Financial Modeling and Forecasting

Importance of the Financial Model and Forecast for a Startup and Spin-off

A financial model and forecast is a strategic management tool. It supports you to estimate and simulate your startup's short term as well as long term performance and profitability. Forecasting potential revenue, expenses, capital investments, including industry-specific operational metrics and KPIs, answers the following questions:

  • What does it take to turn your business idea into an economically viable business?
  • How are you planning to allocate and spend your financial resources?
  • What is your monthly and annual burn rate?
  • What are your funding requirements until the next milestone or break-even point?
  • How scalable is your business model?
  • How fast can you scale your startup with internal or external funding?
  • What are your most relevant KPIs and benchmarks?

How to create a reliable Financial Model and Forecast for your Startup

Creating a solid and reliable financial model and forecast  for startups and spin-offs remains a challenge. The circumstance mostly arises due to lack of historical data and the amount of assumptions that needs to be made during the process. It is therefore not surprising that investors are skeptical about the financial forecasts made by the startups themselves.

Further below we outline the process and the fundamentals that will enable you to create a solid financial model and forecast by yourself that will serve both you as an entrepreneur and your potential investors.


Leave us a message if you lack the time or skills and you just want us to prepare your financial model and forecast on time and in the best quality!

Let a financial modeling example guide you through the process

We start by preparing a framework for your financial model that includes the three statements, namely profit and loss, cash flow and balance sheet statement. Usually, you create a detailed forecast on a monthly basis for the next year that captures short-time operational goals and a less detailed forecast on an annual basis for the next three to five years that reflects your long-term vision. The following three tables showcase each statement in a simplified version before we dive into the details of each. The following link provides you the spreadsheet example to speed up the process.

1. Profit and Loss Statement

2. Cash Flow Statement

3. Balance Sheet Statement

In the next paragraphs, we will explain each of the three financial statements as well as their associated elements in more detail. The downloadable financial modeling template will help you to accelerate the process. The goal is to have a solid understanding of each item but also to know related operational metrics and KPIs. The KPIs are relevant because they enable you to test as well as justify your assumptions made during the creation of your financial forecast with benchmarks observed in the market. Let us start with the profit and loss statement to see how it works.

1) Profit and Loss Statement

The profit & loss statement displays the startup’s income, expenses and profit or loss generated in a specified period. Each line of the statement represents the financial result of a function or service performed by your company. The financial results alone, however, do not explain how the productivity and the efficiency of your operations will be achieved.  You have to link interrelated operational functions with each other and include further operational data in your profit & loss statement. This approach will enable you to state the operational metrics and calculate the KPIs that are specific to your industry. It will also allow you to test and verify your assumptions. Further, you will gain valuable information about the operational performance and scalability of your venture and be able to compare your productivity and efficiency with your competitors.

1.1) Revenue / Turnover / Sales

Your revenue equals the total income generated by the sales of goods or services related to your startup's primary operations. The figure shows your ability to generate money in the market. In the eyes of a startup investor, revenue has a significant impact on your valuation. The basic formula to calculate revenue depends on the type of startup you run i.e product-based or service-based as shown below.

Revenue = Number of Units Sold x Average Price

or

Revenue = Number of Customers x Average Price of Service

Stating the revenue together with the number of customers and average prices or revenue generated by customers enables you to simulate the impact of customer growth and pricing strategies simultaneously. We recommend to include operational metrics and KPIs that fit your business and industry. With this approach you will be able to continuously assess and test your assumptions in your revenue forecast. You will find an non-exhaustive list of operational metrics and KPIs as well as an example for illustration just below to forecast your revenue more reliably.

Operational Metrics - Revenue

  • Serviceable obtainable market
  • Webpage visits
  • New leads
  • Offers outstanding
  • Conversions or new customers
  • Total number of customers
  • Recurring or non-recurring revenue
  • Deferred revenue

KPIs - Revenue

  • Market share
  • Cost per visit
  • Cost per lead
  • Customer acquisition cost
  • Sales cycle
  • Conversion rate
  • Churn rate or retention rate
  • Customer lifetime value
  • Growth rates

Financial Modeling - Revenue

1.2) Cost Of Goods Sold

The line cost of goods sold (COGS) in your profit and loss statement considers all direct expenses related to production and delivery of goods and services. The main drivers are material and labour hours spent for the deliverables. The cost of goods sold move in proportion with your revenue. Deducting them from your revenue determines your gross profit, hence, the remaining revenue share to cover all other expenses of your business. The formula to calculate the cost of goods sold is shown in the following equation.

COGS = Beginning Inventory + Purchases during the Period + Directly related Labour Costs − Ending Inventory

Stating your cost of goods sold in relation to revenue and number of goods or services sold provides you valuable insights about your startup's overall quality. These relative metrics will enable you to assess the strength of your business strategy, product or service lines as well as the operational efficiency of your company. We therefore recommend to include and track operational metrics and KPIs that fit your business in your financial model. You will find a non-exhaustive list of operational metrics and KPIs as well as an illustrative example for modeling your cost of goods sold just below.

Operational Metrics - Cost of Goods Sold

  • Number of goods or services delivered
  • Labour costs per product or service
  • Material costs per product or service
  • COGS per product or service

KPIs - Cost of Goods Sold

  • COGS in % of product or service revenue
  • Share of labour costs
  • Share of material costs
  • COGS in % of revenue

Financial Modeling - Cost of Goods Sold

1.3) Gross Profit

The gross profit provides a good indication about the viability and health of your startup. Investors therefore have a very close look at this profitability figure. On the one hand, your gross profit serves you to cover all other operational expenses. On the other hand, it allows you to simulate the scalability of your business as well as to calculate the break-even point, for example. The gross profit is calculated by subtracting the cost of goods sold from your revenue as shown in the following formula.

Gross Profit = Sales Revenue – Cost of Goods Sold

Taking gross profit in relation to relevant operational metrics enables you to simulate the scalability of your business. Gross profit also is the source to calculate the customer lifetime value and your unit economics. These metrics will provide you the insights you need to scale your startup in a sustainable way with or without raising equity from investors. You will find a non-exhaustive list of operational metrics and KPIs as well as an illustrative example for modeling your gross profit just below.

Operational Metrics - Gross Profit

  • Number of customers
  • Gross profit per customer
  • Customer acquisition costs
  • Gross contribution per customer
  • Management expenses per customer
  • Research and development expenses per customer
  • General and administrative expenses per customer
  • Depreciation per customer
  • Profit per customer

KPIs - Gross Profit

  • Gross profit margin or Gross margin
  • Gross margin per customer
  • Gross contribution margin
  • Customer lifetime value

Financial Modeling - Gross Profit

1.4) Management Expenses

Management expenses occur from maneuvering your venture. They summarize the expenses for strategic and organisational tasks that impact your operations and resource allocation. Elaborating and implementing management systems, defining market positioning and go-to-market strategy are a few examples for such strategic and organisational tasks. The formula to calculate management expenses is stated below.

Management expenses = Hours spent on strategic and organisational Tasks x Hourly Salary

Relating management expenses to other operational metrics provides you insights about the quality and the efficiency of the founders or managers running your business. You will find a non-exhaustive list of operational metrics and KPIs as well as an illustrative example for modeling your management expenses below.

Operational Metrics - Management Expenses

  • Total FTEs
  • Management FTEs
  • Average management salary

KPIs - Management Expenses

  • Management expenses in % of revenue
  • Management expenses per full-time equivalent (FTE)
  • Number of FTEs per manager

Financial Modeling - Management Expenses

1.4) Research and Development Expenses

Research and development (R&D) intends to develop or enhance your products and services. The outcome of this function impacts your profitability but also competitive advantage in the market. Hence, a startup must find the optimal balance between profitability and creating competitive advantages to optimally thrive in its competitive landscape. The formula to calculate R&D expenses is straightforward.

Research & Development Expenses = Hours spent on Research & Development x Hourly Salary

Operational metrics and KPIs for research and development must be evaluated over time. While research and development expenses have a direct impact on short-time profitability, the potential gains occur in the future and will have effects on several performance and profitability metrics. Below you will find a non-exhaustive list with operational metrics and KPIs you have to track over time as well as an illustrative example for financial modeling.

Operational Metrics - Research & Development

  • Number of new products or services developed
  • Number of products or services enhanced
  • Research and development expenses for new products
  • Research and development expenses for enhanced products

KPIs - Research & Development

  • Return on investment of research and development expenses
  • Research and development expenses in % of revenue
  • Change in product-market-fit / Change in conversion rate
  • Change in price
  • Change in customer satisfaction
  • Change in gross margin / Saving level
  • Average time-to-market
  • Planned vs. actual time to market

Financial Modeling - Research & Development

1.5) Marketing and Sales Expenses

The marketing and sales function is your direct link to the market.  The expenses summarize all efforts taken so market and sell your products and services to your customers. Hence, the allocated resources to the function and its productivity determine your revenue growth to a great extent. The expenses mainly consist of salaries and third party costs. The formula for the marketing and sales expenses is stated below.

Marketing and Sales Expenses = Marketing Salaries + Sales Salaries + Third Party Costs for Paid Advertisement and Sales Activities

The marketing and sales activities reveal operational metrics and KPIs that assist you in guiding and setting the right priorities in your startup. The business intelligence gathered in the marketing and sales function indicate where to set priorities and allocate your capital and human resources. The following non-exhaustive list of operational metrics and KPIs will assist you in tracking and monitoring the right information for your business and financial model.

Operational Metrics - Marketing and Sales

  • Reach
  • Number of webpage visits
  • Number of leads
  • Number of new customers or Conversions

KPIs - Marketing and Sales

  • Cost per visit
  • Cost per lead
  • Lead-velocity-rate
  • Visit-to-lead-ratio
  • Lead-to-marketing-qualified-lead-ratio (MQL)
  • MQL-to-opportunity-ratio
  • Opportunity-to-conversion-ratio
  • Lead-to-conversion-ratio
  • Cost per conversion or Customer acquisition costs (CAC)
  • Sales cycle timeline or lead-to-conversion-time
  • CAC payback period

Financial Modeling - Marketing and Sales

1.6) General and Administrative Expenses

The general and administrative expenses summarizes the costs for the support services provided to the organisation, also known as overhead. These consist of the fixed costs to run the business such as IT infrastructure, rent, insurance, accounting and tax. The equation for the general and administrative expenses is as follows.

General and Administrative Expenses = Rent + IT + Administration + Insurance + Accounting and Tax + Other

It is in the interest of a startup to keep general and administrative expenses as low as possible. The following operational data and KPIs assist in assessing the operational efficiency of the support functions with a spreadsheet as an example for the financial model.

Operational Metrics - General and Administrative Expenses

  • Total number of employees
  • Total number of customers
  • New customers

KPIs - General and Administrative Expenses

  • G&A-expenses in % of revenue
  • G&A-expenses per FTE
  • G&A-expenses per customer served
  • G&A-expenses per new customer

Financial Modeling - General and Administrative Expenses

1.7) EBITDA

EBITDA stands for earnings before interest, taxes, depreciation and amortization. The figure is used as a proxy for the operational profitability of a company. In contrast to net profit, the EBITDA is mostly unaffected by financing and accounting practices. You can calculate the EBITDA with the following equation.

EBITDA = Revenue - COGS - Operational Costs

On the one hand, Investors use the EBITDA to assess and compare the profitability of startups with industry benchmarks. On the other hand, the figure finds its application to determine the value of a startup and its ability to serve debt payments. The following operational metrics, KPIs and modelling techniques enable you to highlight valuable information.

Operational Metrics - EBITDA

  • Revenue
  • Employees
  • Debt outstanding

KPIs - EBITDA

  • EBITDA-margin
  • EBITDA per employee
  • Debt/EBITDA-ratio

Financial Modeling - EBITDA

1.8) Depreciation and Amortization Expenses

Depreciation and amortization reflects the reduction in value of assets over time. It is a non-cash expense and an accounting procedure to distribute the costs of fixed assets over their lifetime. The relative size of the depreciation and amortization depends on the applied accounting policies. The following equation illustrates the composition of the expense accounted for in the profit and loss statement.

Depreciation and Amortization = (Fixed Assets / Lifetime) + Change in Loan Values + Change in Value of Intangible Assets

The depreciation and amortization expenses generally play a subordinated role for startups. Notwithstanding, founders have a certain freedom to use accounting principles to their benefit. The following operational metrics and KPIs assist you in reflecting the depreciation and amortization expenses in your financial model. 

Operational Metrics - Depreciation and Amortization

  • Capital expenditures (CAPEX)

KPIs - Depreciation and Amortization

  • Depreciation in % of revenue / Operating-expense ratio
  • Depreciation-to-fixed-assets-ratio 
  • Fixed assets-to-depreciation / Average asset lifetime
  • Capital expenditure-to-depreciation-ratio

Financial Modeling - Depreciation and Amortization

1.9) EBIT / Operating Profit

EBIT is also known as the operating income. The figure measures the profitability of your startup's ongoing operations before accounting for financing and tax expenses. The EBIT can directly be derived from the EBITDA with the following equation.

EBIT = EBITDA – Depreciation and Amortization Expense

The EBIT can be used to compare the profitability with other companies since it neglects the individual capital structures and tax regimes of an organisation. Below you will find a list with operational metrics and KPIs related to the EBIT.

Operational Metrics - EBIT

  • Revenue
  • Average total assets
  • Interest payments
  • Lease payments

KPIs - EBIT

  • EBIT-margin
  • Return on assets
  • Interest coverage
  • Fixed charge coverage
  • EBIT per employee

Financial Modeling - EBIT

1.10) Interest Expenses

Interest expenses occur for borrowed funds. It is a financing expense, income, shown on the income statement. It represents interest payable on any borrowings such as bonds, loans, convertible debt or lines of credit. Interest is essentially calculated as the interest rate times the average outstanding principal amount of the debt as shown below.

Interest Expenses = Debt Outstanding x Interest

Interest Income = Financial Assets x Interest Coupon

The operational metrics and KPIs for interest expenses are listed below together with a financial modeling example.

Operational Metrics - Interest Expenses

  • Outstanding debt

KPIs - Interest Expenses

  • Average interest on debt

Financial Modeling - Interest Expenses

1.11) Tax Expenses

The applicable tax rate depends on the tax regime the company resides and conducts business in. The following equation leads to the tax expenses owed to tax authorities.

Tax Expense = Tax Rate x (EBIT - Interest Expenses)

Operational metrics and KPIs related to tax are shown below together with a financial modeling example.

Operational Metrics - Tax Expenses

  • Earnings before taxes (EBT)

KPIs - Tax Expenses

  • Tax rate
  • Effective tax rate

Financial Modeling - Tax Expenses

1.12) Net Income

The net income is the final element of the profit and loss statement. Next to profitability, the figure also determines the amount available for distribution as dividends. The equation for the net income is the following.

Net Income = EBIT - Interest Expenses - Tax Expenses

Operational metrics and KPIs related to net income are shown below together with an example for your financial model.

Operational Metrics - Net Income

  • Earnings before taxes (EBT)
  • Dividends

KPIs - Net Income

  • Net profit margin
  • Tax burden
  • Dividend coverage ratio

Financial Modeling - Net Income

The profit and loss statement shows the financial results of your operations over a given period, but does not show actual cash flows. On the one hand, the profit and loss accounts depend on the accounting practices applied. On the other hand, the statement does not show the total capital required to run your business. Therefore you have to derive the cash flow statement. In our opinion, this statement is more relevant than the profit and loss statement. The next section will explain why.

2) Cash Flow Statement

The cash flow statement shows the amount of cash inflows and outflows from your operating, investing and financing activities. The cash flow statement is divided into three sections.

  1. Cash flow from operations

  2. Cash flow from investing

  3. Cash flow from financing

The operating cash flow summarises the cash inflows and outflows from your main business activities. The cash flow from investing activities records the capital expenditures and financial investments that your company makes. The sum of the operating cash flow and the investment cash flow, after adjustment for investments that are not necessary for your company, is the free cash flow. The free cash flow is an important indicator, as it corresponds to the burn rate of your startup. The cash flow from financing shows the inflow and outflow of debt and equity, i.e. how you finance your business. The sum of all three cash flows gives the change in the cash in your balance. The table below gives you an overview before we go into the details of the individual sections.

2.1) Operating Cash Flow

The cash flow from operations reveals how much cash your daily business activities have generated or burnt in a specified time period. You can derive the cash flow from operations with the direct or indirect method. Since the indirect method is quicker and provides the same result we only show the latter method. In the indirect method you correct the net-income for cash- and non-cash effective items. The formula to calculate the operational cash flow indirectly is as follows.

Operational Cash Flow = Net Income + Depreciation and Amortization - Change in Working Capital + Change in Non-Cash Provisions

The operational metrics and KPIs related to the operational cash flow reveal valuable insights about your business model and your ability to bootstrap your startup. Find a list of relevant operational metrics and KPIs below together with a financial modeling example.

Operational Metrics - Operational Cash Flow

  • Change in receivables
  • Change in inventory
  • Change in payables
  • Change in deferred taxes
  • Change in non-cash provisions

KPIs - Operational Cash Flow

  • Cash flow-to-revenue ratio / Operational cash flow margin
  • Cash-to-income ratio
  • Interest coverage ratio
  • Cash conversion cycle
  • Cash rotation
  • Dividend payment ratio
  • Cash return-on-assets ratio
  • Cash return-on-equity ratio

  • Debt coverage ratio

Financial Modeling - Operating Cash Flow

2.2) Cash Flow from Investing Activities

The cash flow from investing activities comprises investments in fixed assets and investments in financial assets as well as their divestments. The formula for the cash flow from investing activities is as shown below.

Investing Cash Flow = CAPEX + Financial Investments - Divestments

Operational metrics and KPIs related to investing cash flow are given below, together with an example for a financial model.

Operational Metrics - Investing Cash Flow

  • Revenue
  • Depreciation

KPIs - Investing Cash Flow

  • Capital expenditure-to-depreciation-ratio 
  • Break even time
  • Return on investments

Financial Model - Investing Cash Flow

2.3) Free Cash Flow / Burn Rate

The free cash flow corresponds to your burn rate. The figure reflects all cash inflows and outflows, including investments and disposals of fixed and financial assets, required to run your startup. The equation is as follows.

Free Cash Flow = Operating Cash Flow - Investing Cash Flow

Operational metrics and KPIs related to free cash flow are presented below together with an example in the financial model.

Operational Metrics - Free Cash Flow

  • Revenue
  • Number of days in observed period
  • Number of customers
  • Total debt

KPIs - Free Cash Flow

  • Free cash flow-margin
  • Burn rate per day
  • Burn rate per customer
  • Free cash flow-to-debt-ratio

Financial Modeling - Free Cash Flow

2.3) Cash Flow from Financing Activities

The cash flow from financing activities shows how you finance your business operations. It captures all in- and outflows in debt and equity. The formula for the financing cash flow is as follows.

Financing Cash Flow = Change in debt + Change in Equity - Dividends

Operational metrics and KPIs related to financing cash flow are shown below, together with a financial modeling example.

Operational Metrics - Cash Flow from Financing Activities

  • Total debt
  • Total equity

KPIs - Cash Flow from Financing Activities

  • Change in debt-to-total debt
  • Change in equity-to-total equity

Financial Modeling - Cash Flow from Financing Activities

The sum of the cash flows from operating, investing and financing activities results in your expected change in cash on hand in your balance sheet. The next section explains how the profit and loss account and cash flow statement relate to your balance sheet.

3) Balance Sheet Statement

The balance sheet shows the value of your assets, your financial liabilities and your equity. The assets are categorized as current or fixed assets and sorted by liquidity. The liabilities and equity, which are divided into the categories current, long-term liabilities and equity, are sorted by expected repayment date, i.e. maturity. The sum of your assets and the sum of liabilities and equity have to be equal. The following table illustrates the basic structure of the balance sheet before we dive into the details of each category.

3.1) Current Assets

Current assets consist of the assets you need to run your business and which you could liquidate in the next twelve months to serve liabilities. Hence, the current assets provide you with relevant information concerning the efficiency of your business operations and your liquidity situation. Current assets are the sum of the following items.

Current Assets = Cash Balance + Receivables + Inventories + Prepaid Expenses + Short-term financial Assets + Other Liquid Assets

Relevant operational metrics and KPIs are listed below, together with an example for your financial model.

Operational Metrics - Current Assets

  • Number of FTEs
  • Average total receivables
  • Average total inventory
  • Average trade payables
  • Total current liabilities
  • Average daily expenditures

KPIs - Current Assets

  • Current assets per FTE
  • Working capital turnover
  • Receivables turnover
  • Days of sales outstanding
  • Inventory turnover
  • Days of inventory on hand
  • Current ratio
  • Quick ratio
  • Cash ratio
  • Defensive interval

Financial Modeling - Current Assets

3.2) Fixed Assets

The fixed assets consist of intellectual and durable assets with a duration of over twelve months. The fixed assets and the current assets combined indicate the capital intensity of your business. The equation for the fixed assets is as follows.

Fixed Assets = Intellectual Property + Goodwill + Accrued Research and Development + Machinery + Property + Land

Relevant operational metrics and KPIs are listed below, together with an example for your financial model.

Operational Metrics - Fixed Assets

  • Average net fixed assets
  • Average total assets

KPIs - Fixed Assets

  • Fixed assets per customer
  • Fixed assets per FTE
  • Fixed asset turnover
  • Total asset turnover
  • Operating return on assets
  • Return on assets

Financial Modeling - Fixed Assets

3.3) Liabilities

The liabilities summarize the short and long-term obligations that your business has to cover. Total liabilities are made up as follows.

Total Liabilities = Trade Payables + Deferred Wages + Deferred Revenue + Deferred Taxes + Other Short-term Liabilities + Short-term Provisions + Long-term Debt + Long-term Provisions + Convertible Loans

Relevant operational metrics and KPIs are listed below together with the financial model example.

Operational Metrics - Liabilities

  • Total shareholders' equity
  • Average total equity
  • Total debt
  • Total assets

KPIs - Liabilities

  • Debt-to-equity
  • Debt-to-capital
  • Debt-to-assets
  • Financial leverage

Financial Modeling - Liabilities

3.4) Equity

The equity of your startup comprises your shareholders' equity and the equity generated through your operations. The equation to calculate total equity is as follows.

Total Equity = Shareholders' Equity + Equity Premium + Regulatory Equity Reserves + Retained Earnings + Current Earnings

Relevant operational metrics and KPIs related to equity are listed below, together with an example in your financial model.

Operational Metrics - Equity

  • Net income
  • Preferred dividends
  • Number of shares
  • Equity per share
  • Return per share

KPIs - Equity

  • Return on equity
  • Return on common equity
  • Price-to-book-ratio

Financial Modeling - Equity

Best Practices in Financial Modeling

You have to carry out some best practices to create a robust and reliable financial model and forecast. The most relevant are outlined below:

  • Identify, calculate and include the most relevant KPIs for your industry in your financial forecast.
  • Benchmark your assumptions and KPIs with the metrics observed in the market.
  • Analyze your startup's past performance and relate it with the assumptions in your financial model. Find strong arguments and strategies to achieve your assumptions.
  • Perform a top-down analysis to check the plausibility of your long-term assumptions.

Prices for Financial Modeling and Forecasting

From scratch:

CHF 2000-4000

Model check & benchmarking:

CHF 500-1000

Enhance:

CHF 500

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Risks of not applying Financial Modeling and Forecasting correctly

  • You won’t be able to get to know your startup’s long term growth potential

  • You won’t be able to track your actual performance of your startup with expected budget

  • You won’t be able to define funding needs and strategy to acquire funds

  • You won’t be able to make data driven decisions

  • You won’t be able show your business strategy to Investors

  • You won’t be able to identify most money consuming processes in your startup

  • You won’t be able to do the three scenarios testing and sensitivity analysis

  • You won’t be able to understand key metrics of your business

  • You won’t be able to Identify opportunities arising within your startup