A financial model that produces accurate forecasts is not an easy task to complete. However, it is also a process rife with trial and error, numerous hiccups, and potential frustration. This can make it difficult for a company to predict what is going to happen, spend wisely, and avoid financial bullets.
There is no doubt that engaging in financial modeling for the first time can be a surreal experience for startups. However, a financial expert who specializes in startup finance advises them to embrace uncertainty and take the leap of faith.
During a recent NetSuite webinar sponsored by NetSuite, Miran Nik, an angel investor, an experienced Chief Financial Officer of startups, and the former vice president of finance at healthcare infrastructure provider Truepill, said, "The model you create for your company will always be incorrect." What matters is that we model.
In Nik's webinar, he and his webinar host, Eric Bahn, co-founder of the venture capital firm Hustle Fund Management, stressed that investors want to see a founder who is prepared to think ahead of the curve, and who can project three years into the future. The founders of the company can demonstrate to them their commitment to this goal by demonstrating their interest in financial modeling, especially if they adhere to the golden accounting equation: assets equal liabilities plus equity.
It is very impressive when a founder knows everything down to the nitty-gritty," Nik said. "It is what I would like to see in an angel investor."
Take your limits to the limit.
The founders of startups who are trying to upgrade their companies through financial modeling, or by aiming to act as if they are at a later stage of maturity, have a lot more confidence in him, according to Bahn. As a result, they will often be trying to create a forecasting model without any historical data upon which assumptions can be based. In addition, they will do their best to stay on top of the balance sheet, income statement and cash flow of the organization.
"Even if I know it will not work out, it is still very telling that you are thinking about your business," said Dave Bahn, "even if I know it is going to be completely wrong."
Even so, it is still very important for financial forecasters to be able to make assumptions based on historical data. And that is why Nik recommends that startups pay particular attention to creating accurate historical data. It is a well-known fact that if companies do not, they are subjected to the dreaded "garbage in, garbage out" reality that they will have to endure when working with flawed data.
Therefore, the more thorough and accurate the historical data about a company is, the more accurate and valuable its financial model will be. This is also true of the forecasts it generates.
I think that the model improves with engagement," said Nik. "I think that modeling forces you to think through the inputs in a different way."
Take a big picture approach
This is important because Nik believes that one of the primary potential pitfalls startups should avoid is that tendency to capture everything. Instead of trying to figure out the model's output in a single instance, he advised them to take a broader view and focus their efforts and time on three to five levers that are likely to account for 80% of it.
It is very dangerous to think that modeling is going to be the answer to all of my questions, Nik said. "Don't let the dark side seduce you into thinking that it will answer all of them," Nik said.
Conclusion
A financial model can provide companies with projections that, at a minimum, can help them to determine how much they can afford to spend. It can also help them to determine where they should spend that money in the best way. As they mature, they are able to deliver much more accurate if-then scenarios, which serve as a sort of crystal ball as they become more sophisticated.
"The whole point of a model is to make you think about the future world," he said, "so that you can make decisions about where you want to go in the future."