Your financial model is a map for the future

Planning the future of your company is all fun and games until it comes down to the numbers. That moment when you need to take all that talk about how massive your market is or how many deals you have in the pipeline and put pen to paper, or, in this case, fingers to keyboard. This is where having some sort of framework to build from is a difference maker. So, let’s cover some of the basics of financial modeling.

Basics of financial modeling

Assumptions

We all make assumptions with our business and it’s important to track them and hold ourselves accountable to them. The most important thing about these assumptions is to be realistic with them. If you are launching a new product or are planning a growth year and you haven’t done it before or haven’t thoroughly tested the market, marking down a ridiculous rate of return would be classified as unrealistic. Or saying that the margins on a new product will be 90% when your company has been running at 30% since inception or your margin improvement plan will cut expenses by 50%. At some point in our careers, we’ve all seen these outrageous claims, and have maybe even made them ourselves (I’m in both camps).
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Be realistic about TAM

Know what you are getting into when you are mapping out your sales and your expenses. It’s good to be optimistic about these numbers and set lofty goals but we all have that internal “bullshit” meter and we all know when we’re at that point. Understand that every industry is different and your Total Addressable Market, or TAM, may change through the lifetime of your business. Market share is something all companies discuss and work towards, but touting a potential “market share” that is based on an inflated TAM can get you in trouble.

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Get your people expense right

One of the largest expenses of any company is the people, and that is one expense you need to get right. The larger a company gets revenue wise, the larger the company gets people wise to support that. Pretty simple right? You would think so. I’ve seen countless companies draw up these plans that are all about massive growth and 200% returns with little to no expense increases, including their people. Be honest and fair with your projections and be honest and fair with what you need to get you there. The recipe for building your assumptions is this: set your current baseline of where you’re at today, set your realistic goal of where you want to be, identify your company needs, and fill the gap with realistic assumptions to get you there. In theory, it’s a very simple concept. In practice, it’s one that is fraught with danger and one that us as entrepreneurs must be realistic with and not succumb to the sirens of what could be.