A No-Frills Approach To Financial Modeling For Startups

Post written by

Charlie Youakim

Founder and CEO at Sezzle, a digital payments platform. Prior to Sezzle, he founded Passport, a transportation payments platform.

This article is more than 2 years old.

At a prior company, I worked with an investment banker who loved financial modeling. He was a wizard at it. Over the course of a month, he had built an ultra-complex financial model that modeled our enormous potential. It had plenty of inputs and levers, 30 tabs and tables of outputs, and it made the computer wheeze when it ran.

It was incredible. But it was built for the wrong type of company.

Our company had zero revenue at the time, and the model ended up being a Rube Goldberg machine -- you know, the machine that does 100 steps to knock over the domino. You just want to knock over the domino in business.

The additional negative to our large financial model was that the only one who could understand the model was the banker.

At the early stages of a company, you need to avoid over-complicating your financial modeling. The principles of garbage-in/garbage-out apply heavily. Slight changes in assumptions can make for wild changes in your results, so you need a compact model to connect the input changes to the output results.

What you should be shooting for in your financial modeling is creating a tool to help you make the right business decisions -- and you should be able to create this financial tool in the frame of a single spreadsheet. If you find yourself straying from that single worksheet, you've probably started to make your model more complicated than it needs to be.

Your first decision is whether or not to start this business, right?

First, create a small section of this spreadsheet for market sizing. You can calculate market sizes in a few ways. One would be a customer-centric approach. How many customers exist? What percentage of those customers are you likely to acquire? And how much will each of these customers make you in a year? Another could be taking an existing market and estimating your potential portion of that market.

Good, now you know how big you can become. That's an important step.

Second, take a look at the unit economics. You need good unit economics to build a successful business. Let's say you're selling widgets and you have a manufacturer that helps you make them for $5 a widget. That's your cost. Let's start simple. Make sure to sell your widget for more than your direct costs. If you've got that concept down, great; if you don't, close the spreadsheet and head for the hills.

OK, still here?

The next part of your unit economics calculations should include allocating shared overhead costs among those product costs. How many widgets can you sell per employee? How much does each employee cost the company? Does the company scale well? Don't get crazy on the details -- just make sure that your unit economics still look good after your fixed overhead is applied. It's all about scaling here.

Third, if your unit economics look good, then plan out what your growth might look like for the next three years. Is your business profitable from day one? Great, that makes it easier. If it's not, you probably need to mix in your planned fundraising goals and cash burn to make sure you are set up for success. Life gets complicated when you run low on funds, so don't go there. I've been in that situation, and I plan on avoiding it from now on. Ideally, you should raise money when you don't have to. That means you should project for financings even when your cash balance could be quite high.

Finally, you should also calculate your customer lifetime value (LTV for short). LTV calculations are a "nice-to-know" for evaluating your business health and potential. The calculations are usually quite easy. This simple example from Kissmetrics shows how Starbucks might calculate their customer LTV.

And that's all you should need. Go through these four simple steps to set your company up with simple, easy-to-use financial modeling tools, and leave the 30-page spreadsheets to the bankers.

