What Is a Financial Model—and Why Do You Need It, Not Just Investors?

About a tool that business owners most often underestimate—and most regret not having had sooner

There’s a question I ask business owners during our first meetings: “What will happen to your business if sales drop by 25% next quarter?” Most people pause for a second—and then start talking. More or less. Generally speaking. “Well, it’ll be tough, but we’ll manage.”

A few people respond immediately and specifically: “We have a model. I can say that with a 25% drop, we’ll start running a deficit in the third month, but our cash reserves will cover us for another two months—so we have five months to respond.”

The difference between the first and second answers isn’t a difference in experience or intuition. It’s the difference between managing “by feel” and managing “by the numbers.” And the tool that makes this difference is called a financial model.

What Exactly Is a Financial Model?

When most people hear “business model,” they picture a complex Excel spreadsheet with thousands of rows, created by investment bankers in preparation for an IPO. Or a polished document that a startup includes in its pitch deck.

In reality, a financial model for a small or medium-sized business owner is a much simpler—and at the same time, much more practical—thing. It’s a structured set of calculations—most often in Excel or Google Sheets—that links three things: your assumptions about the business, the financial results of those assumptions, and the flow of actual money.

The key word here is “links.” A good model is designed so that when you change one assumption—for example, the average check or the number of new customers per month—all calculations are automatically updated. You can immediately see how this affects your profit, when a cash shortfall will occur, and how much money you’ll actually have left at the end of the quarter.

That is the essence of it: not a static account of the past, but a living tool for reflecting on the future.

What’s Inside the Model

A typical model for a business owner consists of several interconnected components. Each one addresses a specific question.

Assumptions — the starting point for everything

This is the only sheet where you enter numbers manually. Everything else is calculated automatically. This includes: how many customers you expect each month, the average check, the conversion rate from leads to deals, seasonality, salaries, rent, marketing expenses, and the exchange rate—if it’s critical for you.

The more accurate your assumptions are, the more useful the model is. But even “rough” assumptions based on the company’s actual history are incomparably more valuable than having no forecast at all.

Revenue Section — Where the Money Comes From

Based on your assumptions, the model calculates revenue: by month, by product or business line, and by sales channel. It’s important to factor in realistic seasonality right from the start—because “steady monthly growth” almost never reflects real-world business conditions.

Expense Categories — Where the Money Goes

Expenses are divided into variable costs—those that increase along with revenue (cost of goods sold, logistics, commissions)—and fixed costs, which remain constant regardless of volume (rent, administrative staff, basic marketing). This distinction makes it possible to calculate the break-even point and understand where the business begins to turn a profit and where it is merely covering its costs.

Three financial statements—the heart of the model

Based on income and expenses, the model generates three interrelated reports. All three are important—each provides a different “perspective” on reality:

• P&L (profit and loss statement) — shows how much you earned after all expenses. It reveals profit margins, profit trends, and where the business is generating or “eating up” money.
• Cash flow — the movement of actual money in an account. This is fundamentally different from the P&L: a business can show a profit on the P&L and yet have a zero balance in its account—due to deferred payments or a large inventory of goods. Cash flow shows exactly when “cash shortfalls” will occur and how severe they will be.
• A balance sheet shows what a business owns (assets) and what it owes (liabilities). For most SME owners, it is less critical for day-to-day management, but becomes essential when dealing with a bank or an investor.

Scenarios — answers to “what if” questions

The most valuable part of the model isn’t the baseline forecast, but the scenario analysis. At least three scenarios: baseline (realistic expectations), optimistic (if things go better than planned), and pessimistic (if sales drop, costs rise, or payments are delayed).

An owner who has “run through” the pessimistic scenario in the model once and seen exactly which month the money will run out approaches management decisions in a completely different way. This is no longer a theoretical discussion of risks, but a specific date and a specific amount.

How to Build a Model: From Scratch to a Working Tool

There’s good news and bad news here. The bad news: You can’t build a “perfect” model in a single evening. The good news: It’s entirely possible to build a “good enough” one in a few days, and it will give you 80% of the value.

Here’s a sequence that actually works:

1. Determine why you need the model. Before opening Excel, ask yourself: What questions should this model answer? “Can we afford to hire five new people?” “When will we break even in this new business line?” “How much can we safely pay ourselves in dividends?” The more specific the goal, the simpler and more accurate the model will be.
2. Compile actual historical data. At least 6–12 months of actual figures: revenue by month and product, major expense categories, payroll, rent, and loans. Don’t use “approximations”—use actual financial records. This is the foundation for realistic assumptions—not numbers “off the top of your head.”
3. Identify the key drivers. This is the model’s main analytical task: to understand what your revenue depends on. The number of new customers per month? The conversion rate from leads? The average order value? The frequency of repeat purchases? Every business has its own drivers—but they’re what drive the entire model.
4. Build a revenue model. Use the drivers to calculate monthly revenue. Break it down by product or business segment if they differ significantly in terms of margin.
5. Create a cost structure. For each cost item, establish a clear calculation rule: either a percentage of revenue or a fixed amount with a schedule of changes. Don’t leave any cost item to “gut feeling.”
6. Link the three reports. The P&L is derived from revenue and expenses. The cash flow statement is derived from the P&L, taking into account actual payment terms—because an invoice issued and money in the account are two different things. The balance sheet ties it all together.
7. Add three scenarios: base, optimistic, and pessimistic. Minimum validation: when one assumption is changed, the entire model is recalculated without manual adjustments.

Three Different Models: Why You Shouldn’t Confuse Them

When discussing financial models, people often confuse three different concepts. They are related, but they address fundamentally different questions.

The owner’s model focuses on how much and when the business actually generates income for the owner personally: when it is safe to pay dividends, what the personal financial risk is under various scenarios, and whether the business can cover its obligations even in a bad month.

A business operating model is a tool for managing a company: budget planning, margin assessment by business line, monitoring plan execution, and planning for hiring and resources.

The investor model is a separate version that shows not “how a business makes money,” but “how attractive it is to invest in it”: company valuation, exit projections, internal rate of return (IRR), and multiples.

These three models can be built using the same input data—but their focus, time horizons, and key metrics differ significantly.

Practical tip: Start by building a model that works for you—one that you understand and actually use. Once you have a working model, it’s much easier to create a version for an investor or a bank based on it than to try to build an “investor-grade” document from scratch right away.

A Special Note on Wartime: Why Modeling Is More Important Now Than Ever

It’s tempting to think that building a financial model in the face of uncertainty is pointless. “You don’t know anything anyway. Anything could happen tomorrow.”

In fact, the opposite is true. It is precisely in times of uncertainty that a model becomes the most valuable tool.

Here’s why. When the future is unpredictable, you can’t plan for just one scenario and assume it will come true. But you can develop three: an optimistic one, a realistic one, and one where everything goes wrong. And for each one, you need to understand: in which month will your money run out, where the “point of no return” is, and what you need to do right now to weather the worst-case scenario.

Companies that have weathered the crises of recent years with the fewest losses have almost always had one thing in common: they knew their numbers. Not roughly—but precisely. And that’s why they were able to make decisions quickly, without panicking, because they understood how much time and resources they had.

Here’s another important point. Ukraine currently has real access to external financing—grants, international support programs, and investors interested in Ukrainian companies. But any external resource flows to places where there is transparency and where the owner speaks the language of numbers. A financial model isn’t just an internal tool—it’s your ticket to the conversation about funding.

A Few Practical Tips to Wrap Things Up

First and foremost: start simple. A model with 10–15 lines of revenue and expenses for the next 12 months is already a model. It already provides answers you don’t have right now. Don’t wait for the “right moment” or “more time”—they won’t come. Start now with what you have.

Tip #2: In your model, separate the sheet with assumptions from the sheets with calculations. This is a technical detail, but it’s crucial. If all the numbers are mixed in with the formulas, in a month you won’t even understand what’s going on there.

Third: Be sure to track cash flow separately from the P&L. The most common mistake is to assume that the profit shown on the P&L equals the cash in the account. These figures can differ drastically, and it is cash flow that reveals where the real risks lie.

Fourth: Update the model. Not just once a year—but every month. Enter the actual figures and compare them with the plan. Over time, your assumptions will become more accurate—and the model will become more accurate. This is an iterative process, not a one-time exercise.

Fifth: If you plan to talk to a bank or an investor, do so only after you have your own business model. Not before. Because an owner who understands their numbers talks to financial partners in a completely different way—and gets completely different terms.