basic financial modeling lesson

1. Intro to Financial
Modeling
Eastside Incubator
February 20th, 2013
Martin Zych
Finance Director, Limeade
@martinzych

2. what is
financial
modeling?

3. +
= Financial Modeling?

4. +
= Financial Modeling?

5. you wish

7. almost

8. A Financial Model answers key questions
1. How big can this business really get?
2. How fast can it grow?
3. What will it take to achieve this?

9. A Financial Model answers key questions
1. How big can this business really get?
2. How fast can it grow?
3. What will it take to achieve this?
= How much can this company be worth
in the future?

10. Two methodologies
1st – Top Down Market
“If we can get only 1% of a $10 billion
dollar market = we could make $100
million dollars a year! Let’s Go!”
- Startup Financial Modeling Newbies

11. What investors hear…
1st – Top Down Market
“If we can get only 1% of a super
competitive, already saturated, $10
billion dollar market = we could have a
1 in 100 chance to make $100 million
dollars a year! Let’s Go!”
- Startup Financial Modeling Newbies

12. And most investors will think…

14. 2nd methodology
Bottoms up modeling
Inputs Model Revenue

15. Measurable Inputs are actionable.
When they occur (the model),
an Output = Revenue occurs

16. How much does each customer spend?
= ARPU (Average Revenue / Customer)
How will we acquire customers?
At what conversion rates?
How much do we spend to get each customer?
How long will it take?
= CAC (Customer Acquisition Cost)
How many customers try out,
then stop using our product?
= Churn Rate %
Inputs
What is the average life time of a customer?
1/Churn Rate = Avg Customer Life Time (CLT)
How much does it cost to support a customer?
=COGS $ / # of Customers

17. The Basic Math
[ Remember to define the proper period for each (/mo, qtr, yr) ]
ARPU (Average Revenue / User) = Revenue / # Users
CAC$ = S&M Costs Q(1) / # of New Users Q(1)
CAC (Customer Acquisition Cost) Ratio
=(Gross MarginQ(2)– GMQ(1))*4 / (Sales & Marketing Costs Q(1))
Bad: CAC < 1/3 = Sales & Mktg costs pay for themselves in over 3 years
Good: CAC > 1 = Sales & Mktg costs pay for themselves within a year
Churn Rate
= Σ(Users who stop using service in period) / Σ(Total Users @ start of
period)
Avg Customer Life Time (CLT) = 1/Churn Rate

18. Customer Lifetime Value =
[(ARPU-COGS/User) x CLT] – CAC) = Customer Lifetime Value
If CLTV > 0 means you have a potentially profitable business.
Yippee!
Note: with more info, or on more mature companies we’d use Contribution Margins and NPV

19. More Math
Growth Rate
# of Users P(1) - # of Users P(0)
r=
# of Users P(0)
Estimated Users in N periods = Users x (1+r)^n
Brain Teaser:
How do you quantify an avg monthly growth
rate into how many weeks to double user base?

20. More Math
Growth Rate
# of Users P(1) - # of Users P(0)
r=
# of Users P(0)
Estimated Users in N periods = Users x (1+r)^n
Brain Teaser:
How do you quantify an avg monthly growth
rate into how many weeks to double user base?
log(2)
Est. Weeks to Double = 52 x
log(1+r)

21. Test these basic
metrics on a
small scale as
early as possible.

22. Then infer what your model can do
once funded and at scale

23. Now how do
I model this?

24. Standards / Inputs
• Use Consistent Coding Standards
• Never hardcode variables
• Focus on format & structure first. Inputs can come later.
• Start model off with standard inputs
– Company Name, Departments (if applicable)
– Make all data flow throughout the model

25. Common Excel Functions you should learn
• Logical functions:
– IF(), AND(), OR(), SUMIF()
• Arrays {}
• {Transpose()}
• Offset()
• Countif()
• Vlookup(), Hlookup(), lookup()
• Index(), Match()
• Financial:
– PMT(), PPMT(), IPMT()
• Date Functions:
– EOMONTH(), EDATE(), Day(), Month(), Year()
25

26. Fire up Excel and create….
individual tabs for:
• Inputs
• Market (today’s example)
• Revenue (today’s example)
• Staffing
• Costs
• CapEx
• Debt
• SumFS [Summary Financials]
• Charts [& Metrics]

27. Inputs / Processing
• The Inputs tab takes all
sections + adds
headcount driven
expenses and creates
one place to process the
outputs of P&L, Cash
Flows, Balance Sheet

28. Market
• Clearly define:
– What you’re producing and selling The Marketing Funnel
– Who your customer is Social Media
– How you’re going to grow your PR
customer base (mktg funnel) or
product production
• Some Revenue Model Calculation
Methods: Leads
– Referral / Viral Growth
– Biz Dev / Sales Deals
– Marketing Spend (CPA model)
– Subscription Model Opportunities
– Store Counts
– Production driven inputs
(Manufacturing)
New Customers!

29. Demo Company
• SaaS B2C Business
• Acquires customers via
– SEM
– Affiliates
• Customers pay via
– Subscription model
• 1%/mo churn
(SaaS industry standard)

30. Excel Model Tab
Create calculations for:
• SEM
• Affiliate sign ups
– New users from affiliates
• Churn
– 1%/mo
Result = # of Customers!

31. Revenue
• Once we know how many customers we have
at any given time or products we’ll
produce, we can calculate:
– Product Mix / Parallel products
– Average $ per Transaction
– Average # of Transactions/mo
– Renewal rates
– Traffic driven revenue (i.e. advertising revenue)
and much more…
31

32. Excel Revenue tab
Subscription Model
Basic Plan Pro Plan
•$10/mo •$50/mo
• Core product •Core +
•90% purchase •Premium
Analytics
•10% purchase

33. Costs – we won’t model in detail but:
• Once Revenue section is built out:
– We understand the rough size/scale
of the business revenue-wise
– With customer or user counts, we
can put together COGS for
Production/Hosting
– Can infer staffing needs through
sanity check of X Customers = Y
Service reps/QA/Account mngrs...
– Add outsourced costs / special
projects in the plan
(contractors, engineering
pushes, PR pushes &
campaigns, etc.)
– Set expenses driven per headcount
and/or per dept.

34. Costs
• Common Dept Cost Categories:
– Staffing
• Salaries
• Payroll Taxes & Benefits
• Other Staffing
– Travel
– Facilities
– Equipment
• Equipment Depreciation Exp
• One Time Non-Capital Exp
• Equipment Employee Exp
– Outside Support
– Marketing

35. HOMEWORK - Excel Costs tab
CREATE…
• Staffing Expenses for:
– Staff of:
• CEO, Marketing Manager, Dev, and a few blanks TBH
– Payroll taxes (Social Sec, Medicare, ESD, etc)
– Benefits
• Outside support for
– Legal, Admin, Engineering Contractor

36. CapEx
We’re not going to model CapEx today but…
• Capital Expenditures are driven by:
– Large one time purchases (facilities, equipment etc) or
per New Hire (computer, software, office
equipment, licensing, etc).
– Create a section with a cap limit & schedules.
• Anything under this is immediately expensed. (Usually set
between $500-1500. Ask your CPA.)
• Anything over this limit is depreciated (MACRS, Straight-line
etc.) Depends on standards you set for your company.
36

37. Debt
We’re not going to model a debt tab today but…
• Debt financing schedules
– Contain calcs to figure out loan/note repayments
– Interest Expense for Pro-Formas
– Commonly used excel formulas of:
• PMT(), PPMT(), IPMT()
Use these together and you can easily figure out principal vs
interest paid over time on debt.
37

38. HOMEWORK - Excel Charts tab
Bring Data In Calculate
• Revenue • ARPU
• Expenses • CAC
• Net Income • CLT
• Customers • CLTV
• Cash

39. Once done, the model provides:
• Pro-Forma Income Statements
• Pro-Forma Balance Sheets
• Pro-Forma Cash Flows
• Business Charts & Metrics
39

40. Company Name
PRO-FORMA INCOME STATEMENTS ($000's)
FY Ended FY Ended FY Ended FY Ended FY Ended FY Ended
($1,000s) Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 Dec-12
REVENUE
By Revenue Type
Ad revenue --w eb (Total) $1 $301 $2,341 $4,510 $5,621 $6,635
Site Skinning Sales $ $3 $30 $553 $1,147 $1,538 $1,923
Content Rev $0 $178 $6,897 $12,683 $18,885 $20,729
Featured Fyreball Rev $0 $38 $370 $1,233 $2,750 $5,820
Total Revenue $3 $547 $10,160 $19,572 $28,794 $35,107
COST OF GOODS SOLD
Content Costs $0 $0 $0 $0 $0 $0
Bandw idth Costs Monthly $6 $24 $36 $60 $96 $180
Ad serving cost - Total $ $0 $3 $18 $36 $44 $52
Operations $0 $178 $511 $811 $988 $1,407
Total Cost of Goods Sold $6 $205 $566 $907 $1,128 $1,639
GROSS MARGIN ($3) $342 $9,595 $18,666 $27,666 $33,468
% of Revenue -101% 63% 94% 95% 96% 95%
OPERATING EXPENSES
Sales $0 $171 $652 $952 $2,430 $3,951
% of Revenue 0% 31% 6% 5% 8% 11%
Marketing $16 $286 $755 $1,101 $2,435 $4,000
% of Revenue 507% 52% 7% 6% 8% 11%
Development $272 $1,563 $2,212 $3,070 $5,229 $7,544
% of Revenue 8607% 286% 22% 16% 18% 21%
Admin $83 $585 $1,060 $1,699 $2,385 $2,976
% of Revenue 2629% 107% 10% 9% 8% 8%
Total Operating Expenses $371 $2,605 $4,679 $6,822 $12,479 $18,472
% of Revenue 11743% 476% 46% 35% 43% 53%
Incom e Before Int & Taxes ($374) ($2,263) $4,916 $11,844 $15,187 $14,996
% of Revenue -11845% -413% 48% 61% 53% 43%
Interest Income $4 $64 $70 $346 $782 $1,249
Other Expense ($2) ($6) ($54) ($102) ($148) ($180)
Other Taxes ($0) ($8) ($152) ($294) ($432) ($527)
Incom e Before Taxes ($371) ($2,213) $4,779 $11,795 $15,389 $15,539
Income Taxes $0 $0 $768 $4,128 $5,386 $5,439
NET INCOME ($371) ($2,213) $4,011 $7,667 $10,003 $10,100
% of Revenue -11763% -404% 39% 39% 35% 29%

41. Company Name
PRO-FORMA BALANCE SHEETS ($000's)
FY Ended FY Ended FY Ended FY Ended FY Ended FY Ended
Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 Dec-12
ASSETS
Current Assets
Cash $170 $470 $4,047 $11,396 $21,117 $31,092
Receivables $0 $77 $1,109 $1,764 $2,523 $3,098
Other Current Assets $0 $0 $0 $0 $0 $0
Total Current Assets $170 $548 $5,155 $13,160 $23,640 $34,190
Other Assets
Property, Plant & Equipment $13 $67 $84 $117 $202 $229
Accumulated Depreciation ($1) ($14) ($39) ($71) ($112) ($161)
Other Noncurrent Assets $0 $0 $0 $0 $0 $0
Total Other Assets $11 $53 $45 $46 $91 $67
TOTAL ASSETS $182 $600 $5,201 $13,207 $23,731 $34,257
LIABILITIES
Current Liabilities
Credit Line $0 $0 $0 $0 $0 $0
Accounts Payable $17 $29 $38 $94 $268 $395
Accrued Expenses $0 $0 $0 $0 $0 $0
Salaries Payable $23 $122 $164 $244 $459 $493
Payroll Taxes Payable $5 $24 $33 $49 $92 $99
Income Tax Payable $0 $0 $530 $718 $808 $1,065
Deferred Revenue $0 $0 $0 $0 $0 $0
Other Current Liabilities $0 $0 $0 $0 $0 $0
Total Current Liabilities $44 $176 $765 $1,105 $1,626 $2,052
Long Term Liabilities
Capital Lease $0 $0 $0 $0 $0 $0
Note Payable $0 $0 $0 $0 $0 $0
Other Noncurrent Liabilities $0 $0 $0 $0 $0 $0
Total Long Term Liabilities $0 $0 $0 $0 $0 $0
TOTAL LIABILITIES $44 $176 $765 $1,105 $1,626 $2,052
Stockholders' Equity
Preferred Stock $410 $2,910 $2,910 $2,910 $2,910 $2,910
Common Stock $0 $0 $0 $0 $0 $0
Retained Earnings $0 $0 $0 $0 $0 $0
YTD Profit (loss) ($273) ($2,485) $1,525 $9,192 $19,195 $29,295
Total Stockholders' Equity $137 $425 $4,435 $12,102 $22,105 $32,205
LIABILITIES & EQUITY $182 $600 $5,201 $13,207 $23,731 $34,257

42. Company Name
PRO-FORMA STATEMENT OF SOURCES AND USES ($000's)
FY Ended FY Ended FY Ended FY Ended FY Ended FY Ended
Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 Dec-12
BEGINNING CASH $0 $170 $470 $4,047 $11,396 $21,117
SOURCES OF CASH
Net Income ($273) ($2,213) $4,011 $7,667 $10,003 $10,100
Add Depreciation and amort. $1 $13 $24 $32 $41 $50
Issuance of Stock $410 $2,500 $0 $0 $0 $0
Issuance of Debt $0 $0 $0 $0 $0 $0
Plus Changes in:
Accounts Payable $17 $12 $9 $56 $174 $127
Accrued Expenses $0 $0 $0 $0 $0 $0
Salaries Payable $23 $99 $42 $80 $215 $35
Payroll Taxes Payable $5 $20 $8 $16 $43 $7
Income Taxes Payable $0 $0 $530 $188 $89 $257
Deferred Revenue $0 $0 $0 $0 $0 $0
Other Current Liabilities $0 $0 $0 $0 $0 $0
Other Noncurrent Liabilities $0 $0 $0 $0 $0 $0
Capital Lease Obligations $0 $0 $0 $0 $0 $0
Notes Payable $0 $0 $0 $0 $0 $0
Total Sources of Cash $183 $432 $4,625 $8,038 $10,565 $10,576
Uses of Cash
Less Changes in:
Receivables ($0) $77 $1,031 $656 $759 $575
Inventory $0 $0 $0 $0 $0 $0
Other Current Assets $0 $0 $0 $0 $0 $0
Other Noncurrent Assets $0 $0 $0 $0 $0 $0
Property and Equipment ($13) $55 $17 $33 $85 $26
Total Uses of Cash ($13) $132 $1,048 $689 $844 $601
CHANGES IN CASH $170 $300 $3,576 $7,349 $9,721 $9,975
ENDING CASH $170 $470 $4,047 $11,396 $21,117 $31,092

43. Summarized in Charts such as:
Company
2010-11 Rev/GM/NIBT
$4
Rev
GM
$3 NIBT
Cash
$2
Millions
$1
$0
($1)

44. Business Metrics & Targets
44

45. Business Metrics & Targets
45

46. That’s just the tip of the iceberg

47. That’s just the tip of the iceberg
Adding in department level spending
Accrual basis AR/AP
Depreciation & Amortization
Taxes & NOL
Inflation adjustments
Milestone & Fundraising timing
SUPER DEEP
DCF: Discounted Cash Flow Analysis
Current and Future Valuations
ROI: Return on Investment
And more….

48. Questions
I’d like to know…. ?
contact
? Ask Me Now
http://about.me/martinzych
martin.zych@limeade.com
@martinzych 48

49. Questions
contact
http://about.me/martinzych
martin.zych@limeade.com
@martinzych 49