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Financial Modeling

A practitioner's framework for building financial models that inform real decisions. This skill covers the mechanics of DCF valuation, revenue forecasting, unit economics, scenario analysis, and cap tables - with emphasis on what drives the numbers, not just how to calculate them. Designed for founders, operators, and analysts who need models that hold up to scrutiny.

When to use this skill

Trigger this skill when the user:

• Builds a revenue forecast or bottoms-up SaaS model
• Performs a DCF valuation or wants to value a business
• Models unit economics (LTV, CAC, payback period, contribution margin)
• Creates scenario analysis (base, bull, bear cases)
• Builds or updates a cap table (pre/post-money, option pool, dilution)
• Models operating expenses by department or headcount plan
• Runs sensitivity analysis or builds data tables
• Prepares financial projections for a board, investor, or fundraise

Do NOT trigger this skill for:

• Accounting or tax compliance questions (use a CPA, not a model)
• Real-time market data, stock screening, or trading strategies

Key principles

1. Assumptions drive everything - make them explicit - A model is only as good as its inputs. Every key assumption (growth rate, churn, gross margin) should live in a clearly labeled inputs section, not be buried in formulas. If you can't defend an assumption in 10 seconds, it's not ready.

2. Build for scenarios, not point estimates - A single-case model is a false sense of precision. Reality will land somewhere between your bear and bull cases. Structure every model with at least three scenarios from day one - it forces you to think about the range of outcomes, not just the hoped-for one.

3. Separate inputs, calculations, and outputs - Inputs (assumptions) belong in one section. Formulas (calculations) reference only inputs or other calculations. Outputs (charts, summaries) reference only calculations. Never hard-code a number in a formula that should be an assumption. This separation makes auditing and updating the model fast and safe.

4. Stress test the downside - Most financial models are too optimistic. Reverse- engineer the downside: "What churn rate makes this business unviable?" or "What growth rate do we need to hit break-even in 18 months?" Knowing the failure thresholds is more valuable than the base case.

5. The model is a tool, not the answer - A model produces a range, not a verdict. Use it to understand sensitivity, pressure-test logic, and communicate trade-offs. Never present a DCF output as a price target without showing the key sensitivities. The goal is better thinking, not false precision.

Core concepts

Three-statement model

The foundation of any serious financial model. The three statements are interconnected:

For most startup models, a simplified version suffices: revenue build, gross margin, operating expenses, and ending cash balance. Add the balance sheet and full cash flow statement when modeling working capital, debt, or M&A.

DCF mechanics

A DCF (Discounted Cash Flow) values a business by the present value of its future free cash flows. The mechanics:

1. Project free cash flows (FCF = EBIT*(1-tax rate) + D&A - capex - change in working capital)
2. Choose a discount rate (WACC for the whole business, cost of equity for equity-only)
3. Calculate terminal value (Gordon Growth or exit multiple)
4. Discount all cash flows back to today using: PV = CF / (1 + r)^n
5. Sum the present values - that is the enterprise value

The terminal value typically represents 60-80% of DCF value. This makes the discount rate and terminal growth rate the two most important (and most uncertain) inputs.

Unit economics

Unit economics measure the profitability of a single customer or transaction:

• LTV (Lifetime Value): (ARPU * Gross Margin %) / Churn Rate
• CAC (Customer Acquisition Cost): Total sales & marketing spend / new customers acquired
• LTV:CAC ratio: Benchmark 3:1 or higher for healthy SaaS
• CAC Payback Period: CAC / (ARPU * Gross Margin %) - months to recover acquisition cost
• Contribution Margin: Revenue minus variable costs per unit

Cap table structure

A cap table tracks ownership in a company across all shareholders:

• Pre-money valuation: Company value before new investment
• Post-money valuation: Pre-money + new investment
• Price per share: Pre-money valuation / fully diluted shares outstanding
• Dilution: Each new share issued reduces existing shareholders' ownership percentage
• Option pool shuffle: Investors often require the option pool to be created pre-money, which dilutes founders, not investors - model this explicitly

Common tasks

Build a SaaS revenue forecast - bottoms-up model

Start from customer counts, not a top-down percentage. Bottoms-up is more defensible:

New customers per month  = (Website visitors * conversion rate)
                         OR (SDR capacity * meeting rate * close rate)

Monthly Recurring Revenue (MRR):
  Starting MRR
  + New MRR       (new customers * ARPU)
  + Expansion MRR (upsells/upgrades)
  - Churned MRR   (prior MRR * churn rate)
  = Ending MRR

ARR = Ending MRR * 12

Layer in gross margin (typically 60-80% for SaaS) to get gross profit. Model cohort-level retention to capture expansion revenue and logo churn separately.

Key assumption to stress test: monthly churn rate. At 2% monthly churn, you lose ~21% of revenue per year. At 5%, you lose ~46%. The business model changes entirely.

Build a DCF valuation - step by step

1. Project revenue - use a bottoms-up model for years 1-3, apply a fade to a long-run growth rate for years 4-10
2. Project margins - start from current gross/EBIT margin, model expansion toward a steady-state comparable (check public comps)
3. Calculate unlevered FCF - EBIT * (1-tax) + D&A - Capex - change in NWC
4. Set the discount rate - For early-stage: use 20-35% (reflects risk premium). For public comps-based: use WACC (8-12% range for established businesses)
5. Calculate terminal value - Use exit multiple (EV/EBITDA or EV/Revenue) anchored to comparable public companies. Cross-check with Gordon Growth model
6. Discount and sum - Enterprise Value = Sum(FCF / (1+r)^t) + TV / (1+r)^n
7. Bridge to equity value - Equity Value = Enterprise Value - Net Debt

Sanity check: implied revenue multiple at your DCF value vs current comps. If your DCF implies a 30x revenue multiple when comps trade at 8x, revisit your assumptions.

Model unit economics - LTV/CAC/payback

Build a cohort model to make unit economics concrete:

Inputs:
  ARPU (monthly)      = $500
  Gross margin        = 75%
  Monthly churn       = 2%
  Blended CAC         = $3,000

Calculations:
  Average customer life  = 1 / 2% = 50 months
  LTV                    = $500 * 75% * 50 = $18,750
  LTV:CAC ratio          = $18,750 / $3,000 = 6.25x  (healthy)
  CAC payback period     = $3,000 / ($500 * 75%) = 8 months  (excellent)

Model the blended CAC separately by channel (paid, organic, sales) - blended CAC hides the efficiency differences between channels.

Create scenario analysis - base/bull/bear

Scenario analysis is not sensitivity analysis. Scenarios change multiple assumptions together to tell a coherent story: