Building a simple financial model
This week, we discuss financial models. What are they for, what should be included in them, and how sophisticated to they need to be for different types of businesses?
- A financial model is something that takes inputs (e.g. historic data and assumptions about the future) and gives outputs (e.g. how much money might you make this year). It can be as simple as some notes on a piece of paper, or it can be much more complicated.
- There's no standard model that everyone should follow. The key is to figure out what questions you have, and build a model that will answer them.
- In some cases you'll want more than one model. For example, you might make a specific model to help predict what your customer acquisition could look like in the future, and then use the output of that as an input of a higher-level model predicting what your overall profit might be.
- The complexity of your model probably depends on the complexity of your business. Don't compare yourself with other companies.
- Having said that, you might find the process of building a model helpful as a way to force you to think through your business.
- If you're trying to raise money, your model needs to communicate information to them which you might not otherwise be interested in. Things can get more complicated at that point.
- Understanding all of the above, building a model is just a matter of opening up Excel, entering the inputs, and doing your best to generate reasonable estimates for the outputs. Each model is different, so it's hard to be more specific than that.
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