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Financial Modeling for Entrepreneurs

Taylor Davidson

FORESIGHT

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angel.co/tdavidson

@tdavidson

Financial Modeling for Entrepreneurs Taylor Davidson FORESIGHT buildforesight.com angel.co/tdavidson @tdavidson @tdavidson

@tdavidson

I’m Taylor

BA Economics, University of Virginia

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MBA Finance, Tepper School of Business at Carnegie Mellon

Former strategy consultant, startup business development, private equity, innovation at big nancial services company, nance consultant, photographer. Code HTML and CSS. Entrepreneur-ish.

VC at kbs+ Ventures

Head of Foresight

@tdavidson

consultant, photographer. Code HTML and CSS. Entrepreneur-ish. VC at kbs+ Ventures Head of Foresight @tdavidson @tdavidson

@tdavidson

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What is the point of a nancial model?

buildforesight.com What is the point of a fi nancial model ? @tdavidson @tdavidson

@tdavidson

@tdavidson

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“To tell a story about your business with math.”

Unknown experienced VC

buildforesight.com “To tell a story about your business with math.” Unknown experienced VC @tdavidson

@tdavidson

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The key is to show someone how you think.

What someone wants to see in a model is how you approach building a business, what are the most important drivers of your business, and how you understand the equation underlining your business.

are the most important drivers of your business, and how you understand the equation underlining your

@tdavidson

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Every nancial model you build will be wrong.

But being “right” isn’t important.

Creating a nancial model is about going through the process of detailing how a business “works”.

The goal: Make the business model in your head explicit.

of detailing how a business “works”. The goal: Make the business model in your head explicit.

@tdavidson

@tdavidson

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What do I often hear about nancial models?

… they are largely BS. The fact is, a nancial model is a framework that shows you how things go up or down as you change certain inputs - but without knowing the inputs, it's impossible to really derive any useful data.

In the end, the most important thing isn't a really detailed nancial model - it's having a grasp of what the major in uencing factors are on your model (hint: sales and growth) and then getting some kind of data that helps you accurately predict these variables.

In the end, a nancial model is just a fancy equation with a bunch of input variables. If the input variables are mistaken, it doesn't matter how good the equation is, the whole thing is useless - or even worse than useless, as it breeds false con dence.”

Direct feedback from a survey I ran in 2012

than useless, as it breeds false con fi dence.” Direct feedback from a survey I ran

@tdavidson

@tdavidson

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Accuracy is a misguided goal.

Start with well-grounded assumptions, good structure, and scenario analysis of key inputs, and that's as good as we can get.

good structure, and scenario analysis of key inputs, and that's as good as we can get.

@tdavidson

@tdavidson

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Instead of focusing on the bottom-line income statement and the hockey-stick growth in year 5, focus on your process, assumptions, key drivers, and scenarios and build a detailed month-by-month model that you can modify and update over time.

and scenarios and build a detailed month-by-month model that you can modify and update over time.

@tdavidson

@tdavidson

How detailed?

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The Minimum Viable Product needs its Minimum Viable Model.

How detailed? buildforesight.com The Minimum Viable Product needs its Minimum Viable Model . @tdavidson @tdavidson

@tdavidson

@tdavidson

Building Blocks

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Turning Business Models into Financial Models

Unit Economics

Bottoms-up and Top-down

Verifying Inputs

Point Estimates and Range Estimates

Scenario Planning

Bottoms-up and Top-down Verifying Inputs Point Estimates and Range Estimates Scenario Planning @tdavidson @tdavidson

@tdavidson

@tdavidson

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Make your business model explicit.

There is an equation underlying your business. Take the ideas in your head, and outline how a business works in detail.

For example: apply the Business Model Canvas to Financial Models

how a business works in detail. For example: apply the Business Model Canvas to Financial Models

@tdavidson

@tdavidson

Unit Economics

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i.e. Revenue per user, cost per user, cost to acquire a user, cost to retain a user, cost to serve a user.

i.e. Revenue per sale, cost per sale, COGS per sale, marketing costs per sale, shipping costs per sale

Revenue per sale, cost per sale, COGS per sale, marketing costs per sale, shipping costs per

@tdavidson

@tdavidson

Bottoms-up

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Build estimates from the bottom-up.

Top-down

Verify from the top-down.

i.e. “We’ll capture x% of a $500 MM market” should be the result of your estimates, not the start of your estimates.

x% of a $500 MM market” should be the result of your estimates, not the start

@tdavidson

@tdavidson

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Inputs. How do I know if they are accurate?

Research. Public information. Test in-market. Ask other entrepreneurs.

Don’t obsess over how accurate your assumptions are.

Test in-market. Ask other entrepreneurs. Don’t obsess over how accurate your assumptions are. @tdavidson @tdavidson

@tdavidson

@tdavidson

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Focus on range estimates, not point estimates.

i.e. Spending time guring out if $5 or $10 is the best price point is very tough, and probably wrong. Instead of deciding if $5 of $10 is correct, estimate using both, and understand the range of results.

Even better, estimate using ranges and probabilities of outcomes.

understand the range of results. Even better, estimate using ranges and probabilities of outcomes. @tdavidson @tdavidson

@tdavidson

@tdavidson

Plan out scenarios.

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Analyze key metrics and drivers. Which assumptions have the most impact on your projections? Will a small change in price have a big impact on prots?

Develop best, worst, and “normal” cases.

small change in price have a big impact on pro fi ts? Develop best, worst, and

@tdavidson

@tdavidson

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Combine everything into nancial statements.

i.e. Do the math.

Income statement rst, then balance sheet and statement of cash ows as necessary.

math. Income statement fi rst, then balance sheet and statement of cash fl ows as necessary.

@tdavidson

@tdavidson

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Is it reasonable? Verify.

How big is the addressable market for your product or service, and is it growing or declining?

Who are your major competitors and what portion of the market do they currently have?

What percentage of the market are you estimating you’ll be capturing within 3 months, 6 months and a year?

of the market are you estimating you’ll be capturing within 3 months, 6 months and a

@tdavidson

@tdavidson

Metrics matter

Which businesses care about… CPA LTV Viral cycle and viral coecient Churn MRR % Paying Users DAU, MAU CPM

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CPA LTV Viral cycle and viral coe ffi cient Churn MRR % Paying Users DAU, MAU

@tdavidson

@tdavidson

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Modeling Viral Growth

buildforesight.com Modeling Viral Growth Virality Study, http://worklogistics.com @tdavidson @tdavidson

Virality Study, http://worklogistics.com

buildforesight.com Modeling Viral Growth Virality Study, http://worklogistics.com @tdavidson @tdavidson

@tdavidson

@tdavidson

Key to Viral Growth

% of users who invite others

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*

#

of people that each user invites

*

% that convert

*

#

time that it takes to convert

Virality Study, http://worklogistics.com

* % that convert * # time that it takes to convert Virality Study, http://worklogistics.com @tdavidson

@tdavidson

@tdavidson

Cohort Analysis

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Cohort = Groups of similar users

(by time joined, by subscription type, by engagement, by primary access device, etc.)

Goal is to deaverage usage to pull out important insights

More about cohort analysis at “LEARN” on http://buildforesight.com

out important insights More about cohort analysis at “ LEARN ” on http://buildforesight.com @tdavidson @tdavidson

@tdavidson

@tdavidson

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Presenting your results: Always remember the goal.

The goal of a fundraising pitch / conversation can range from getting someone interested, to getting them involved, to getting a decision. Match the information presented to the desired outcome.

them involved, to getting a decision. Match the information presented to the desired outcome. @tdavidson @tdavidson

@tdavidson

@tdavidson

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Fundraising: Focus on the big picture.

Focus on the market size, the business model and the fundamental economics.

Revenue and Net Income projections are far less interesting or meaningful for early-stage companies.

But have the details ready to dive into if needed.

or meaningful for early-stage companies. But have the details ready to dive into if needed. @tdavidson

@tdavidson

@tdavidson

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Don’t build a detailed nancial model if you don’t have past earnings, a signicant nancial history, or insight into the issue. Instead, include your current status and milestones for the next 1-3 quarters for product, team, marketing, sales, and quarterly and cumulative burn”

Venture Hacks, http://venturehacks.com/articles/deck

Also, see http://investors.dressrush.com/

Venture Hacks, http://venturehacks.com/articles/deck Also, see http://investors.dressrush.com/ @tdavidson @tdavidson

@tdavidson

@tdavidson

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“You can’t predict your revenue with any kind of precision, but you should be able to manage your expenses exactly to plan.”

Brad Feld and Jason Mendelson, Venture Deals, p 21

to manage your expenses exactly to plan.” Brad Feld and Jason Mendelson, Venture Deals , p

@tdavidson

@tdavidson

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“… we focus on two things: (1) the assumptions underlying the revenue forecast (which we don’t need a spreadsheet for – we’d rather just talk about them) and (2) the monthly burn rate or cash consumption of the business.”

Brad Feld and Jason Mendelson, Venture Deals, p 21

rate or cash consumption of the business.” Brad Feld and Jason Mendelson , Venture Deals ,

@tdavidson

@tdavidson

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What this all means: build a simple model that plans out what you expect to spend for the next 3-12 months, how you plan to spend it, and what you expect to achieve from it.

Explain your fundraising requirements simply.

to spend it, and what you expect to achieve from it. Explain your fundraising requirements simply

@tdavidson

@tdavidson

First: Cost Budget.

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Focus rst on cash ow cost budget. Create a 12-24 month budget of expected expenses to achieve key milestones.

Template models at http://buildforesight.com

of expected expenses to achieve key milestones. Template models at http:// buildforesight.com @tdavidson @tdavidson

@tdavidson

@tdavidson

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Next: User and Revenue Estimates.

Once you’ve planned out your key costs, start estimating users, customers, sales, and revenues. Focus on the drivers and processes, not the estimates themselves.

Detailed list of example revenue models at

https://hackpad.com/EgXuEtSibE7

Template models at http://buildforesight.com

revenue models at https://hackpad.com/EgXuEtSibE7 Template models at http://buildforesight.com @tdavidson @tdavidson

@tdavidson

@tdavidson

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Last: Financial statements.

While income statement gets most of the attention, managing cash ow is priority #1. Pay attention to accounts receivable, accounts payable, payments cycle, and other key nancial indicators. Key nancial metrics tell a story, but only powerful if analyzed along with key performance indicators.

Template models at http://buildforesight.com

if analyzed along with key performance indicators. Template models at http://buildforesight.com @tdavidson @tdavidson

@tdavidson

@tdavidson

EXAMPLE INFORMATION

Raising $750K

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Primary expenses on hiring 1 FT back-end developer, 1 FT front-end developer, 1 community manager, and opening an

o ce.

16 months of runway Increase burn from 30K to 60K

Key milestones Complete v1 beta product, sign 15 customers, build and launch v2 production product

Key milestones Complete v1 beta product, sign 15 customers, build and launch v2 production product @tdavidson

@tdavidson

@tdavidson

Simplicity wins.

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i.e. Graphs, charts, simple descriptions of revenue models and budgets. Find easy ways to communicate complex thoughts.

simple descriptions of revenue models and budgets. Find easy ways to communicate complex thoughts . @tdavidson

@tdavidson

@tdavidson

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Common misconceptions

Don’t get lost in details. (i.e. don’t slap a screenshot of your projections on a slide)

Everybody shows a hockey stick. Be careful.

All projections are “conservative”. Don’t game the projections to the reactions, focus on the fundamentals rst.

Don’t game the projections to the reactions, focus on the fundamentals fi rst. @tdavidson @tdavidson

@tdavidson

@tdavidson

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Resources

1)#Read#more#on#the#web#and#download#more#financial#models#to#see#how

financial#statements#work:

#####h"p://buildforesight.com/build.html56>5links5to5templates

3)#Take#a#class#about#how#to#build#a#financial#model

#####Online:5 h"p://skl.sh/U2u0Gc 55555In6person:5Through5General5Assembly5or5 Skillshare ,5 h"p://skl.sh/U2u0Gc

55555In6person:5Through5General5Assembly5or5 Skillshare ,5 h"p://skl.sh/U2u0Gc @tdavidson @tdavidson

@tdavidson

@tdavidson