Lately, I have had the pleasure of working with several innovative and rapidly growing companies that are poised to have a significant impact on the industry. One of the common components to their success has been the early development of a dynamic financial model that accurately reflects the key elements of their business.
A comprehensive business and financial model, outlining the plans for a company’s growth and execution, is critical for understanding profitability and cash flow, defining profitable growth, understanding scalability and setting and executing goals. It can also be essential in raising capital, if needed.
Often, companies are started with a great idea that is quickly developed into a product/service. Yet many of these companies fail to put together a comprehensive financial plan that supports the profitability and long-term vision of the organization. A strong financial model not only bolsters several facets of a rapidly growing organization but also serves as the backbone for a pitch deck and goal setting activity.
Prior to the development of the financial model, as part of its strategic assessment, a company should consider external influences. There are several data points to consider, including defining your brand and understanding your brand in relation to the market.
First, a company should consider its overall value proposition and what the brand represents. This is a critical step because how a brand is defined will guide the pricing of the product/service and will help determine its cost base. Does your brand represent the high end of the market for the product/service or the budget-friendly version? Up-front brand definition will help guide product pricing and will serve as a determinant in the costs to support it. For example, if a brand stands for high-touch customer service, its costs will look very different than a model with little client interaction.
Another major external factor to be considered is the competitive environment. Are you a trailblazer where your product will be the first of its kind? Or will you be entering a crowded market where there is fierce competition? You will need to assess how your product/service compares to competitors and where you want to position it in relation to those competitors. This is a critical step to assess as it will impact all aspects of your financial model.
To build the actual financial model, the company will need to consider pricing, variable costs, fixed costs and tax laws (county and state). A company also needs to consider its growth trajectory and how it can effectively scale the business. One needs to consider how the product will be priced and what type of discounts, if any, will be offered. Will you have a recurring fee for the product/service you provide? Will you offer repeat customer discounts? Or is your product/service a one-time consumer purchase? Depending on the answers to these questions, your model will contain different attributes.
Costs need to be broken into fixed and variable. Variable costs increase as each product/service is produced. Fixed costs tend not to change until critical mass is achieved. Costs should also be separated into manufacturing, sales, distribution and support under these categories. Defining which costs are scalable versus those that are incurred with the application of each product/service will help determine scalability and overall profitability of what is being offered. This will also allow you to assess cash flow and profitability. Many support and management costs fall into the fixed category (for example, legal, accounting and support costs).
Additionally, taxes need to be taken into consideration. Tax laws vary from county to county and state to state, so it is important to familiarize yourself with how much your business needs to set aside for taxes. In addition to local, state and federal taxes, companies may be subject to sales tax, and if the business has employees, it will need to plan for payroll taxes.
Other areas to consider in a model are how much you plan to spend on advertising and sales. This depends largely on how you plan to distribute your product/service and how you want to get the word out to the marketplace. Advertising costs can be more intensive for a startup compared to a known and well-established brand. Sales costs can be variable if you compensate your sales team in commissions based on the number of products/services they sell. Also, determine how much money you need to continue refining the product/service to keep it relevant.
The financial model should be designed to support monthly, quarterly and annual projections and should be flexible enough to support shifts in pricing, quantities, product inputs and tax calculation. This will allow for scenario analyses that outline how changes in variables can impact your overall financial health. It will also allow you to have a dynamic, real-time plan.
Once the financial model is finalized, it can be leveraged for many different uses. It will allow you to plan financial goals for your company to achieve. A pitch deck, which is instrumental in outlining the company’s value proposition and raising capital, can be developed. Regardless, a solid and well-thought-out financial model will serve as the foundation to your company’s growth and will aid in the overall success of your business.
Kim Gladkowski is a partner in New Agrariae, LLC, a full-service consulting firm committed to parity in the agricultural supply chain. The company provides equitable solutions from seed to shelf and can provide all aspects of consulting, including C-suite services, corporate social responsibility planning, fundraising, expertise and consulting in farming, research and development, regenerative agriculture, reduction in carbon footprint, vertical supply chain integration and all aspects of operations, production and sales. She is also the owner of EBalance, a full-service accounting firm, and can be reached at email@example.com.