How to Build a Basic Financial Model Investors Will Love: A Step-by-Step Guide with Examples

Financial modeling can be intimidating, especially if you don’t have a financial background or lack experience with complex Excel functions. However, it’s hard to overstate its importance, especially if you’re interested in raising capital. 

A well-crafted financial model can be the difference between a compelling pitch that secures funding and a missed opportunity. But whether you’re managing cash flow or preparing for future growth, a financial model provides a structured way to make informed decisions.

Fortunately, building a basic financial model doesn’t have to be as difficult as you might think. Here, we’ll guide you through financial modeling basics step-by-step, with practical examples you can use to streamline the process.

How to Build a Basic Financial Model in Excel

1. Define Your Financial Objectives

A financial model is a tool that predicts certain financial outcomes based on specific inputs, like historical data and trend assumptions. That leaves room for many different financial models, which can support many different types of analysis.

For example, you might need your financial model to help you:

• Project your overall financial performance
• Facilitate budget variance analysis
• Value your business before approaching investors

The purpose of your financial model plays a significant role in how you build it. By defining your objectives early, you can shape your model to deliver the most relevant insights.

If you need help getting started, consider asking your favorite AI chatbot for some general help. These tools’ understanding of the financial modeling process has already been shown to rival that of financial analysts.

2. Include Key Components

While there are many different types of financial models, most include three foundational components: the linked financial statements, which capture your business’s financial position, financial performance and net cash flows.

Each of these should be organized on separate tabs in your Excel spreadsheet:

• Profit and loss statement: Also called the income statement, this is where you detail your revenues and expenses, culminating in your net income or loss for a period of activity. 
• Cash flow statement: This section should track and break down your cash inflows and outflows from operating, investing and financing activities, resulting in your net cash flows during a period. 
• Balance sheet: This section should provide a snapshot of your assets, liabilities and equity. It essentially outlines your financial position at a single point in time.

Beyond these three components, you should include a separate section for any part of the model that warrants additional focus or requires more sophisticated projections. That often depends on the type of model you’re constructing and the nature of your business.

For example, say labor costs are your most significant expense and have an outsized influence on your financial performance. If you plan to expand your staff in the coming years, you might include a separate section where you can project staff wages and benefits in detail to make your income statement model more realistic.

3. Incorporate Your Assumptions for Scenario Planning

Your assumptions are the metrics that drive your financial model. They’re typically based on historical data and your strategic plans. Organize these on a dedicated tab as well in order to make it easier to make changes that flow through your model. It will also enable creating dynamic financial modeling scenarios. 

• Key assumptions: Add assumptions for critical, business-specific metrics such as sales growth rates, labor costs and profit margins.
• Scenario planning: You can use your assumptions to test different “what-if” scenarios, such as increased sales or higher operating costs. Keep reading to find out how to create a scenario planning model specifically.

4. Avoid Common Pitfalls

While it doesn’t have to be overwhelmingly difficult, building even a basic financial model is a delicate process. Excel spreadsheets are powerful, but one typo in the wrong place can break your formulas and leave you scouring your cells to find the mistake.

Here are some steps you can take to help prevent that:

• Minimize hardcoding: Hardcoding values directly into cells may be quicker initially, but it makes your model much harder to update. Instead, use cell references wherever possible to keep your model adjustable and reduce the risk of manual errors.
• Use clear, consistent formatting: Set clear formatting rules that make your model easier to interpret at a glance. For example, it’s helpful to color code your text, using one color for historical data and another for calculations. 
• Focus on your key objectives: It can be tempting to pack your model with projections, but that often makes the model confusing. Stick to the primary objectives you defined at the beginning of the project to avoid trying to do too much with one model.
• Build in checks and balances: Create checks throughout your model that highlight potential errors in your calculations. For example, your balance sheet should include a check to confirm that assets = liabilities + equity. If the financial statement doesn’t balance, you’ll know something’s wrong.

Your financial model’s user interface often makes the difference between it being a valuable tool in your planning or something that collects dust in your files. 

A well-constructed model must be easy to update so you can adjust your projections as your business evolves and new data becomes available. It may require more effort upfront, but it will pay off in the long run.

Financial Model Examples with Step-by-Step Guidance

Now that you know the basics of financial modeling, let’s explore some specific model templates and how to build them in more detail.

3-Statement Financial Model Example

The 3-statement model is the most basic financial model and is useful for businesses needing an integrated financial overview to guide your strategy. It integrates the balance sheet, income statement and cash flow statement to track your company’s overall performance. It serves as the foundation for many other models. 

Follow these steps to create one:

1. Choose your layout: Set up separate tabs for the assumptions and each statement.
2. Input historical data into Excel: Enter your income statement, cash flow statement and balance sheet data from the last several periods into Excel. Use formatting to help readability.
3. Break out your assumptions: Define the metrics that will drive your model.

4. Forecast the P&L: Use your assumptions to forecast the income statement down to earnings before interest, taxes, depreciation and amortization (EBITDA).
5. Create long-term debt and fixed asset schedules: To forecast your interest, depreciation and amortization expenses, create schedules for your long-term debts and fixed assets.

6. Complete the rest of the P&L: Use your forecasted data to finish the income statement. Add in taxes last to arrive at your net income.

7. Complete the balance sheet (excluding cash): Update your long-term debt and fixed asset balances using your schedules. Forecast working capital accounts, like inventory, accounts payable and accounts receivable. 
8. Complete the cash flow statement: Link your income statement and balance sheet to the cash flow statement to forecast cash flows from operating, financing and investing activities.
9. Update cash on the balance sheet: Update the cash account on the balance sheet to reflect the cash flow statement.

Budget vs. Actual Financial Model

The budget vs. actual financial model can help you compare your projected financial performance against your actual financial results. It’s essentially a forecasted income statement that’s ideal for monitoring expenses and making adjustments based on real performance.

Use these steps to create it:

1. Choose periods to compare: Set your model up to compare your budgeted and actual results on a monthly, quarterly or annual basis. A monthly basis may help you pivot more quickly, but trends may be clearer on an annual basis.
2. Input your budget categories: List the expense categories you want to include in your budget. Consider making them more granular than your regular income statement categories to make the model more useful.

3. Forecast your financial performance: Use a copy of the P&L from an existing 3-Statement Model or follow the steps in the previous section to build one. 
4. Input actual results: Once the forecasted period passes, go back into the model and enter your actual results next to the budgeted numbers for comparison.
5. Calculate variances: Subtract budgeted amounts from actual results to calculate the variance between your actual and budgeted numbers. Divide the result by your budgeted numbers to get your variance percentage.

Scenario Planning Model

A scenario planning model can help you project the financial outcome of various sets of circumstances. Typically, that includes optimistic, pessimistic and realistic sets of inputs, giving you an idea of what you can expect in the best, worst and most probable scenarios. This type of model is particularly useful for small businesses seeking to plan for uncertain economic conditions.

Follow these steps to build one:

1. Choose your key assumptions: Determine which metrics you want to be the defining circumstances in each scenario.
2. Create a 3-statement financial model: Use an existing 3-Statement Model or follow the steps in the earlier section to create one.
3. List assumptions for each scenario: Create an additional assumptions list for each scenario you want to simulate. Assign each list a number and make sure their layouts are identical.

4. Use the CHOOSE function to cycle scenarios: Update the original assumptions list using Excel’s CHOOSE function. This allows you to switch between scenarios by typing each assumptions list number into a single cell.
5. Analyze outputs: Review how each scenario impacts overall performance metrics so you can understand risks and opportunities.

Financial Model for Investor Pitches

When pitching to prospective investors, you’ll often be asked to provide a financial model. There is no singular investor financial model, and the request is often less about your forecasted performance than you might expect.

Jeffrey F., one of Paro’s fractional CFOs and fundraising experts, says investors tend to care much more about the following:

• Checking for red flags: Investors want to see that your projections are generally reasonable. Claiming that a pre-revenue business will be raking in billions within three years is going to raise some eyebrows.
• Gauging your understanding: How well do you understand your model and your business? Even the most impressive spreadsheet may mean little if you can’t explain it. Focus on the reasoning behind your assumptions, because investors won’t be impressed if you simply grow revenues by the average historical growth rate.

Jeffrey also strongly recommends that you avoid simply using a basic financial modeling template when pitching to investors. Templates are inherently generic, and they want to see something unique to your company.

Whatever financial model you share, show that you understand the key performance indicators driving your success. For example, that might be customer acquisition and retention rates or sales per product line.

You can even use visuals, like charts or graphs, to highlight those metrics in your model. Just make sure to keep formatting as a priority. You want the spreadsheets to be as digestible as possible for your investors.

Take the Next Step: Build Smarter Models with Expert Help

Effective financial modeling doesn’t require complex tools or advanced expertise. By defining your objectives, building core components and tailoring basic financial model examples to your specific needs, you can create a dynamic tool that can help improve business decision-making and investor engagement.

If you’d like more guidance or need help creating customized or in-depth financial models, consider having one of Paro’s fractional financial planning and analysis experts handle your modeling for you. A professional model, along with insights from an experienced consultant, can keep your business financially healthy and investor-ready.