A financial model is essentially a picture of your business that generates the 3 key financial statements:
- Cash flow
- Profit & loss
- Balance sheet
You then use this model to test scenarios, stress test your business, test assumptions and ultimately, plan how your business will evolve over the coming months and years.
Now, if you’re looking to create a financial model of your business, then you might be wondering where to start.
It’s very easy to say you’ll go ahead and create a financial model, but actually doing it isn’t so easy – or many people think it isn’t.
The truth is, if you don’t have your data together, creating a financial model will be difficult.
New businesses will need to have a written down list of your costs and you’ll charge for your products/services. For a complete list of what you need to get started with your model, checkout our article on “How to create a sales forecast with no historical data”.
Existing businesses will need to gather this information from past data and use previous year trends to create a sales forecast.
Choosing your tool
Either you’ll want to create your forecast in Excel or use a specialist tool, like Brixx. We actually wrote an entire article about choosing the right tool for your financial models, which you can check out here.
Be aware that Excel does have its drawbacks for modelling, some of which can be mitigated, but remember that unlike modelling software, Excel was never created for forecasting/modelling purposes, so be patient and know what you want to build before doing so.
Right, with that out the way, let’s dive into the meat of this article.
Step 1: Top-down or bottom-up?
First you need to establish whether your forecast will be “top-down” or “bottom-up”
I wrote an article about choosing the right one a few months ago, but here’s a quick reminder of what these are:
- In short, for top-down forecasting, a business assesses its market size and how much potential customers are willing to pay for its goods or services.
- “bottom-up” forecasting begins with the business’ actual activities and builds a forecast up from these activities.
Here at Brixx we prefer using a bottom-up forecast as we believe it provides a much more granular look at your business and allows you to do all the important aspects of building a model, like testing scenarios.
I’d also recommend taking some time to brush up on the cash flow, profit & loss and balance sheet reports, as you’ll need to have a working knowledge of what goes into each line on the reports.
Step 2: Identify all the key elements of your business
Just write down, either on a piece of paper or a new document on your computer, all the key sections of your business:
- Your primary sources of income – the stuff you sell
- Your costs of sale – costs directly related to the provision of your products or services
- Your team – the salaries of the people you need to make it all happen
- Your operating costs – other costs required to run your business
- Your marketing costs – the activities that generate new customers and drive new revenue
- Your sources of funding – any money injected into the business and any debts you owe from these
- The things you own – like computers, and their approximate value
Once you’ve got these written down you’ll have an idea of how your business works, identify the activities that drive growth and how each component links into each other, for example, does increasing Google Ads spend increase conversions?
Next, you need to actually look at building your model.
Step 3: Creating your model
If you’re going to use Excel, I’d recommend getting our free templates:
But if you want a tool that’s built specifically for the job, I’d recommend taking a free trial of Brixx, it’s completely free for 7 days with no-obligation to continue.
Take a look at Product Manager Robin’s video on creating your financial model in Brixx below.
This video explains:
- Starting a plan
- Adding structure
- Adding components
- Drilling down in reports
- Copying components, & switching them on and off
- Using the Timeline
- Structuring different businesses
Broadly, creating your plan will involve inputting your piece of paper or doc into the relevant spaces on each sheet or component. If you are using Excel, you’ll need to link the three statements together, so updating one updates all of them. Brixx does this for you!
Step 4: Using your financial model
It’s not enough to simply build your financial model. Once you’ve built a model, you’ve opened up the ability to see how and what makes your business tick, through stress testing, scenario modelling and more.
What you can do with your model is limitless, you’ve just got to do it!
Here’s a getting started guide on scenario modelling.
Getting started with your financial model can be a daunting task, especially if you’ve got a new or complex business. The trick is to take things slow, write down all the elements of your business and ensure you’re being as accurate as possible with your figures.
It’s hard work but pays off in the end with the limitless potential a well-built model provides.