This article will walk you through why your startup needs a financial model, with a step-by-step guide on how to build it.

What is a startup financial model?

A financial model gives you an overview the past and current state of your business, and forecasts what might happen in the future. It typically has different interconnected pieces that represent different parts of your business:

• Expenses — how much your business spends on software, professional services, product delivery, etc.
• Revenue — how your business generates money
• Headcount — your employee roster, future hiring plan, and associated costs and details
• Profit-and-loss (P&L) — an overview of your business’ spending, income, and profitability
• Balance sheet — an overview of your business’ assets and liabilities at different points in time
• Cashflow statement — an overview of how cash enters and exits your business

It helps to know the basics of finance and accounting before you start building your model. Taylor Davidson has written a great 5-min guide to these basics that we'd recommend checking out.

Startup financial model templates

An easy way to build your first financial model is to use a template as a starting point.

Your choice of software will dictate which templates are available to you. Here are the best templates that we recommend for different tools:

• Causal: The Startup Suite templates
• Excel/Sheets: Foresight by Taylor Davidson

Why does your startup need a financial model?

Even if you haven’t made your financial model explicit (e.g. by building it in a spreadsheet or other tool), you’ll still have some implicit model in your head for how your business works.

There are many benefits to making your financial model explicit:

1. Forces you to think through how your business works — building a financial model is a good forcing function to think about how your business actually works — what drives revenue and costs, and what actions could meaningfully improve your business results. Again: you will already be doing this implicitly in your head, but it would be better to do it rigorously and explicitly.‍
2. Gives you visibility into past performance — having a financial model that’s kept up-to-date will give you digestible way to understand how your business is performing.‍
3. Gives you visibility into the future — the forecasts produced by your financial model will give you a good indication of where your business is heading over the next few months and years. This can help you discover whether you need to course-correct, or whether you double down on your strategy.‍
4. Lets you set realistic targets — an accurate financial forecast lets you set realistic targets, based on historical results and concrete plans rather than top-down hopes. Realistic targets are crucial for setting direction and motivating your team.‍
5. Helps with fundraising — when raising money, investors will want to understand your business performance and future plans in detail. Having a robust financial model that you can share will let them do this, and demonstrates that your company will be a responsible steward for their capital.‍
6. Lets you plan your business — having accurate forecasts lets you run “what-if” scenarios to decide on your company strategy. For example, you can run a scenario to see how your runway would be affected if you hire more people.

A company at the ideation stage can benefit from a model and so can a fully scaled business, albeit in different ways. Often the model building exercise is more important than the specific outputs or conclusions. The process should give the operator clarity on the key levers in the business, how they interact and what the company can do operationally to achieve company goals. — Alex Oppenheimer, Managing Partner at Verissimo Ventures

How to build your startup financial model

Startup financial modelling tools

Historically, spreadsheets like Excel and Google Sheets have been the only tools available for financial modelling.

Excel and Google Sheets are great in many ways, but there are now dedicated startup financial modelling/planning tools available that can solve some of the main issues that you’d face with spreadsheet financial models:

• Pulling historical data from your systems — dedicated financial modelling tools can connect directly to your accounting system (e.g. QuickBooks, Xero) and other tools (e.g. HRIS, CRM, data warehouse) to pull historical data, saving you time and reducing the chance of errors when manually exporting each week/month

• Sharing and collaboration — dedicated financial modelling tools have specific functionality to let you control different levels of access for different stakeholders in your organisation. For example, you can keep sensitive data in the Headcount model private while sharing outputs from the P&L with your team.

• Easier to build and maintain — some dedicated financial modelling tools allow you to work with human-readable formulas across multiple dimensions (e.g. months, products, geographies), reducing the number of formulas you need in each model. This makes your models much easier to develop and maintain, and reduces the chance of errors.

If you're an early-stage company or small business, you won't want to spend thousands of dollars per month on financial planning software. Here are some tools with a cheaper starting point for small businesses:

1. Causal - from $99 per month, simple to get started but flexible enough for advanced power users
2. Fathom - from $50 per month, great out-of-the-box reports, but very limited flexibility on forecasting/planning

For a complete guide on the best tools and software to run a modern finance function, check out our blog post on the Modern Finance Stack.

P&L and Expenses

You should think of the P&L as the central piece of your financial model — it will give you an overview of your whole business, and will include outputs from the other pieces of your model.

If you want to learn more about what a P&L is and why it exists, or how Revenue is defined, then check out our Beginners’ Guide to Financial Statements).

Your P&L should have the following sections:

1. Revenue — how you make money. In this section you should have a separate row for each business line (e.g. product sales vs services). Since you’ll have a more detailed revenue model that connects to these, don’t worry about adding tonnes of detail here.
2. Cost of Goods — what it costs to directly produce your goods/services. In this section you should have a separate row for each different cost line (e.g. software infrastructure vs payments processing fees).
3. Operating Expenses — your indirect costs. In this section you should be careful not to overthink it — your chart of accounts could have 50–100 different operating expense GLs, but you’ll likely want to group them into 10–15 digestible rows. You can always drill down into the details separately.
4. Outputs — key metrics you want to track. This will include metrics like Gross Profit (Total Revenue - Total Cost of Goods), Net Profit (Gross Profit - Operating Expenses), Runway (how many months until you run out of cash) and Profit Margin (Net Profit / Total Revenue).

Revenue

The way you model your revenue will depend on your business model. Here are some common business models and how you should think about them:

• Sales-led B2B SaaS
• Marketing-led B2B SaaS
• B2C SaaS/subscription
• E-commerce
• Services (e.g. an agency/consulting firm)

Recommended reading:

1. Modeling Your SaaS Startup's Revenue Growth Effectively - Tomasz Tunguz
2. Mastering Revenue Models - Taylor Davidson

Headcount

This model should contain a list of all your employees, and, at a minimum, the following data points for each:

• Base salary
• Start date + End date
• Job title
• Department

On top of monthly salaries, your model should calculate important employment overheads like payroll taxes and benefits. These might vary based on different levels of seniority or different departments.

If you have employees in multiple countries, you’ll need to include currency conversion as part of your model, ideally using up-to-date exchange rates.

If you have more than 30 employees, you might want to include planned salary increases (e.g. based on inflation) in the model.

Keeping your startup financial model up-to-date

Once you’ve built your startup’s financial model, you’ll need to keep it up-to-date as your business evolves. This involves 2 things:

1. Updating your financial model with historical data
2. Updating your forecast assumptions as things change

Bringing in historical data

Each month you should bring in the latest data (known as “actuals”) from your accounting system. The process for bringing in historical data depends on your financial modelling tool:

Using Excel/Sheets

Every month:

1. Log into your QuickBooks/Xero account
2. Navigate to your P&L report, and export as CSV
3. Import your P&L CSV into your Excel/Sheets file
4. Either
   1. Copy the data from the CSV import tab into your financial model tab(s) to override historical months, OR
   2. Set up formulas to automatically pull the latest historicals from the CSV import tab and override your forecasts

Using Causal

Once:

1. Authenticate to QuickBooks/Xero via Causal
2. Connect each row of your model to the correct GL accounts

By default, your data will automatically refresh each month, but you can also manually trigger refreshes whenever you want.

Updating forecast assumptions

Each month, after bringing in the previous month’s data, you should re-evaluate your model assumptions — do they still make sense? Here are some examples:

• Revenue: are your funnel conversion rates and sales cycle assumptions still accurate? Have your inbound leads gone up or down recently?
• Expenses: do you have any new major software vendors you should add to your model? Is the growth rate of your infrastructure/hosting the same as before?
• Headcount: is your hiring plan up-to-date with planned hires? Have you set an “end date” for everyone who’s exiting the firm?

Wrap-up

A startup financial model is important for understanding the current and future state of your business, and communicating this to your team and investors. When building your model, don't think of it as a "tick-box" exercise — the model can be a genuinely useful tool to help you make better business decisions.

If you want to save time and reduce the chance of errors, Causal is a great option for building your model. You can get started with a 2-week free trial, and if you'd like to hire a consultant to help you build your model, then let us know here.