Speaker 1: This week I sat down to look into every single financial model video on YouTube and they all just focus on the spreadsheet part. Hi all and welcome to this video. Now what we can do is we can do exactly the same. And yes of course a financial model is a spreadsheet and we are going to get to spreadsheets today. But before we even touch spreadsheets we need to get on the same page about what the financial model is, how it should work, and the most common mistakes that startup founders make while doing a financial model. Because it is a spreadsheet at which you throw data, you throw expenses, you throw assumptions about the business, you throw real benchmarks from other companies. And on the other side this spreadsheet spits out some key company questions. But these are super key company questions. Some of them are really urgent like almost like life-and-death questions for your business. Like how much runway do you have? Which means how long do you have until you run out of money? Or can you afford that new hire that you're planning? Or that new marketing campaign? Or if you're looking for investors how much money exactly do you need to raise and buy when? I've seen way too many founders just put in that we're raising a million dollars with no backing of any numbers and not having run the math. And of course what happens is that this falls apart the moment that investors start asking questions about what they plan to do. Now other answers more midterm like how big can the company get or how much will it cost to get that big or how effective will this marketing campaign be or what the company valuation is today. Many companies, most companies I see honestly approach this by just putting out a few revenue assumptions or a few user acquisition assumptions. So this is how many users that we're gonna get. We're gonna get 10% more customers every month and therefore this is how much revenue we're gonna make every month. Or even worse they'll just say revenue is gonna grow 10% month over month for the first three years. Period. And to do that we're just gonna put a number for what we plan to spend on marketing. And this is the team that we need to hire. And this of course makes no sense. The right way to do this is to understand the drivers of your revenue and to think of revenue as the effect not as the cost. This approach is called driver based financial modeling or driver based planning. And in this video I'm gonna teach you everything that I know about it. We're gonna draw some diagrams for a few common financial models together and we'll get to turning that logic into an actual spreadsheet. So like I said we're not getting into spreadsheets just yet. We work on dozens of these financial models for customers every year and every single one of them starts with a canvas. Color coding here is green for revenue, red for costs, any expense that's directly proportional tied to revenue like your servers or product manufacturing costs. And then blue is for SG&A, that's sales, general and administrative expenses. Pretty much every other expense the business makes will fall into SG&A. And then yellow is for CAPEX, that's capital expenditures which are expenses of cash that buy assets like computers or stuff that you own that still has monetary value even though you've spent dollars to buy. Now this color coding is used pretty much across every single spreadsheet that we do. So it's pretty easy to navigate and to tell what is what across the different pages. I've also placed links to all of these templates in the cards of the video so you're gonna keep an eye on those. Now each one of these categories is of course split into others and most of them are pretty easy to grasp. For example, you can budget your rent or add your subscriptions to estimate how much the bill will be at the end of the month. Inside of SG&A, the easiest connection that you can make is connect your headcount to the cost of this tool. For example, your G Suite will be six bucks a month per user so you know that for every new team member that you add you're gonna pay Google an extra six dollars. If you work out of a co-working space that's probably about $500 per seat so again you can tie those numbers together to always have an accurate estimate of what the expense is going to be. Now that is the easy part. I want to get to the good stuff. Now if we're to draw out the model that I mentioned, the one that doesn't work, that's a model in which revenue is the input so that's the driver. So you input revenue and then that drives hires and marketing costs but again that's of course not how things work in real life. In real life, you spend money on a campaign and then that campaign drives conversions or you spend money on a sales team and then that sales team will drive new leads down your conversion funnel. Both that marketing campaign and that sales team are the drivers. They drive the revenue but most importantly they are blue boxes. You need to spend money so that if the campaign is effective it'll drive revenue. So this is a blue SG&A expense box. When you look at this on a spreadsheet it doesn't really make that much sense and that's why I think people get very lost but visually I think it's a lot easier to grasp and that's why we always start there. And it's these KPIs, the numbers in the arrows, that function as a reality check to see if your assumptions are real. For example, it's common knowledge that a cost per install for an app will range between one and three dollars in the US or that the cost of a click via Google app will rarely cost under one dollar. So this benchmark will help you keep your assumptions within reality. So let me show you a few common financial model examples. An app, for example, is driven by marketing costs and those drive downloads. A percentage of those downloads become active users and a percentage of those active users pay whatever subscription or in-app purchases you're selling. A B2B platform, on the other hand, will probably spend marketing dollars to drive new leads to jump on a call with your team. Those leads will need to be processed by a human sales team, that's an expense, and maybe 100 leads per agent per month and some of them will end up converting to revenue. So that driver marketing budget could be a lot of things, a combination of things. It could be sponsoring a booth at an event or it could be Google Ads or influencer marketing. So your head of marketing will have to run performance numbers and understand the conversion rates and the cost per lead of each one of them separately. And that can easily be dozens of campaigns at the same time. But what the financial model really cares about is the macro trend, the general number. How much did we spend total and how much did a lead cost? And of course, you can balance how simple and complex the model gets depending on how savvy you are and how well you understand these metrics. In its simplest form, you could go from the paid marketing budget to the cost of converting a new customer. In a more complex example, you can account for website traffic first, then signups, then monthly active users, and finally conversions. Okay, I want to pause for a second to clarify that the key here is not for the model to be perfect and to take every single thing, every single KPI into account. The key here is for the model to be useful for you. I'm on our company financial model maybe twice a week, always budgeting and estimating and finding new KPIs that we need to track. It needs to be easy to manage and respond to the needs of your business. It starts simple and it gets more complex as your business evolves, as you start to understand these spreadsheets a lot better. So what you can see here is that all of these revenue lines that we've talked about, they're all driven by an expense. When you're adding your own assumptions into the model, what you can't really control is how much you spend on a campaign or on a team and how well it works by improving your product and bettering your conversion rates. That means that your assumptions are always grounded. There is no such thing as a one cent cost per click. There's also no such thing as a 100% conversion rate. It's also extremely unlikely that if you doubled your marketing from one month to the other, the same numbers will hold up because aggressive spikes in spend usually lead to less efficiency. Now there is one single exception to this, a driver that is not directly tied to an expense. There's only one and it's organic traffic. Our business is built on organic traffic. We get about a million views a month on this YouTube channel, about 300,000 visits per month on our website and that is not tied to an expense, at least not directly. If I go and double our media team next month, we won't get double the number of views on YouTube. It's not proportional. Same if we double our content, our SEO team, because it just doesn't work like that. But it does work. So to me, organic traffic is really the only exception of a driver that is not proportionally tied to an expense and we will allow it in a model as long as it's taken into account as a reasonable expectation. So when using organic traffic as a driver, you have to keep three core rules in mind. One, make sure that you're budgeting the team that will cause that to happen even if it's not directly tied to that growth. Two, make it reasonable. Maybe look at your competitors' traffic. And three, know that the more traffic you get to a website, the lower the conversion rate will be. This is because SEO depends on content and a lot of your traffic, this extra traffic that you're getting, will be to blog posts or people reading but not necessarily ready to convert. If your website is mainly landing pages, those, of course, will convert much, much better. Okay, so we've covered all these drivers. Now let's zoom into these revenue lines. We have modeled the cause for the growth so we can look into the effect. So let's take the simplest case of an e-commerce platform. That's a combination of paid traffic and organic traffic that'll drive new orders into the platform. In the simplest approach possible, you could take that expected number of new orders per month converted from this traffic and then multiply it by an average order size in dollars or currency. You don't need to model and map every single SKU in your inventory. If you take the average order size and the average margin or the average markup that you're putting on products, that should give you a decent estimate of how much revenue and how much profit you're gonna be getting. Now that revenue must, of course, be tied to an expense, which is the products themselves and the shipping per order. And then SaaS is, of course, my favorite example. I see a lot of companies struggling to add plans to this, to break down how many people are gonna convert to each one of these plans. But you don't really need that, at least at first. You can just use the average revenue per account or average revenue per user. So, if you have a $50 and a $100 plan, chances are your ARPU will land somewhere in the middle. And you can use that estimate for your MRR. Multiply that by the number of new conversions. And then, of course, you have to account for churn. Customers don't stay forever, so you have to account for those monthly cancellations. Churn sucks. It's like startup cancer. We made a whole video about it. The point is that the numbers your model uses, these inputs that drive everything else, they're KPIs. And they're KPIs that you don't have to make up. You can ask other startups in your industry. And the very moment you have some real user data for your platform, you can plug those values and then create an estimate that's very realistic. In SaaS, for example, you can even tie in your MRR or your active customers to your server and infrastructure costs. Those might be close to zero today, but you need to know what those will look like when you have millions of customers. And when you're doing driver-based modeling, you can also create other connections to other expenses. For example, you can assume that for every 1,000 active customers on the platform, you're going to need to hire a new customer support agent, which are themselves already tied to the Google Workspace cost and the office cost that we talked about earlier. At the end of the day, you have a model that does the homework for you, but nothing works unless you understand this thing first. This that we've been going through. We've done hundreds of these models, enough to know that that part is so key. Okay, so I want to spend some time on the spreadsheet now, showing you how all these diagrams connect into numbers on a spreadsheet. But let me give you one real live example now. We have this new plan on Slidebean called the Financial Modeling Workshop, where we handhold you in building a financial model for your business. So, for example, on day one, we give customers a blank model so they can start playing around with it. And then the plan includes two hours a month with a senior analyst that helps them build this diagram and helps them focus on what's more urgent for their businesses. And it includes six hours of our spreadsheet team to actually build the functionality on the spreadsheet, which is just spreadsheets, formulas, stuff. And since I'm training the new expanded team that's running this, I'm actually gonna be leading the next 10 projects that we book. So, I'll play that senior analyst role and you would get a couple of hours of me every month. So, the idea with this thing is very much a teach a founder to fish approach. So, we want you to take what you need to learn and then to be on your way. It's not a plan that you stick around forever. So, I'm dropping links below if you feel that this is something that might be useful to you or if you want to get on a call with our sales team to learn more. And then, of course, this is how the model looks like in general. The spreadsheet, like I said, is this blank financial model that has been available as a free download for a while. Everything here is already connected. Revenue is connected to costs, to SG&A, to Capex, and they're all connected to the summary spreadsheets, to your financial statements, either monthly or annual. We also build the cap table, so if you intend to raise capital, you can also run assumptions on how much equity that is going to cost you and your co-founders. So, on this spreadsheet, you can actually start bringing in your expenses for the team and the salaries and the benefits. We actually built a separate sheet where you can manage all that. But then, the tough part here is that you have to bring this diagram into the model. My recommendation to keep things organized is to place all the inputs and the assumptions on the projections page. That way, everything that you have to input, everything that you have to change, is controlled from a single page. So, you have to be jumping across spreadsheets on the model. And keeping everything on the same page would eventually allow you to run scenarios. For example, to compare what would happen with one set of variables versus the other set of variables. But I don't want to get ahead of ourselves. The idea now is to list all these drivers because they're gonna become inputs. They're gonna become variables that will cause changes in the model, new calculations in the model. So, a common practice that I use is to make variables blue and results black. That way, you know which numbers you're supposed to be changing and which ones you're not supposed to touch. So, here's how that e-commerce model ended up looking once we put it into the spreadsheet. We have the organic traffic, we have the paid traffic as drivers, we have an average order size, we have shipping costs, and then we have margin per order. Now, in this case, we also added some functionality for reordering. So, essentially, we're saying that a set of the customers that make a purchase become regulars and they continue to make a set of orders per month. Not from new customers, but from existing customers. So, it's a bit of a loop in the model structure. On the mobile app financial model, for example, since there are so many possible ways in which an app can be monetized, the main driver here is monthly active users. That's a driver for the revenue lines from ads to in-app purchases to subscriptions. But, again, monthly active users is itself driven by real blue boxes marketing efforts. Connecting these formulas in the background, that's the easy part. It's tedious and that's the part where our team can help the most because they're super fast and they're super efficient doing this. They do spreadsheets all day. But, again, the key to all of this is you, founder, understanding what's happening behind it, understanding this logic behind the model. Okay, so time for all the resources. The black model, that's available as a free download, link below. We've standardized templates for the most common scenarios and they're all available for our Slidebean customers, so you can sign up for that with the link below. And then, last but not least, if you need my team or myself to build a model more like this turnkey service, you should chat with our sales team. I'm linking that below as well. Hopefully, this video allows you to zoom out from the numbers and the spreadsheet and just to understand the logic first before getting into building. For you to understand this logic, for you to get this, is the absolute key takeaway that I want you to take from this video because if you understand this, running your startup will be a lot easier from now on. Thanks a lot for watching.