I don’t have a crystal ball. How can I build a financial model?

I don’t have a crystal ball. How can I build a financial model?

Let’s face it, if you could predict the future, would you be reading this right now?  Would you be on LinkedIn trying to network or learn something about your business if you could forecast, say, Google’s stock price?  We didn’t think so.

Nevertheless, there are compelling reasons why you as a business owner seeking funding from a VC or other sophisticated investor need to prepare a financial model.  Here are some of them.

A financial model ultimately helps you develop and refine your business plan.  It forces you to break down your value drivers into milestones and benchmarks.  Thus, it helps you identify those value drivers, set goals and analyze your company’s underlying business proposition.

A well structured, bottoms-up financial model let’s you analyze what-if scenarios.  By changing your set of assumptions, you can “test drive” different scenarios and develop a strategy for dealing with them in the future.  As such, a financial model becomes a management tool that helps you understand the financial implications of certain actions, without going through potentially costly trial and error phases.

There are many more compelling reasons why you need a detailed financial model.  In the end, if you would like to raise funds from sophisticated investors, you need to show that you have done your homework.  A financial model becomes a sales tool that tells investors that you know what you are talking about.

What should a model not be used for?  In our view, it should not be used to calculate a single number such as an IRR or return multiple.  If you think you can accurately predict that, you may want to think about becoming that day trader.

If you have a valuation question or are currently considering raising funds and you wish to become a CENAK Consulting L.P. client, please submit your information to info@cenak.com.

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