Nuts and bolts #3: your financial model and your understanding of your business, your market and your customers, and your value drivers

Dear founder.

This is a letter to all you founders who are preparing a financial model for your Series A or even Series B round.

First, may I congratulate for getting this far.

Second, for those of you who are using xls with formula and a separate input / assumption and output sheet (and as few hard-coded cells as possible), well done.  You have made a great start and you know the crux of the fundamentals of good modelling.

Third, please consciously make a pause to ask yourself: do I know the business plan of the company without opening an xls spreadsheet?  What are they?  What are our objectives and the strategies?  What are the growth rates and cost trends I see and expect for the next 12 months, and the following 12?

You should definitely know this before starting work on any financial forecasts.  Put differently, your financial model should support your business plan and be aligned with it, and not the other way round.  For those of you have not put the cart before the horse, congratulations, because you have the right understanding the purpose of having a model, that it is subsumed to the business plan.  The financial model is just a tool to help you with your business planning, even if it can be a very useful and valuable one if you set it up well.

Once you’ve ticked these off, you are ready to start working on the xls.  And this gives me the opportunity to highlight one of the most important points of having your financial model.  Please make your key assumptions clear.  Indeed, be clear what your key assumptions are.

Most importantly, and the most important bit to it all: show us how well you understand your business by highlighting what the top value drivers are –> these will be the key assumptions in your financial model.  Here is your opportunity to impress upon us how well you understand the drivers of your business.  Is it unit cost, is it ASP (average selling price), is it volume growth, is it commission %, or is it something else?  And what drives the quantum of these?  Nothing else matter more than what are the key assumptions to your model.  (Sometimes, we suggest you do a “value map” of your business – a bit like what you see in the image above).

A few further smaller points: we really don’t need your second decimal point, in fact, we don’t need your first decimal point most of the time either.

Scenarios.  It would be great if you could build your model in a way such that we can run a few scenarios by changing some inputs / assumptions.  In fact, we are so grateful if you do it that way.  You’ve already earned some significant brownie points that way.  As you get to Series A and Series B and beyond, building in some resilience and weather-proofness will become more important.

“Test” cells.  And if you even build in some “nice to have” features like “check” cells that check the model balances or do not have careless calculation mistakes, we would know you are good with details.

That’s it.  Despite my (misplaced?) fear, this letter that has turned out to be relatively short and painless.  You know how to do the rest – and keeping it short and sweet is what we like too.

And thank you!



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