Michael Sheridan, COO of Docstoc (http://www.docstoc.com/) talks about the best way to go about constructing a financial model for your business plan. By looking at sales projections it is possible to both calculate and itemize any potential expenses.
- Describe the assumptions your business model is based on
- Bottom-up: deriving sales projections from the expenses
- Top-down: building expense model around sales projections
- Calculate & itemize any potential expenses
The financial model of any business plan is basically the first section any real investor will flip to as you’re constructing a business plan or as they’re looking at your business plan and what’s really important about setting up the financials is creating a baseline of assumptions that your business plan is driven off of.
Whether those assumptions are a market growth rate, whether those assumptions are your ability to hire key sales people and drive revenue, whether those assumptions are you have multiple ways that you can make revenue through your business, you’ve really got to create what is the baseline so somebody understands where you’re coming from right out of the gate in the financial model.
There’s really two ways to create the financial model. You can either go with the bottoms-up approach which is really driving the top line and sales revenue from the expenses that you have so if you think that each sales person contributes X dollars to your business and you have one sales person, then you can begin to think about what your top line is.
Vice versa, when you talk about the top-down approach which is the second way that you can build your financial model, it’s really starting with the end in mind. Here’s the type of sales and projections that we need our business to have and what is it going to take from an expense line item to get those sales projections.
Neither way is better or worse than the other. It’s really the thing that you choose that sets it up best for yourself and is easier for you to think of.
And then the last piece is really all of the expense line items and these are the pieces of the business, whether it’s the people that you’re hiring, whether it’s the rental space you need, the insurance that you have, the phone lines that you need to call customer, the traveling, all of the nitty-gritty details are so important in understanding how much it’s going to cost to run your business and get to the revenue projections that you want to, to be a successful business and to be appealing to potential investors.
So when you’re thinking and constructing your financial model, you really want to make sure you spend time setting the assumptions, projecting the revenue and analyzing the expense line item so that you know you have a solid model.