Creating a Simple Financial Model for Your Business

What Is a Financial Model, and Why Do You Need One?

A financial model is essentially a map of your business's financial future. It’s a tool that allows you to project revenue, expenses, cash flow, and profitability over time. Think of it as your business’s crystal ball—except it's powered by numbers, not magic.

Here’s why it matters:

• Decision-making: Need to hire a new employee? Launch a new product? A financial model shows if you can afford it.
• Fundraising: Investors will want to see solid projections before handing over their cash.
• Crisis prevention: Identify financial gaps or risks early and create mitigation strategies.

Step 1: Gathering Historical Data to Build your Financial Model

Before we jump into building one, let's break down what you'll need to create a financial model for your business. This article is focused for businesses who already have been at business for at least a year. For businesses who haven't launched yet, we'll be creating a separate post.

Your financial model should start with the basics—your historical financial statements. These documents provide the data foundation for all projections and insights. Here’s what you need to include:

1. Profit and Loss (P&L) Statement
   The holy grail of all financial statements. The P&L is the statement that most non-finance business owners are most comfortable with. The Income Statement summarizes revenues, costs, and profits over time, showing how they’ve evolved. The P&L is usually tracked using accounting software platforms like Quickbooks or Xero. If you don't have a P&L statement you'll need to create one using historical transaction data pulled from your bank.
2. Balance Sheet:
   This shows your business's assets, liabilities, and equity at a specific point in time. It’s critical for understanding your financial health and ability to take on additional investments or expenses.
3. Cash Flow Statement:
   This tracks how cash moves in and out of your business. It helps you understand whether you have enough liquidity to cover operating expenses and investments.

If you don't have any of these statements, then you should probably spend some time putting them together. Technically you can create a financial model with just a Profit and Loss statement but we don't necessarily recommend it.

Step 2: Consider the Goal of your Financial Model

Once you have your historical data in a good spot you want to consider the goal of your financial model.

• Are you planning for the new year and want to create a budget?
• Are you looking to add a new service or product and want to project what it would do to revenue/expenses?
• Are you planning to sell your business?
• Are you reacting to an unexpected expense or business circumstance and needing to re-forecast?

These are all examples of different ways financial models can be used for businesses.

Step 3: Build Your Base Model

Now that you have your data and goals in mind, you're ready to build your model. The quickest way to do this is to fire up Excel or Google Sheets. However, Kordis also offers forecasting software that you may prefer if you're anti-spreadsheet.

The income statement (also known as the Profit and Loss or P&L statement) is the heart of your financial model. It’s where all forecasting—revenue, expenses, and ultimately profitability—comes together. By using your historical P&L as a starting point, you can create projections that guide your business strategy.

Here’s how to structure your projections within the P&L:

Revenue Projections (Top Line)

Forecasting revenue starts at the top of the income statement. Here’s how to approach it:

1. 12-Month Average Revenue
   • Calculate your monthly average revenue over the last 12 months from your historical P&L.
   • Use this as your baseline for future projections. Adjust for any known changes, like market shifts or new product launches.
2. Incorporate Seasonality
   • If your business experiences seasonal trends, reflect those in your projections.
   • Example: For a business with a holiday spike, adjust Q4 revenue projections to be 30% higher than the monthly average based on past performance.
3. Growth Rate Trends
   • Use year-over-year growth rates from your historical P&L to project future revenue.
   • For example, if your revenue grew by 15% last year, apply that growth rate to next year’s forecast while considering external factors like market competition or expansion opportunities.
4. Break Down Revenue Drivers
   • Disaggregate revenue by key sources (e.g., product lines, services, recurring revenue).
   • Example: If one product line historically contributes 40% of total revenue, ensure that’s reflected in your forecasts.

Expenses

Expenses are the next major section of your P&L. To make accurate forecasts, separate your costs into two categories: Cost of Goods Sold (COGS) and Below-the-Line Expenses.

Cost of Goods Sold (COGS)

‍COGS are the direct costs associated with producing your goods or delivering your services. This includes materials, labor, and other costs that scale with your revenue. Here’s how to project it:

• Historical Averages: Calculate COGS as a percentage of revenue from your historical P&L.
  Example: If your COGS is consistently 40% of revenue, use this ratio to forecast future COGS based on your revenue projections.
• Anticipate Changes: If you expect shifts in production costs (e.g., rising material costs or new suppliers), factor these adjustments into your COGS forecast.

Below-the-Line Expenses

‍Below-the-line expenses are the operational costs that support your business but aren’t directly tied to revenue generation. These include categories like rent, salaries (for non-production roles), marketing, and utilities. Here’s how to forecast them:

• Salaries and Rent: These are generally fixed costs. Carry them forward as-is unless you anticipate changes, like hiring or office expansion.
• Marketing and Growth Initiatives: Use historical spending patterns as a baseline. For instance, if you typically spend 10% of revenue on marketing, apply this ratio to your projections—adjusting for planned increases or decreases.
• Miscellaneous Costs: Review your historical P&L for “other” expenses, like software subscriptions or professional services, and include these in your forecasts.

Profitability

Once you’ve forecasted revenue, COGS, and below-the-line expenses, calculate your Gross Profit and Net Profit:

• Gross Profit: Subtract COGS from revenue. This tells you how much is left to cover operational costs.
• Net Profit: Subtract below-the-line expenses from Gross Profit to see your business's profitability.

Example:
If revenue is $100,000, COGS is $40,000, and below-the-line expenses are $45,000:

• Gross Profit = $100,000 - $40,000 = $60,000
• Net Profit = $60,000 - $45,000 = $15,000

Why Use the Income Statement?

Forecasting directly within the income statement format ensures that your projections are:

• Comprehensive: You capture both direct (COGS) and operational (below-the-line) expenses.
• Actionable: Identifying net profit highlights where adjustments may be needed for sustainability.
• Investor-Ready: A well-structured income statement makes your model easier to understand for stakeholders.

Pro Tip: Tie COGS to Revenue

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When projecting COGS, think of it as a percentage of revenue that scales with your sales. This approach ensures your forecasts reflect the true cost of delivering goods or services as your business grows.

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Conclusion: A Clear Path to Financial Clarity

Building a financial model may seem complex at first, but by grounding it in your Income statement, you can create a simple, structured, and reliable forecast for your business’s future. By focusing on revenue projections, Cost of Goods Sold (COGS), and below-the-line expenses, your model provides a clear snapshot of your profitability and helps you make informed decisions.

Here’s what you’ll gain:

• A roadmap for growth, guided by data you already have.
• Insights to confidently plan for investments, hiring, and expansions.
• The ability to identify potential challenges early and pivot effectively.

However, the success of this approach depends on one crucial factor: accurate historical data. If your bookkeeping isn’t up to date or your records are incomplete, your financial model will be flawed from the start. Good bookkeeping forms the foundation of accurate forecasting—without it, even the best financial model will fall short.

That’s why it’s vital to have a reliable bookkeeper or accounting system in place. At Kordis, we understand the importance of clean and accurate financial data. Our team of highly trained bookkeepers can help you organize your past financial records, clean up discrepancies, and set you on the path to success. We don’t just help you look at your books today—we help you structure them for future growth.

So, whether you’re crafting your first financial model or refining an existing one, remember that accounting and bookkeeping are critical parts of the process. Let Kordis be your partner in creating financial clarity and empowering your business for the future. Ready to take control of your financial data? Get in touch with us today!

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