A financial model aims to predict a business’ future performance and, in the case of a startup, understand whether a business makes sense to start at all. This includes a close look at budgeting your expenses and to model how high your revenues will likely be. To develop a complete financial model, that allows you to understand your funding needs, your company’s potential break-even point and its valuation we will need to conduct all kinds of complex calculations to estimate bank (or cash) balances. This is because a company with fast revenue growth can easily run out of cash due to high operational costs or simply cause customers don’t pay fast enough.
Revenue Models help validate your business while saving a lot of time
But especially in the early days, when a lot of your inputs are still only vague assumptions, it makes sense to start with a financial model that only focusses on revenues and expenses and leaves out the important (but time intensive) cash flow calculations.
This may go against grain what most textbooks would propose you to do, but think of it this way: What you initially really need to know is: Can your business, with all the employees, software, office- and other expenses, actually generate any profits in the end?
Now, some of you, who know accounting, will probably think: Wait a second, revenues are not cash flows and what about the impact of depreciation? But let me tell you, Angel investors do not care about your balance sheet. They just want to know: is there something real and potentially profitable about that cool “idea” of yours?
While predicting financial statements and complete cashflows really are very important, the impact on a young startup is much less significant than you think. And the process of building, and especially constantly updating, a full discounted cash flow model can take almost an entire employee’s time in practice, especially when you are working with incomplete accounting data and you got fast-growing numbers.
Startup Valuation is mostly based on Revenue multiples, not Cash Flows
In addition, most investors will value your early-stage startup either on something totally intangible like how much they like you and your track-record (which you won’t find in a financial model per definition) OR as a multiple on revenues (for which, again, you don’t really need full cash flows, to begin with).
The Lean Financial Model: Just build your Revenue Model and start pitching!
Hence it might be a good idea to save yourself all this work and just build a revenue model and simply start showing it to some angel investors. That said if your business has been around for a while and even has historical data, or you are talking to very number-minded investors, it might be the right time for you to build the most sophisticated and accurate financial model you can.
In this section, we will discuss modeling revenues and expenses of a company. This is the core of every financial model, independent of whether you intend to build complete cash flow predictions, or not at all. So start with this step, no matter what.
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