The best way to think of a financial model is as a numbers-driven roadmap, which shows a business or project's financial performance, allowing for projections, analysis, and decision-making. It typically involves calculating various financial statements and key performance indicators (KPIs) based on your assumptions, market trends, and future growth rate.

1. They enable startups to evaluate their financial viability, identify potential interconnections and risks, and optimize their business model.

Before you start your business and spend your investments, you can:

• estimate profitability, understand how viable this particular business is, what basic income the business will generate, what principal expenses it will incur, and what investments it will require;
• determine how the various indicators are interrelated. For example, a certain amount of revenue will be related to the number of customers that you have to be ready to handle, hiring staff in a timely manner and preparing the infrastructure;
• during the modeling process, it will be possible to identify underperforming activities and optimize them.

2. It’ll help you understand the key levers of your business
This is key for swift, efficient decision-making.

For example - increasing pricing will generally lead to more revenue. But while some customers will accept higher prices, others will leave if there is a price increase. Should you price down at first to capture the market, or will that erode your future profitability?

Maybe hiring software developers will help you perfect the product, but investors will want to know if you have an effective go-to-market plan, for which you need sales personnel. Which should you prioritize, or do you have enough capital to do both?

3. It’ll help you test and iterate on key assumptions
Your business will perform differently, which is based on parameters you assume. So being aware of and preparing for different scenarios is critical to any decision-making exercise. A well-built, flexible model will allow you to quickly shift between scenarios and modify assumptions, adding a new layer of information to in-depth strategy discussions.

4. It’ll help you effectively communicate with key stakeholders
Among other uses, financial models are also powerful sales documents, which speaks volumes about a founders’ business acumen and commercial capabilities. Assumptions should be well-backed, but ambitious; growth expectations should be sensible, but compelling; and strategy points should be purposeful and well-timed. Little is more compelling to investors (and partners & future employees) than a founder who can show, not only qualitatively but concretely, why their success is inevitable.

A financial model isn’t just an exercise in futility; there’s a point to it. Several points in fact. A potential investor wants to see:

•  that you have a good handle on the revenue drivers of your business;
• the evolution of your costs and expenses over time as compared to revenue growth rates to ensure that your business model is profitable and scalable;
• if you are realistic about growth potential;
• that your financials are complete and presented clearly;
• how their investment will be used and whether more will be needed in the future (it probably will); and, finally,
• strong investments ratios, that show what return an investor can expect, and when.

If you answer at least on time YES to one of these questions, you definitely need a Financial Model:

1. Do you want to build a (financially) sustainable business?
2. Are you looking for funding?
3. Do you want to avoid going bankrupt?

If your startup is at the fundraising stage, a well-constructed financial model is even more critical. It will enable you to:

• Showcase your startup's potential growth and profitability to investors.
• Provide a solid foundation for negotiations, ensuring you're well-prepared to answer questions and justify your valuation.
• Help you determine the amount of funding needed and the optimal use of funds to accelerate growth.