by Will Little and Troy Henikoff
This series is the result of a friendly debate I had recently with Troy Henikoff (Techstars Chicago Managing Director) regarding the best approach for founders to take when building a financial model. More accurately, the “debate” was a strong adverse reaction from Troy after I shared a template I built for Prota Ventures’ portfolio companies. His feedback was, essentially, to never use a template and instead build each model from scratch.
He invited me to a 90-minute lecture he gave where he overwhelmingly convinced me and the room that, indeed, founders need to take the time necessary to build their models from scratch. After I asked him where I could find his lecture material online, he suggested we co-author this article series since there weren’t many solid resources available. We sincerely hope you find this series helpful.
What is a Financial Model?
In short, a financial model is an abstract mathematical representation of how a company works (and more importantly, how it will work going forward). The model has inputs and outputs. The inputs are the assumptions that drive the model, things like what drives your customer acquisition cost, what your churn rates are, how much you pay people, etc. The outputs are a set of projections that show how the company will perform if the assumptions are true. One model can produce multiple sets of projections given different assumptions.
Based on a set of assumptions, a financial model is used to make smart decisions (e.g. how many sales people to hire and what to pay them). The model includes financial projections that are tied mathematically to the assumptions, which allows operators to “play with the variables” in order to understand how certain decisions might affect the future health of their company.