In this blog, I will walk you through the top 3 financial models you should know to build a successful startup. Unfortunately, 1000+ startups have pitched me in the past five years, and 8 of 10 startup founders don't have a well-organized financial model, which creates enormous friction in fundraising and instances of potential investors misunderstood the business models. Having financial models is like driving with a GPS. It can navigate you through the most optimal route by simply planning ahead.
Calculating ROAS is pretty straightforward. Let's use the same example we have above. We know the lifetime value of ABC Saas's customer is $1,000, and we know it costs them $100 to acquire a customer. So we can easily see the ROAS is 10X ($1000 / $100) for ABC Saas. Once we have the individual ROAS for each channel or strategy, we can retire the ones that underperform the benchmark and double down on the ones that outperform others.
Often time, I see too many startups try to do it all at once. What happens then is that they diluted their marketing power by putting effort on underperformed channels. Without knowing what ROAS is for each channel, you won't know which channels to pick. There are just way too many options for startups. ROAS financial model allows you to choose the top-performing marketing channels and make your capital go a long way.
For early-stage startups, it's also a great way to set company-wide goals with revenue forecasts. Startup growth positively correlates to revenue growth. Thus, you can align the company direction with investor expectations by tracking revenue and customer growth milestones. Moreover, you can convey a clear message to the stakeholders that you plan to build a successful company.
Constructing a revenue forecast is not rocket science. First, you have to come up with the first set of your revenue drivers. It can be marketing spend and customer acquisition cost (CAC), growth in SEO traffic, or referral programs. Once you have your first set of revenue drivers, you then map out your revenue forecast, but the work doesn't stop here. With using only the first set of drivers, the estimates would be highly inaccurate. So what you want to do next is decompose the first set of drivers into smaller drivers and map it out onto your revenue forecast again. And you have to keep repeating this process until you find the most optimized accuracy. To keep in mind, you have to balance between decomposing drivers and overfitting the model.
To calculate your runway, you divide the cash you have by the average amount of money you're burning per month. And, this is your runway until you run out of money.
Return on Ad Spend
Most of the startups overlook the importance of return on ad spend (ROAS). However, when you're a startup, you can't compete on resources against incumbents. Incumbents are known to be wasteful. The best competitive advantage a startup has is the skill of resource allocation and capital efficiency. Tracking ROAS is all about betting your marketing dollar on channels or strategies that can give you the most proportion of revenue.Calculating ROAS is pretty straightforward. Let's use the same example we have above. We know the lifetime value of ABC Saas's customer is $1,000, and we know it costs them $100 to acquire a customer. So we can easily see the ROAS is 10X ($1000 / $100) for ABC Saas. Once we have the individual ROAS for each channel or strategy, we can retire the ones that underperform the benchmark and double down on the ones that outperform others.
Often time, I see too many startups try to do it all at once. What happens then is that they diluted their marketing power by putting effort on underperformed channels. Without knowing what ROAS is for each channel, you won't know which channels to pick. There are just way too many options for startups. ROAS financial model allows you to choose the top-performing marketing channels and make your capital go a long way.
Revenue Forecast
Why do you need a revenue forecast? You, as a founder, can think through the economics of your business model and plan for the bigger picture by constructing a revenue forecast. For example, ABC Software company charges each customer $100 per month, and it has a 10% churn rate. We can quickly know that every customer ABC Software bringing in will add $100 to its MRR (monthly recurring revenue) for the next ten months (1 / churn%). Now, you can allocate a more optimized budget to hiring, marketing, and product development by knowing how much revenue you're bringing in in the coming months. Boom! That's how you grow a business and organization.For early-stage startups, it's also a great way to set company-wide goals with revenue forecasts. Startup growth positively correlates to revenue growth. Thus, you can align the company direction with investor expectations by tracking revenue and customer growth milestones. Moreover, you can convey a clear message to the stakeholders that you plan to build a successful company.
Constructing a revenue forecast is not rocket science. First, you have to come up with the first set of your revenue drivers. It can be marketing spend and customer acquisition cost (CAC), growth in SEO traffic, or referral programs. Once you have your first set of revenue drivers, you then map out your revenue forecast, but the work doesn't stop here. With using only the first set of drivers, the estimates would be highly inaccurate. So what you want to do next is decompose the first set of drivers into smaller drivers and map it out onto your revenue forecast again. And you have to keep repeating this process until you find the most optimized accuracy. To keep in mind, you have to balance between decomposing drivers and overfitting the model.
Runway Forecast
Runway Forecast is probably the most critical financial model a startup should have. What happens if the runway is out? The startup dies. If investors fund your startup, typically, you would want to make sure you can get to your following round fundraising milestones within the next 18-24 months. Managing a startup's runway is a craft; you're constantly adjusting the lever between spend more and grow faster or slow down and optimize existing.To calculate your runway, you divide the cash you have by the average amount of money you're burning per month. And, this is your runway until you run out of money.
