Financial Models Are Always Wrong: Create One Anyway.January 13th, 2009 View Comments |
Yes, financial models are always wrong; but they are still very powerful for helping you understand your business. Download this sample financial model (zipped XLS file) to get started.
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Sample Financial Model created by Taylor Davidson Right-click to download. Zip file, 230 KB. |
Also: Check out the new, simplified model released Nov 12 at Financial Models Are (Still) Always Wrong: Create One Anyway.
Despite my wide range of interests and my pained explanations of what I do as “an importer and exporter of ideas” and “bridging online and offline experiences by driving cross-country to meet entrepreneurs and investors”, at my core I’m still a financial modeling geek that loves to use Excel to break down and understand how a business works.
Why is creating a financial model important?
Creating a financial model forces an entrepreneur to outline very specifically how a business “works”: how a company creates their products, how users and customers find and use their products and how those processes create revenues and costs. The result, a set of operational metrics, financial statements and the “equation of the business”, is one view of a potential reality of the business. While any one view is inevitably wrong, by digging deeper and analyzing the key drivers and testing a range of assumptions an entrepreneur can create multiple views to help make crucial product design, marketing, organizational and strategy decisions.
Instead of focusing on the bottom line profit and net income, focus on the assumptions and key drivers of the business. Developing a financial model creates the type of thought and data that helps entrepreneurs figure out what they are betting on and how likely their bets will pay off.
What is needed to start creating a financial model?
The best way to start building a financial model is to start thinking about how the business works:
- What is the business? What is the product / service?
- How do you target, and acquire customers?
- What are the revenue streams? (prices, sales of products or services, advertising, usage fees, etc.)
- What costs will the business create? (items and estimates, employees, hosting, SG&A; fixed costs, variable costs, etc.)
- What timeline of development and product launch and market / customer adoption are you expecting?
- What do you think are the major drivers of revenue and costs?
- What do you know about the market? (# of potential customers, $ spent currently, market trends, growth, competitors, etc.)
- What lessons, revenue / cost models and performance / operational metrics exist from studying existing competitors and complementary and substitute products?
When I work with entrepreneurs, I typically ask for some preliminary information and data around the above questions, and then after an overview conversation I am able to hack together a first draft of a customized financial model. I typically start with one of two models:
- First Look: A basic one-sheet model that outlines the customer acquisition process, revenues and costs; customized to help an entrepreneur understand the business they are creating.
- Deep Thought: A highly customized, detailed model that creates a full set of financial projections that can be used to raise capital and operate the business.
For an example of a detailed Deep Thought model, download the sample financial model below:
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Sample Financial Model created by Taylor Davidson Right-click to download. Zip file, 230 KB. |
What happens next?
After your startup is up and running, it’s time to start managing your finances; we’ll delve into how to manage your finances in a later post. Have a question you need answered now? Drop me a line…
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Thanks to Bryan for forcing me to outline my typical data request…
December 31st, 1969 at 23:59
Finance and Excel wizard @tdavidson tells us why we should create financial models even if they are always wrong! http://bit.ly/8zi6
January 13th, 2009 at 15:57
Great post and advice to all entrepreneurs! Having had the opportunity to see some of Taylor's wizardry demonstrated in-person, I'd say you'd be crazy to start a business/startup without doing this kind of financial modeling.
Taylor's virtuosity with Excel allows him to create living, dynamic frameworks which let you play with the factors that deeply effect the success of your product. I would never have guessed that looking at detailed financial data could be so fun! What a brilliant way to make smart decisions and alleviate anxiety caused by not understanding your pricing/finances/model.
Take the guess work out of how your business will work and be rewarded manyfold for your diligence!
January 13th, 2009 at 15:57
Great post and advice to all entrepreneurs! Having had the opportunity to see some of Taylor's wizardry demonstrated in-person, I'd say you'd be crazy to start a business/startup without doing this kind of financial modeling.
Taylor's virtuosity with Excel allows him to create living, dynamic frameworks which let you play with the factors that deeply effect the success of your product. I would never have guessed that looking at detailed financial data could be so fun! What a brilliant way to make smart decisions and alleviate anxiety caused by not understanding your pricing/finances/model.
Take the guess work out of how your business will work and be rewarded manyfold for your diligence!
January 13th, 2009 at 15:57
Great post and advice to all entrepreneurs! Having had the opportunity to see some of Taylor's wizardry demonstrated in-person, I'd say you'd be crazy to start a business/startup without doing this kind of financial modeling.
Taylor's virtuosity with Excel allows him to create living, dynamic frameworks which let you play with the factors that deeply effect the success of your product. I would never have guessed that looking at detailed financial data could be so fun! What a brilliant way to make smart decisions and alleviate anxiety caused by not understanding your pricing/finances/model.
Take the guess work out of how your business will work and be rewarded manyfold for your diligence!
January 13th, 2009 at 15:57
Great post and advice to all entrepreneurs! Having had the opportunity to see some of Taylor's wizardry demonstrated in-person, I'd say you'd be crazy to start a business/startup without doing this kind of financial modeling.
Taylor's virtuosity with Excel allows him to create living, dynamic frameworks which let you play with the factors that deeply effect the success of your product. I would never have guessed that looking at detailed financial data could be so fun! What a brilliant way to make smart decisions and alleviate anxiety caused by not understanding your pricing/finances/model.
Take the guess work out of how your business will work and be rewarded manyfold for your diligence!
January 15th, 2009 at 06:16
more deep thought from you on your comment on umair's latest
January 15th, 2009 at 06:16
more deep thought from you on your comment on umair's latest
January 15th, 2009 at 06:16
more deep thought from you on your comment on umair's latest
January 15th, 2009 at 06:16
more deep thought from you on your comment on umair's latest
January 15th, 2009 at 09:41
Thank you; but like Umair I need to turn thinking into action…
January 15th, 2009 at 09:41
Thank you; but like Umair I need to turn thinking into action…
January 15th, 2009 at 09:41
Thank you; but like Umair I need to turn thinking into action…
January 15th, 2009 at 09:41
Thank you; but like Umair I need to turn thinking into action…
February 14th, 2009 at 10:48
[...] we went over the basic information about the product and business (a standard part of my initial data request before creating a startup financial model), I realized the crucial part in creating the financial model was going to be understanding the [...]
February 14th, 2009 at 10:51
[...] Need help figuring it out? [...]
February 14th, 2009 at 11:30
[...] though I’m trying to focus more on “translating business strategies into financial models”, I can’t help but explore. Pardon me for a bit of rambling [...]
March 1st, 2009 at 18:06
Nice post. I agree on the need to go through the numbers regardless of the outcome. You need to get a sense of what makes your business tick, what drives what, what has the big impact, what are the baselines and what what you need to be worried about.
Like all planning, you can't outsource it. It's not the end number that is important, it's how well you live and breath the mechanics of the business model and operations. I've seen startups pay $20k to consultants to do projections and then the first investor makes a suggestion which changes the formula and they have no idea how to adjust.
March 1st, 2009 at 18:06
Nice post. I agree on the need to go through the numbers regardless of the outcome. You need to get a sense of what makes your business tick, what drives what, what has the big impact, what are the baselines and what what you need to be worried about.
Like all planning, you can't outsource it. It's not the end number that is important, it's how well you live and breath the mechanics of the business model and operations. I've seen startups pay $20k to consultants to do projections and then the first investor makes a suggestion which changes the formula and they have no idea how to adjust.
March 1st, 2009 at 18:06
Nice post. I agree on the need to go through the numbers regardless of the outcome. You need to get a sense of what makes your business tick, what drives what, what has the big impact, what are the baselines and what what you need to be worried about.
Like all planning, you can't outsource it. It's not the end number that is important, it's how well you live and breath the mechanics of the business model and operations. I've seen startups pay $20k to consultants to do projections and then the first investor makes a suggestion which changes the formula and they have no idea how to adjust.
March 1st, 2009 at 18:06
Nice post. I agree on the need to go through the numbers regardless of the outcome. You need to get a sense of what makes your business tick, what drives what, what has the big impact, what are the baselines and what what you need to be worried about.
Like all planning, you can't outsource it. It's not the end number that is important, it's how well you live and breath the mechanics of the business model and operations. I've seen startups pay $20k to consultants to do projections and then the first investor makes a suggestion which changes the formula and they have no idea how to adjust.
March 2nd, 2009 at 09:31
Agreed: you can't outsource it completely. A consultant can help an entrepreneur / startup with the process, asking the right questions and creating the right analysis, but the entrepreneur has to be deeply involved in the process. I've always believed that once an entrepreneur has been through it once, they should be able to do it themselves the next time
March 2nd, 2009 at 09:31
Agreed: you can't outsource it completely. A consultant can help an entrepreneur / startup with the process, asking the right questions and creating the right analysis, but the entrepreneur has to be deeply involved in the process. I've always believed that once an entrepreneur has been through it once, they should be able to do it themselves the next time
March 2nd, 2009 at 09:31
Agreed: you can't outsource it completely. A consultant can help an entrepreneur / startup with the process, asking the right questions and creating the right analysis, but the entrepreneur has to be deeply involved in the process. I've always believed that once an entrepreneur has been through it once, they should be able to do it themselves the next time
March 2nd, 2009 at 09:31
Agreed: you can't outsource it completely. A consultant can help an entrepreneur / startup with the process, asking the right questions and creating the right analysis, but the entrepreneur has to be deeply involved in the process. I've always believed that once an entrepreneur has been through it once, they should be able to do it themselves the next time
March 22nd, 2009 at 01:44
Atarax (hydroxyzine) for Anxiety: I take this along with Lexapro… I was having such hard times falling asleep due to nine million things going on through the day … then the anxiety kicked in…sometimes I would be up for hours while everyone is sound to sleep…When I started taking this I fall asleep within thirty mins and usually sleep sound. It is not addicting… and good price for the good things the meds do
March 22nd, 2009 at 08:44
Atarax (hydroxyzine) for Anxiety: I take this along with Lexapro… I was having such hard times falling asleep due to nine million things going on through the day … then the anxiety kicked in…sometimes I would be up for hours while everyone is sound to sleep…When I started taking this I fall asleep within thirty mins and usually sleep sound. It is not addicting… and good price for the good things the meds do
April 16th, 2009 at 05:47
[...] is hard. It’s easy to read anything I’ve written, it’s easy to download generic financial models I’ve created, but how will you make sense of it and use [...]
April 24th, 2009 at 15:05
Great tips on financial modeling for entrepreneurs, including a model template http://tinyurl.com/7ucbzq
April 24th, 2009 at 15:34
RT @altgate: Great tips on financial modeling for entrepreneurs, including a model template http://tinyurl.com/7ucbzq
July 21st, 2009 at 18:13
[...] assumptions for future financial trends. My friend Taylor Davidson, has a great list about the information you need to start a financial model and I [...]
November 12th, 2009 at 06:10
[...] January I released a free financial model to help entrepreneurs model and understand the story behind their business. After a lot of interest [...]
December 3rd, 2009 at 14:21
Great post on Financial model.rnFor more jobs visit http://www.staffingpower.com