What are the different types of financial models?
Financial modeling is woven into everything you’ll do as an entrepreneur and business owner or investor. So, how hard is it? What does it take to be good at it? Who should be doing the financial modeling for your organization?
What Goes Into A Financial Model?
When you are looking into the different types of financial models, keep in mind that financial models can be very simplified in the early idea stage of a startup. They can get very complex when you are raising big rounds of capital, or are looking at exits through startup M&A deals and initial public offerings.
Some of the basics you’ll often have in your numbers will include:
- Gross revenues
- Static expenses
- Variable expenses
- Profit margins
- Customer acquisition and sales figures
- Financial projects for the next 12 months through year five
Purposes Of Financial Modeling
There are many uses for financial modeling as well as types of financial models. Here are some of the most frequent reasons you’ll be using them.
Ensuring your business idea actually has the potential to be a viable and profitable business and not just a hobby. In the video below I explain in detail how to validate a business idea.
Out of the types of financial models, raising money is without a doubt one of the repeated reasons. Investors want to see that you know what you are doing, have put the time in, and they can expect a return in line with what they need for their portfolio. This of course also applies to borrowing through debt and estimating what you can expect to get, and the outcome of various financing terms.
Remember that storytelling plays a key role in fundraising and you will need capital to scale things up. This is being able to capture the essence of the business in 15 to 20 slides. For a winning deck, take a look at the template created by Silicon Valley legend, Peter Thiel (see it here) that I recently covered. Thiel was the first angel investor in Facebook with a $500K check that turned into more than $1 billion in cash.
Remember to unlock the pitch deck template that is being used by founders around the world to raise millions below.
Even if you aren’t raising outside capital you need to be modeling your finances to ensure you aren’t going to run out of money and go bankrupt, as well as making sure you are allocating capital to the most important and high rewarding things.
This applies to both sides of the table. You may often look to acquire or absorb other companies to remove competition, consolidate the marketplace, bring in talent, reposition, add more growth and revenues, and expand. Financial modeling will be used to evaluate these companies for formulating your offer and forecasting the potential returns and rewards of doing these deals.
Exiting Your Company
Financial modeling will give you targets to know where you need to be to sell, how much you can expect to get, and evaluating the best way and time to get your company acquired.
Types of Financial Models
There can be many ways to model. Here are some of the most common:
- Discounted financial model
- Three statement model
- Sum of the parts model
- Budget model
- Consolidation model
- LBO model
- M&A model
- IPO model
- Option pricing model
- Forecast model
How Detailed Does Financial Modeling Need To Be?
As you are looking into the types of financial models, note that financial modeling needs to run the gamut from the super simple presentations to incredibly complex reports.
A lot will depend on your stage and use. If this is just for your peace of mind before exploring a business idea further or sharing a few slides with potential cofounders, then a few bars with revenues, sales, expenses, and profits may suffice. Of course, you also need to do enough underlying math to support these figures. This really begins to need an upgrade when creating an internal business plan and pitch deck slides for raising money from investors.
The more modeling you can do, the better your chances of not only growing and succeeding financially but surviving too. Remember, that it is often just about who can survive the longest.
As you grow to larger fundraising rounds and pitching your company to be bought, these reports can get very detailed. You can’t just say my revenues are X and expenses are Y, so you’ll make Z. They want to know the details. This ensures they know all the math is included, the types of revenue and expenses, and where the opportunities are to improve and grow or create profits. As well as where the risks are.
What It Takes To Be Good A Financial Modeling
Obviously, it really helps when looking into the types of financial models if you love details in general and are going to make the investment in being detailed.
You need to be good at basic math. It certainly helps to be a ninja with Excel and have studied accounting. It will go much faster and smoother. It will help you justify personally spending your time doing it.
However, you also really need to understand all of the above as well. The purpose, types of models, and the detail and data expected by readers in the scenarios.
When it comes to recruiting, raising money, and selling a business, you also have to really understand sales and be able to be creative and put yourself in each reader’s shoes.
Don’t forget to know acceptable accounting principles, standards, and laws. This is a big area for legal. You do not want to be caught with bad math, which could look like you were trying to deceive anyone.
Who Should Do Your Financial Modeling?
At the beginning with those types of financial models, you may do some of your own rough financial modeling as a startup entrepreneur. Though this can leave a substantial risk of missing important things, and robbing yourself of a lot of your potential.
Alternatives may include:
- Accounting firms
- Investment bankers with teams of financial experts
- Professionals specializing in financial modeling for your specific purpose
Hopefully, this gave you an insight into the types of financial models. It can be simpler than you think at the beginning. You definitely need to embrace understanding it, even just for hiring the right person to do it for you. It can become quite complex as well. Don’t forget to include the expense of getting this help with your business or business idea if you are early in the process. It can make all the difference in surviving and thriving to your full potential.