus, one of their favourite metrics is the free cash flows that equate to Net Income + Amortization/Depreciation - Changes in Working Capital - Capital Expenditures 和 shows that a firm can pay for its own operations.

Having completed the 损益表 和 the 资产负债表, it is easy to build the cash flow statement. We start with the net income, then add back depreciation, adjust for changes in non-cash working capital, 和 then we have the cash from operations. 然后, the cash used in 投资ing is a function of capital expenditures, while the cash from financing can be found in the assumptions for raising debt 和股票 or in the 资产负债表. 下面, we can see a cash flow statement 和 how easy it is to build, after having built the two other statements:

No. 5: Business Valuation 和 Sensitivity Analysis

When all the three statements are ready, we can proceed with the discounted cash flow analysis. 在这里, we estimate the free cash flow, as we described before, 和 we bring it to today’s 价值 by using the opportunity cost or even the required rate of return. 以这种方式, we can get a first glimpse at the 价值 公司的. 此外, now we can perform sensitivity analyses by modifying assumptions 和 creating various operating scenarios. 在这个练习中, we can see how the 价值 公司的 changes in different case in order to better assess risk 和 plan ahead if, 例如, sales decline or marketing conversion drop more than expected.

结论

Financial models are tools used to inform decision-making 和 arrive at projections. Financial models come into play at many stages in a company’s lifecycle, such as when the company seeks to raise capital, 进行收购, 预算, or simply underst和 how changes to any of the business’ drivers will impact overall performance. Given the importance of models at these critical junctions, it is essential that an experienced professional who can accurately capture the specifics of your business is behind the financial model.