Founders often don't know how to present their financial projections or what type of financial model they need to secure funding. This confusion is common because there are many types of financial models, and not all are suitable for a startup's needs.
In this article, I’ll explain what a 3 statement financial model is and why your startup needs one.
What is a 3 Statement Financial Model?
The 3 statement financial model is a type of financial model that offers a detailed overview of a company's financial performance and health through three key financial statements: the Income Statement, Balance Sheet, and Cash Flow Statement. Let's explore each of these in detail:
1. Income Statement
The Income Statement, often referred to as the Profit and Loss Statement, assesses the profitability of a company over a specific time period. This statement is crucial for tracking financial progress and evaluating the profitability of your startup. It includes:
- Revenue: Total sales made. This might include diverse income streams such as product sales, subscription fees, and service charges.
- Cost of Goods Sold (COGS): Direct costs associated with production. This includes raw materials, manufacturing costs, and direct labor. For a tech startup, COGS might include software development and hosting costs.
- Operating Expenses: Costs incurred in the normal operations of a business. This includes rent, utilities, marketing, salaries, and administrative expenses.
- Net Income: Also referred to as "the bottom line," it’s the earnings your startup makes after all expenses and taxes (Revenue - COGS - Operating Expenses - Taxes). This metric is vital for assessing the overall profitability of the startup.
Understanding and regularly reviewing this statement helps ensure your startup remains on a profitable path and allows for informed decision-making to drive growth.
2. Balance Sheet
The Balance Sheet offers a ‘snapshot’ of a company's financial health at a particular instant, listing:
- Assets: What the company owns. This might include cash, accounts receivable, inventory, and fixed assets like equipment and intellectual property.
- Liabilities: What the company owes. This includes various obligations such as accounts payable, which are short-term debts to suppliers and creditors, short-term loans that need to be repaid within a year, and long-term debt, which encompasses financial obligations due after a year or more.
- Equity: Ownership left for the company's owners after debts are paid. This reflects the initial investment by the founders and any retained earnings or accumulated losses.
The Balance Sheet is vital for understanding financial equilibrium, capacity to meet current obligations, and how effectively borrowed funds are being leveraged to generate profits. It helps in assessing the company's liquidity and financial flexibility.
3. Cash Flow Statement
The Cash Flow Statement traces the movement of actual cash within a business, categorized into:
- Operating Activities: Core business operations. This includes cash receipts from sales, payments to suppliers, and salaries. Having a positive cash flow from operations is a key indicator of sustainability.
- Investing Activities: Cash transactions for long-term assets such as land, buildings, or equipment. For a tech startup, this might include purchases of new technology or software development costs.
- Financing Activities: Changes in loans, dividends, or equity. This could include cash inflows from investors, bank loans, or equity financing, and outflows such as repayment of loans.
The Cash Flow Statement is essential for understanding whether a startup is generating more cash than it consumes, which is fundamental for evaluating long-term viability. It helps in identifying potential cash shortages and allows for proactive management of cash reserves.
Additionally, the Cash Flow Statement aids in calculating the cash burn rate—the rate at which a startup spends its cash reserves—and the cash runway, which indicates how long the startup can continue operating at its current burn rate before running out of cash. These metrics are critical for planning and ensuring the startup remains financially sustainable.
Why Does Your Startup Need a Financial Model?
1. Helps You Validate Your Assumptions
Financial models are not just for large corporations. For startups, they are equally—if not more—important. When founders need to make critical decisions, such as setting prices, choosing suppliers, or hiring staff, the financial model offers a quantitative basis for these choices. It helps answer key questions: Can we afford to expand? What will the impact be if we adjust our pricing strategy? How much funding do we need to reach the next milestone? By providing a clear view of the financial implications of each decision, startups can avoid costly mistakes and optimize for growth.
2. Helps You Secure Funding From Investors
When it comes to securing funding, a strong financial model can be the key to unlocking investor interest and capital. Investors want businesses that demonstrate a clear path to profitability and a deep understanding of their financial landscape. A 3 statement financial model allows startups to present a compelling narrative backed by data, showing how the business will generate returns over time.
It also helps founders articulate the use of funds, whether for product development, market expansion, or team growth. Having a detailed financial model signals to investors that the startup is managed by a team that is thorough, forward-thinking, and prepared to take on the challenges of growth.
Get Funded with Our Investor-Ready Financial Models
To truly stand out to investors, it's essential to present a financial model that reflects the unique aspects of your startup. Our tailor-made financial models are crafted to cater to the specific needs of different business types, whether you're running a SaaS, Ecommerce, Mobile App, Marketplace, or Fintech startup.
They are designed with ease of use in mind, yet perfectly tailored to your business model. With our financial models you can demonstrate to investors that you've thought through every aspect of your business, from revenue streams to cost structures, and that you're prepared for the challenges and opportunities ahead. This level of detail and customization can significantly enhance your fundraising efforts and set you apart from the competition.
