Whether you’re an entrepreneur looking to launch your next big idea or a company founder ready to expand your existing product line, it’s a major step and a significant decision. Before you move forward, you need confidence that your concept is financially viable. You’ll have lots of questions—but you may not have an easy way to answer them.
That’s when financial modeling can help.
Financial models are powerful tools that help entrepreneurs and founders make informed decisions of all kinds, including whether to move ahead with a new product or service idea.
Knowing When You Need a Financial Model
Financial modeling is a must-have in several critical business situations.
You’re launching a startup.
Before you invest capital in a brand-new venture—either your own funds or seed capital from other sources—you need to assess how your concept will play out in the real world. That means pressure testing your idea from a financial perspective, checking to see if (and when) you can expect to turn a profit.
You’re expanding your product line.
Let’s say you’re already operating an early-stage company and you see an opportunity to expand your products or services to meet evolving customer needs or industry trends. Before you invest funds in developing this new offering, you need to confirm whether it’s a profitable proposition and how it will impact the performance of the company.
You’re preparing for a fundraising round.
If you plan to approach investors to secure capital to launch your new venture or expand an existing business, they’ll expect more than just a flashy product pitch. Before investors commit significant capital, you’ll need to convince them there’s a strong return on investment (ROI) potential.
In situations like these, a financial model can provide the projections you and your investors need to make informed decisions about moving forward with plans for a new product or service.
What a Financial Model Can Tell You
Whenever you embark on a new venture or consider expanding your current product lineup, you need assurance that the idea is financially sound and you can make money—at a minimum in the long term, and ideally in the short term.
A well-developed financial model is a relatively inexpensive way to make that determination—before you take the more expensive step of launching your startup or operationalizing your concept. A financial model allows you to test your assumptions, consider different what-if scenarios, and determine whether your new product or service concept will yield a strong ROI.
Financial models can help address questions like these, and many more:
- How should we price our new product offering to be both profitable and competitive?
- What kind of margins can we expect to achieve based on our estimated cost of goods sold (COGS)?
- What will our revenue look like in year one, two, and three if we sell a technology service on a subscription basis and achieve a 75 percent customer retention rate?
A financial model also can help you determine which levers will help ensure a good outcome if you decide to move ahead with a new product or service. With many levers to pull in operating a business, each with a potentially significant impact on company performance, the ability to assess their effects through financial modeling can help you make operational decisions with greater confidence.
What Goes into the Financial Model
Building a financial model starts with gathering information about various aspects of your business—the inputs that go into the model and determine the final outputs. While some of those inputs might vary by type of business or industry, a few information sources are integral to any good financial model.
- Your projected revenue, based on the total units you expect to sell and the price you expect to sell the product or service for
- All the direct costs that go into producing the product (also known as COGS)
- Other operating expenses associated with the product, including selling and administrative expenses
What Comes out of the Model
While the outputs of a financial model may vary, one of the most useful formats is the three-statement model, which includes:
An income statement (also known as a profit and loss statement), which shows your revenues and expenses for a specific period
A balance sheet, which is a snapshot in time that shows your assets, liabilities, and shareholder’s equity
A cash flow statement, which shows how cash will flow in and out of the business
The timeframe your financial model covers and the level of detail it includes will vary based on the model’s purpose. The shorter your time horizon, the more detailed and robust the model will be, and vice versa.
Let’s say you want to add a new service and need to see how it will impact your business’s financial performance next year. You’ll have more robust short-term assumptions to base the model on, but you’ll only forecast out through the next year for the greatest accuracy. In this case, a one-year operating budget may be ideal.
If, instead, you’re asking investors for capital to launch a new venture based on a new product idea, they’ll typically want to see your projected financial picture three to five years out. Those longer-term assumptions will be less refined, so your model will be less detailed, focusing instead on showing where you’re heading directionally.
Getting Started with Scrubbed Financial Modeling Services
The quality of your financial modeling outputs is highly dependent on the quality of your financial inputs. But gathering that information—and making sure it’s based on sound, realistic, data-based assumptions—isn’t always straightforward.
For example: How can you accurately gauge your cost structures? How can you forecast revenue with confidence? Should you forecast revenue based on market size, or take a bottom-up approach based on the volume of units you can produce now and as you scale up?
That’s where the finance professionals at Scrubbed can help!
We work closely with entrepreneurs and founders to develop accurate information and assumptions before we develop the financial models that are critical to your decision making. We guide you on what type of information you need to gather and develop and prompt you on how to think through key questions thoughtfully. The information-gathering process alone can pay big dividends, yielding eye-opening discoveries that impact how you operate the business.
If you’re thinking of launching a new venture or adding a new product or service to your offering, financial modeling can help you make an informed, strategic decision. Get in touch with Scrubbed to learn how our financial modeling services can aid your new product decision making!