3 traits of a great financial model

Founders and non financial people in general usually hate building financial forecasts. But, every startup needs one. You need one in order to raise capital. You need one every year thereafter to present to your board.

For me, financial models are very powerful. The numbers in them are rarely right. It’s not like you need to hit the revenue target that you set for 36 months out. But, the thinking into how your business works, how you grow users, revenue and staff is invaluable.

I have posted before on how to build pro forma models like a pro. Here, I’d like to share the three traits of a great financial model. If your model has these, then you will have a truly useful tool for running your business.

All great models clearly articulate the following:

Drivers: A great model should clearly show you which are the most important levers to focus on. You should be able to clearly see which lever can deliver the most growth. For some businesses, that’s website conversion. For others its sales team upsells. Every business is different. Know which drivers have the biggest impact on your business.

Sausage Machine: Redpoints Tomasz Tunguz calls this the “fundamental unit of growth“.  A great model should clearly show you what machine you have to build in what order as you grow. How many sales reps, sales development reps, etc. do you need for each additional million in revenue? How many marketing-qualified leads are needed to deliver a new account? If you know these things, then you can build a predictable growth machine.

Milestones: When the model is done, it will give you a clear sense of targets and milestones you need to hit each month and quarter. Is conversion rate forecast to go up in 2 quarters? If so, then your growth team had better be working on tests now? The best models translate into actionable and sequenced targets for the entire team so that they “live” the model.

  • I like these considerations a lot. One of the most important aspects of knowing your drivers is that added level of variance analysis – if you know how many users or widgets you needed to drive revenue, and that revenue isn’t as expected, the cause may not be that hard to determine. If you share the story, along with the numbers, it shows you’ve got an idea of what you’re doing versus plastering numbers on the board to see what sticks.

  • Outstanding … and on the unit drivers and related fundamental units of growth, I’d add more-often-than-not stress testing of those drivers too.

    Great stuff – enjoy your writing.

  • Dominic Wun

    Great points Mark. To continue the thoughts in this article, having a great financial model sets out the path for how an organization can achieve stated goals. Tracking milestone achievements and/or driver improvements as performance measurement metrics will ensure operations align their efforts with management plans. The idea is that what gets measured gets managed.