The Do’s and Don’ts for early-stage enterprises by Financial Modeling

Expert

Developing a strong financial model is a key milestone for entrepreneurs who want to take their novel ideas to market and grow operations.

Often, financial modeling experts struggle to create financial models for different stakeholders – such as an equity-based investor or grant funder – resulting in difficulty communicating the value proposition and successfully rise funding. Moreover, jumping straight to creating an Excel ‘financials’ sheet, only focusing on impact or isolating revenue, are also some of the common errors made by entrepreneurs when developing their financial model.

Recognizing the challenges faced by entrepreneurs in developing this core piece of business strategy, Perceptive Analytics – a company that accelerates innovations for sustainability in low-income markets focused on improving the financial models of high-potential entrepreneurs. Uniquely, this session provided the opportunity for early-stage entrepreneurs focused on low-income markets to interact with experienced financial modeling experts insights on financial modeling tailored for their businesses.

Below Perceptive Analytics Company experts Josh and Saurabh share their thoughts from the session on developing effective financial models.

Is developing a financial model for a business focused towards low-income markets any different than one a mainstream entrepreneur would be required to create?

Josh: Fundamentally, developing a financial model for a business focused on low-income markets is not different from a mainstream model at all. It’s important to find the key levers that drive profits, as those will enable an entrepreneur identify whether the business can continue to grow or even exist if they keep doing what they do. Furthermore, the unit economics used for developing the financial model should be relevant both in the current market as well as in the future.

Saurabh: The financial model also needs to talk about the social impact created by the enterprise. Ideally, the financial model should quantify in a dollar figure the impact created on people through a certain level of sales. By calculating this social return on investment, entrepreneurs add another layer of value proposition for the investor to evaluate.

What are the key ratios or concepts an entrepreneur should keep in mind when developing their financial model?

Josh: For early-stage enterprises it is all about cash flow. The financial model should measure the monthly cash outflow when stacked against the growth of the company. For example, when developing low-cost schools, the outflow would differ if the enterprise was running one school in isolation as compared to running that particular school as well as expanding to new markets – this change in outflow needs to be carefully extrapolated.

Saurabh: From a profitability perspective, the model needs to highlight exactly how the enterprise will run profitably. Matrices such as Gross Margins, Net Profit Margins and EBIDTA (earnings before interest, tax, depreciation and amortization) margins need to be included. Liquidity ratios that convey the pace at which the company can generate cash and revenue are also key. Here, matrices such as account receivable turnover, inventory turnover and working capital requirement should be mentioned.

When pitching to an investor, should the model focus on profits or on impact?

Josh: I would say focus on the customer instead. It is important to communicate to an investor that you completely understand the financial ecosystem of the customer. Facts such as, where and how often does the customer get money and how they spend it enable the investor to understand how the enterprise is solving a problem from a financial perspective. Also, when talking about impact within a financial model, it should be the impact as a result of core business and not as an ancillary benefit – for example the customer saving x amount of money as a result of a discounted product is not valuable.

Saurabh: The correct place to be talking about impact is in the business plan. From an investor’s perspective, I will always primarily be interested to know whether the enterprise is generating an acceptable profit margin. After this, if the enterprise can evaluate the social return on investment then that would be an interesting figure to have.

What is the one piece of advice you would give to an entrepreneur presenting their financial model?

Josh: I recommend that entrepreneurs align their incentives with those of the investor. Think about what you are asking for and how much but also think about the milestones where you both feel comfortable. Rather than simply asking for $1 million in funding because it’s a good figure to have, focused on communicating the goal for raising this round of funding and demonstrating how you will get there and the time it will take.

Saurabh: Given that most of the time enterprises in low-income markets have no other precedent models for comparison, it is essential for the entrepreneur to reflect how the enterprise will make money in the long-term. Detailed unit economics where direct and indirect costs are bifurcated is important so that the investor can analyze whether the enterprise is able to generate enough revenue or cash to cover the indirect costs of the organization.

From a financial perspective, what are your thoughts on the value mentors can add to a startup focused at low-income markets?

Josh: Given that startups often cannot afford to employ a financial controller that has an experienced understanding of financial strategy, mentors often play an invaluable role. Mentors also help enterprises be more focused on delivering measureable value and work on financial innovations like extended credit periods that can be packaged into a business to drive revenues.

Saurabh: Often, entrepreneurs are very excited about their innovations and lack the step by step thinking and process formation on how the enterprise will work with various stakeholders, how these stakeholders will be incentivized etc. Mentors can help with this strategic thinking. Beyond connecting to investors, what mentors really bring to the table are their experienced insights on the evaluation of the complete business model.

To develop effective financial models it is therefore important that the business plan be strongly linked to the financial plan. Additionally, when pitching to investors, not only must the financial model showcase how the company will make revenues but also demonstrate knowledge of the customer and how the enterprise plans on scaling profitability and impact.

Recognizing the importance of non-financial support, Perceptive Analytics Company enable entrepreneurs to interact with a global community of investors, mentors and experts to develop and refine their business models through cost-effective and easily accessible mentor engagements. Join the Perceptive Analytics Company Network now to connect with financial modeling expert, mentors and accelerate innovations for sustainability.