Financial Model

Investors in early-stage companies typically look 5 to 10 years ahead as that’s how long it takes a decent return to be generated. Some industries are faster moving than others (anything medical that requires formalised trials and approvals, or anything seasonally restricted can take much longer).

The one truth of financial models is they are invariably inaccurate because no-one can predict the future. They are therefore underpinned by a series of assumptions, especially around the revenue expectations. A key factor is to record these assumptions clearly, link the parts of the model that use them back to this list, and update them as new data arrives, or to model scenario variance (what’s the error margin if that assumption is incorrect).

One part that should be easy to construct are the costs. Fixed and overhead costs for the staff, premises and assets required to do business should be clearly differentiated from variable costs related to supplying the product or service, and cost of acquisition costs to bring customer onboard.

Whilst for most start-ups the cost of development is simply everything spent up until the point of commercialisation, it is good practice to keep a record of what the product or service cost to bring to life (as opposed to the business that sits around it) as it helps to value the IP. Capitalising these costs means that they are moved to the balance sheet (changing the taxable position of the company, and the valuation measures) and are amortised across a number of years or sales. This means that the business will become profitable more quickly.