How To Build A Rock-Solid Ecommerce Financial Model
Are you about to launch a new online shop? Are you fundraising for your existing ecommerce business? Building a solid ecommerce financial model is crucial to successfully raise capital.
In this article we guide you through all the key steps you need to follow to build your own. Whether you have a Shopify store, Amazon FBA business or any other ecommerce business, we explain you how to do it yourself.
Are you looking for a template instead? Check out our template and start building!
What is a ecommerce financial model?
Ecommerce businesses are on the rise worldwide, on the back of highly efficient shipping and fulfillment services, increased mobile adoption rates. Indeed, 79% of smartphone users have made a purchase online using their mobile device in the last 6 months. Shopify alone recorded 1 Billion active stores in 2021.
Ecommerce startups have a highly specific revenue model (think Gross Merchandise Value), expenses (think paid ads, shipping, packaging, etc.) and metrics of their own.
Do you want to know more about the 7 most important Ecommerce metrics you should track and include in your pitch deck? Read our article here.
Why is it important to build a financial model for your ecommerce startup?
Startups usually build financial plans when fundraising. Yet, raising funds is not the only reason why you would create your own financial model. Communicating to investors, estimating a valuation for your business, or simply elaborating a well-thought business strategy are some of the many reasons why any entrepreneur or founder would look into forecasting their business.
Whilst financial models are likely not to be fully accurate for early stage startups, building a rock-solid financial plan is very important for 2 reasons:
- Understanding better your revenue model, growth and its impact on cash flows allows you to make better, informed decisions
- Investors will give more credit to a well-thought financial model with verified assumptions, benchmarks and calculations
Also, it is quite common for ecommerce businesses to require working capital or revenue-based financing to accelerate growth. Companies providing these financing solutions will require a financial model.
Step 1: Forecast the number of orders
Revenue is a function of the number of orders, themselves a function of the number of visitors who visit your online store. Thus, before looking into revenue, we need to calculate the number of visitors you will attract (or “acquire”) over time.
Visitors (often called as “traffic”) come from 2 sources:
Paid marketing: you pay for each visitor (Google Ads, Instagram ads for instance). Whether you pay per click (CPC) or per impression (usually referred to as CPM: cost per mille impressions), you pay a certain platform to promote your content and products on their platform. Cost varies depending on the type of products you are selling. As a rule of thumb, the higher the value of the item, the higher the cost.
Note: If you are unsure which CPC you should use, simply use Google Ads free keyword research tool. Here is great article on how to do it
- Organic: visitors come organically (for free) on your ecommerce store. There is no direct cost associated with organic visitors, indeed you do not pay a CPC to Google for instance. Yet, organic growth is fuelled by your investment in content and SEO over time. The relationship between investment and organic traffic cannot be estimated easily: it usually take several months to see the first results
Once you have estimated visitors over time, simply use a conversion rate (which can be different between the different acquisition sources) to calculate the number of orders (also referred to as conversions).
Step 2: Build your revenue
Revenue is calculated using the number of orders, and applying an average order value (the average price of all your SKUs). For more granularity, list all your SKUs and, for each of them, set a sales mix percentage (which should sum up to 100%) and their respective unit price.
The result is your Gross Revenue or Gross Merchandise Value.
Unfortunately, GMV is not the ‘real’ revenue: calculate Net Revenue by subtracting returns and cancellations to GMV. That way, you obtain the total net revenue you generate after all refunds.
Step 3: List all your roles in the Hiring plan
Salaries are often the most important expense category for subscription and SaaS businesses. That is why building an accurate and flexible hiring plan is key:
- Accurate because you will need to list all the roles, their salaries and starting dates as accurately as possible in the foreseeable future (12 to 24 months usually)
- Flexible because if it can be cumbersome to list dozens, if not 100’s of roles (especially if you are forecasting 5 years) but also because it may difficult to assess how to scale your workforce in the outer years (anytime beyond 24 months usually)
For more information around how to build your hiring plan, please refer to our free hiring plan model in Excel format here.
Step 4: Build your expenses
For expenses other than salaries, list them and try to bundle them into categories. Usual expenses categories for ecommerce businesses include:
Cost of Goods Sold (COGS)
- Payment processing expenses
- Hosting (and other tech infrastructure costs)
- Customer service (whether in-house or outsourced)
- Fulfillment costs: shipping, packaging, warehousing, and fulfillment itself (salaries of the operators who prepare the orders)
Note: Fulfillment costs are very easy to estimate when you are using a outsourcing fulfillment provider (such as Amazon FBA), it is simply a cost per order.
Sales, General & Administrative expenses (SG&A)
- Marketing: paid media, offline marketing, agencies fees, etc.
- Other operating expenses: subscriptions, travel costs, office supplies, rent, etc.
- Other expenses: legal advisory, bank fees, miscellaneous, etc.
Note: we recommend adding relevant salaries to their respective expense category (for instance marketing team salaries under Marketing) for more clarity in your forecasts.
When forecasting expenses, you have 2 options, they can be either:
- Dynamically calculated: suitable for variable expenses (they will grow in line with a given metric, such as users, or revenue). It can be as simple as a given % of revenues for instance (payment processing fees), or more complicated (for instance, customer service can be estimated by using the number of customer service tickets, your customer service team efficiency and their hourly rate); or
- An input from you: suitable for fixed expenses (they don’t vary based on growth). They can be expenses such as bank fees, rent, etc.
Step 5: Wrap it up
Once you have built your revenue and your expenses (including all the salaries in the hiring plan), you can easily build your profit-and-loss, cash flow statement and balance sheet. You can also easily calculate key metrics such as CAC, LTV, etc. For more information around the 7 most important metrics for ecommerce businesses, see our article here.