In this multi-part series we are sharing the details behind creating a financial model for your small business. A small business financial model is critical for making good decisions and helping to build a more predictable business. Your financial model is your small business in black and white. As they say, "the numbers don't lie.”
- If you feel like you need to hire more staff but are not sure if you can afford it, a financial model can help.
- If your sales are growing, but you are not making any more money, a financial model can help.
- If you are profitable month after month, but you are not sure where all the cash is going, a financial model can help.
- If you're not sure which products are profitable, a financial model can help.
A financial model is meant to help detail the mechanics of your business and give you deep insight into how well your business model is working.
According to Jack Stack of the Great Game of Business, businesses exist for two reasons - “to make money and....to generate cash. As long as you do those these things, your company is going to be okay, even if you make mistakes along the way, as you inevitably will.”
A financial model can help you make sure these two things are happening.
In part one, which you can read here, we shared how to model:
- The products you plan to sell and the revenue generated from those products.
- Your COGS or "cost of goods sold" which are the costs incurred when you sell your products.
- Your headcount or who you think you will need to hire, what they will do (COGS, admin, sales etc) and what you will pay them.
In part II of this series we'll focus on modeling the following three areas:
- How much you will spend on sales and marketing.
- How much you will spend on general and administrative costs.
- The profit generated by your business.
As a reminder, we are using a Google sheet which you can access to help illustrate these principles. We are modeling a simple doughnut business called ABC Doughnuts.
Modeling Small Businesses' Sales and Marketing Costs
Sales and marketing costs are considered part of "OpEx" or operational expenses.
According to Accountingtools.com, operational expenses are defined as "those expenditures that a business incurs to engage in any activities not directly associated with the production of goods or services. These expenditures are the same as selling, general and administrative expenses"
To determine your sales and marketing expenses, think through what you expect to spend on the following sub-categories:
- Wages and Salaries (you can link this to the "headcount" model we created in the first post).
- Advertising and Marketing - advertising and marketing are often confused, but this would be expenses like leads, Google Adwords, print advertising, conventions etc.
- Travel - any expenses related to selling and marketing (for example, traveling to a conference).
- Meals and Entertainment - taking out a prospect for lunch or dinner.
For example, if you are planning on spending $1000 per month on "marketing,” what are you expectations for that spending? What results should that marketing produce for you? How many leads do you expect to generate?
What about marketing software like Hubspot? What about a CRM (customer relationship management) tool to track your leads and sales results?
Do your best to project what you think you will spend on each of these expenses.
This exercise will force you to think about your marketing plan. I've written about this before in a previous blog, so for more detail, please head over here and check it out.
If you have a person in your organization that is focused on marketing, ask them to develop a marketing budget. Ask them to detail what they expect that spend will generate in terms of MQL (marketing qualified leads).
Modeling Small Businesses’ General And Administrative Costs (often called G&A)
According to Accountingtools.com - General and administrative expenses are "the set of expenses required to administer a business, and which are not related to the construction or sale of goods or services. This information is needed to determine the fixed cost structure of a business. Another way of describing general and administrative expenses is any expense that will still be incurred, even in the absence of any sales or selling activity."
Examples of general and administrative expenses are:
- Building rent
- Consulting expenses
- Corporate management wages and benefits (such as for the chief executive officer and support staff)
- Legal staff wages and benefits
- Office supplies
- Outside audit fees
Again take some time to think through these costs. The easiest way to do this is to look at your spending on these costs over the past year. If you have not set up an accounting system, Quickbooks Online and Xero are two good options.
Determine If Your Small Business Will Make A Profit
Once you've modeled all this information, you are ready to determine the profit and loss of the business (often referred to as P&L). We've updated the model now to show a P&L tab which takes the combined revenue, COGS and OpEx for each month into one sheet named "P&L.”
You can access the model here to check it out.
How is profit defined?
Profit (Loss) = Revenue - COGS - Opex. Profit can be either a positive or negative number. You can have a negative profit in one month and a positive profit in another.
Based on our inputs into the model, you can see that the business will generate $384,000 in revenue with a $60,362 profit.
Hopefully you can see that creating a financial model can give you incredible insight into your business. If you'd like help developing a financial model for your start-up or small business, please reach out!