Financial business model: where to start an entrepreneur

Often aspiring entrepreneurs have a vague idea of what the financial model of a business is. Some think that financial flows will add up as the company works, while others think that the field of finance is too complex and requires a long mastery. The truth is that translating your business into cash flow and […]

Financial business model: where to start an entrepreneur

Often aspiring entrepreneurs have a vague idea of what the financial model of a business is. Some think that financial flows will add up as the company works, while others think that the field of finance is too complex and requires a long mastery. The truth is that translating your business into cash flow and numbers is important, but it’s easier than it looks.

What is a financial model?

In fact, a financial model is a description of your company and its development in monetary terms. To make a model, you need to understand the specifics and processes of your business, its financial flows. This is the primary task of the entrepreneur.

Traditionally in large companies, the financial model includes a number of blocks: a planned statement of cash flows, which reflects operating, investment and financial cash flows, a profit and loss statement, and a balance sheet.

At the start, you should start with an estimate of the operating part, which will include your revenues and variable and fixed costs. This article will only touch on that part of the model.

Start with revenue planning

The best way to do the financial model at the start is to do it in Excel and plan by month. First, make a list of all sources of revenue and consistently for each of them, enter the sales plan by month in the table.

For a more realistic sales forecast, start by estimating the market and building a sales funnel. To do this, start with the conversion rates of the tools you plan to use. These may be events, context, SMM, content on the network – for offline. Then focus on the possible conversion of your sales department or the conversion of your website into orders / registrations and further on the conversion into payments.

It goes like this: calculate the number of customers per month for each line or position, multiply by the price and the frequency of purchases in that period, then add up the results and you get the final inbound cash flow.

When you’ve projected sales for all your lines or items, estimate your cost of sales. In accounting, this refers to all costs associated with the sale of products, and this includes production and shipping costs. In our case we are talking only about those costs that are associated with the sale of a unit of product: contextual advertising, manager’s bonus, agency commission, and so on. In fact, this part of the model is already related to variable costs, but it is convenient to do a miscalculation of it at this step to understand what resources are needed to generate a given incoming cash flow.

You should end up with a spreadsheet of sales and cost of sales.

Plan your expenses.

In the next step, divide your costs into variable costs, that is, those that depend on the volume of revenue, and fixed costs, which do not directly depend on the volume of revenue.

Variable costs will include all costs that depend on unit sales or service delivery: for example, purchasing, production personnel, including taxes on those salaries, subcontractor work, and transportation costs.

Add up all the variable costs, including sales costs (the cost of sales we previously calculated) and subtract that amount from income – and you get gross profit. It is a good reflection of the efficiency of the operating model.

Next, we calculate the fixed costs, that is, various administrative and business expenses. For example, these are rent, payment of non-production personnel, equipment maintenance, marketing costs, which cannot be directly attributed to the sale of a unit of product.

Cost planning is no less responsible part of the work. The main thing is to be detailed and realistic in your projections. Try to account for all expense items. You may not be able to do it at the first time, and it will take several attempts. Researching the market and competitors, and talking to more experienced entrepreneurs will also help.

Depreciation, taxes, interest – what to do with it?
For a complete understanding of the financial model, several other components are missing. For example – taxes: their calculation depends on the taxation system of the company.

The second is the calculation of costs for the purchase of the means of production, that is, those assets without which you can not start work: equipment, computers and so on. Make a list of necessary purchases and calculate the total costs that you will incur at one time. This is already part of the financial model, which affects the investment component.

For management, accounting, and tax accounting, what is used is what is called depreciation – the allocation of the entire lump sum of the costs of purchasing capital assets over a certain period. From an accounting point of view, this period is set by law. To begin with, you can focus on the useful life of this equipment. That is: divide the total costs by the number of months of depreciation and record the result in the costs of each month. So, for example, the purchase of two laptops for 60 thousand rubles, which will be used during the year, record the costs for each month in the amount of 10 thousand rubles.

Everything to do with depreciation and taxes, especially for companies with large capital expenditures at the start, is closely connected to questions of accounting and tax accounting. The budding entrepreneur should seek advice from professionals who can help navigate through the intricacies of regularly changing legislation and adjust the model.

What to do next with the financial model?

When you put together a forecast of operational, investment and financial activities, you will have one of the key reports – the projected cash flow statement. In addition to that, a complete financial model of the business includes an income statement and a balance sheet. This is the composition most often requested by investors and banks. We will talk about these reports a little later.

Keep in mind that no financial model in a new business is 100% feasible. Your plans need constant adjustment and refinement. Only in the mode of regular monitoring and making changes the financial model starts to bring real benefits to the entrepreneur, helping him predict the future more accurately.

PS:

And a few more technical tips for making a financial model:

  • Establish the planning horizon in which you’ll get the payback on the project.
  • Separate for yourself the components on which you will be guided, and derived from them. For example, you can set the conversion rate of visitors into orders, and then change it by watching how the gross profit changes. These key assumptions are better highlighted in color.
  • For convenience, write the amounts by expense with a minus sign. This will make it easier to work with formulas when calculating financial results.

 

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