Financial modeling is a process of creating an abstract representation of the business future financial performance.
It is a task of building a financial model typically in Excel that shows future financial performance the key performance indicators of a specific industry.
This financial model has always built-in flexibility to exhibit different results based on varying assumptions.
Importance of financial modeling
Financial modeling is design to represent real-life financial situation to make better decisions. A sound financial model will enable decision-makers to see a big picture of different scenarios that could arise in the future and address it in a timely and effective manner.
It could also assist in quantifying different purposes of decision-making like capital investments, loan applications, or business valuation.
How does financial modeling forecasts the financial performance of a Startup?
In order that financial modeling for startup businesses becomes effective in forecasting performance, the Key Performance Indicators (KPI) need to be accurately determined.
You need to choose the right model for your startup business to know what KPI and benchmarks you will follow.Let’s assume you’re in Software-as-a-Service (SaaS) businesses, it is critical for you to know your growth drivers, cost drivers and milestones you should be hitting.
Once you already determine the growth drivers, youcould make realistic forecast about the business’s future. SaaS financial model should provide for the following metrics.
- Customer Acquisition Cost (CAC) represents the amount of money you have spent in order to acquire additional customer. To calculate the CAC, you need to determine the entire cost of sales and marketing including salaries of your marketing team divided by the number of new customers acquired in a particular period. This is a bit tricky because your CAC should be higher than cost to acquire them, it’s a matter how you are going to monetize your new customers?
- Average Revenue per User (ARPU) represents the amount of monthly revenue generated per user. Measuring your ARPU will help you predict your MRR accurately. It is calculated as ARPU multiplied by total subscribers.
- Churn Rate – indicates the rate at which customer decide not to continue their subscriptions. In simple words its kind of the opposite of the renewal rate. SaaS companies target to keep their customers happy by aiming for a low churn rate.
- Monthly Recurring Revenue (MRR) represents the normalized amount of revenue received monthly. It is the lifeblood of every SaaS business. Once you have a consistently increasing MRR, you do not have to worry about one-off sales. MRR is one of the reliable metric of the SaaS business growth. This will indicate whether your momentum is picking up or slowing down. Understanding how much MRR you’re coming will enable you to make smarter decisions that would maximize your return. MRR is the key financial metric in forecasting your sales.
- Lifetime Value (LTV) represents the sum of money expected to receive per customer during their lifetime. It is equally important to figure out because it would help you make decisions whether you will invest more money acquiring a new customer or focus on retaining existing customers. In other words, you might want to calculate your LTV based on actual purchases over the years or how much your customers will spend in the future. It is mostly relevant for subscription base business.
- Breakeven and payback it is both equally important as this will indicate when you will reach profitability. However, this is not so simple for SaaS business. SaaS recurring revenue over time is nothing more than the sum of its parts. The sooner you breakeven, the sooner you will reach profitability. The formula to breakeven is BE=CAC/(Average Recurring Revenue-Average Recurring Cost). The moment your reach your breakeven, that would also be the time you will you’re your payback.
Conclusion: Financial modeling for Startups helps to better understand the business concept
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In general, a startup business should understand better how KPI impact profits and cash flows.
Determining what drives your growth and what drives your cost are both equally important as the result would indicate where your business is going. In order for a SaaS business to survive, it is essential that you know exactly how many subscribers or users are required for you to breakeven and for your SaaS business to reach profitability.
Knowing all these will allow you to plan strategically and evaluate the effectiveness of your game plan. Financial modeling for startups template shall exhibit your firm grasp on the different factors that could influence your business such as market share, competitors and so on.
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No matter what the challenges are, the goal is not to make the perfect plan, having a better plan is better than having no plan.