How to Create Your Financial Model
Financial modelling and scenario planning are the core tools we’ll focus on in this section. Getting a handle on them will help you reach investment readiness, project future financial performance, and plan for different ways your studio’s business might unfold over months or years.
Three-Statement Method
The three-statement method for financial modelling is a widely used approach that involves creating three interconnected financial statements: the income statement, balance sheet, and cash flow statement. This isn’t the only way—there are many different approaches to financial modelling, with varying degrees of technical and financial complexity. We’re focusing on the three-statement method because it uses documents you likely already have (or should create) and because it is foundational to other methods.
Staying on top of your accounting practice—with the support of a professional, ideally—is extremely helpful for identifying trends over time, making informed decisions, and demonstrating financial knowledge to potential funders. It also lets you gauge the viability of a particular revenue model and the potential for a return on investment (ROI), which can guide you in making sound business decisions (and impress investors!). We encourage you to involve everyone in your studio in the process of analyzing and maintaining these documents, so that everyone is educated and able to contribute to financial and investment decisions.
For Existing Studios
Let’s get to creating your model! (New studio? Jump to the next section.)
Step 1: Choose Your Tool
First, pick your tool: Excel or Google Sheets. Whichever you’re most comfortable with is fine.
Step 2: Enter Your Historical Data
Next, in three separate sheets, enter up to three years of financial information for each of the three financial statements: income statement, balance sheet, and cash flow statement.
Step 3: Analyze Your Financial Statements
So, how do you make sense out of all these numbers? Financial statement analysis involves examining trends and relationships.
Horizontal analysis (also known as trend analysis) compares financial data over several accounting periods to identify trends and growth patterns.
- Think about periods that include major events for your studio, such as game launches, funding rounds, or marketing campaigns.
- Calculate the percentage change from one period to the next for each line item on your income statement and balance sheet. Subtract the old value from the new value, divide the result by the old value, and then multiply by 100.
- Look for items that show substantial changes and try to correlate these with events in your studio’s history (or external events). For example, a spike in revenue might correlate with a showcase featuring your game.
- To help you pinpoint trends, it may help to create charts and graphs to visually represent these changes over time.
Vertical analysis represents each line item as a percentage of a base figure, such as Revenue on the Income Statement and Total Assets on the balance sheet. This helps an investor compare your studio to others of different sizes.
- Determine the base figure: For the income statement, use Total Revenue; for the balance sheet, use Total Assets.
- Convert each line item into a percentage of the base figure. For instance, if Total Revenue is $500,000 and marketing costs are $50,000, marketing costs are 10% of Total Revenue.
- Compare across periods or benchmark against industry norms (if you have access to that type of data, which can be tricky).
Financial ratios provide insights into performance. For game studios, which generally don’t hold inventory and are rarely profitable in the early stages, the current ratio is most relevant. The current ratio assesses your ability to meet short-term obligations (such as salaries and loan payments). To calculate your current ratio, divide your company’s total current assets by its total current liabilities.
Step 4: Forecasting and Assumptions
Create a new sheet and calculate drivers (such as development costs and budget, funding, sales, release timing, and operating expenses, including wages) and ratios as detailed in the previous section. Based on these drivers, create assumptions (scenarios) for the next three years. You’ll want to detail the best (unexpected runaway hit), worst (total flop), and most likely (somewhere in the middle) scenarios using information like industry trends, comparables, and economic downturns.
Don’t write an essay on your assumptions or reasoning behind your comps. Just be diligent in the way you present this data.
Step 5: Build Your Financial Statements
Complete your income statement. Your revenue streams likely include sales, subscriptions, grants, and service work. To arrive at net income, include calculated depreciation, interest, taxes, etc.
Build your cash flow statement using cash from operating, investing, and financing activities to determine the closing cash balance.
Finalize the balance sheet. Add the closing cash balance from the cash flow statement.
Step 6: Linking and Integrating
Link your statements using formulas—changes in one should affect the others appropriately:
- Net Income from the income statement is added to Retained Earnings on the balance sheet, impacting equity.
- The opening line item on the cash flow statement under Operating Activities should be linked to Net Income from the income statement.
- Balance sheet items, such as loan liabilities, are reflected in the cash flows from financing activities on the cash flow statement.
- Asset transactions on the balance sheet, like purchases or sales, are represented as gains or losses on the income statement.
Tips
Review the financial model from an investor’s perspective, questioning your assumptions and changing figures to understand their implications. While traditional investors are looking for your path to profitability, social impact investors are looking for sustainability, the realism of your projections, and how you re-invest profits in the community.
Some common pitfalls to keep in mind are over-optimistic revenue forecasts, underestimating costs, and improper cash flow timing. These mistakes can affect the realism of your model and how investors perceive it. Avoid them through sober analysis, diligent research, and periodic reviews.
For New Game Studios
📊 Financial Model Template for New Studios - choose File > Make a copy
If you’re a brand-new studio (congratulations! 🎉), you need to build a foundation for investment readiness from the ground up. Here’s how to do it:
Step 1: Choose Your Tool
Select either Excel or Google Sheets based on your familiarity and comfort level. Create four separate sheets within your document for the income statement, balance sheet, cash flow statement, and assumptions.
Step 2: Establish Your Initial Data
Since you don’t have three years of historical data, start by estimating your initial costs. Document all startup costs, such as wages/salaries, legal fees, software licenses, computer purchases, and any other upfront payments needed to get your studio running. Detail your funding strategy, including any initial capital from personal savings, loans, or seed funding you expect to secure. Estimate revenue streams from game sales, in-app purchases, subscriptions, and advertising. Analyze market trends and comparable games to make realistic revenue projections.
You can break things down in whatever way makes sense to you—monthly, quarterly, “seasonally” (considering tradeshow season and launch windows), or annually.
Step 3: Forecasting and Assumptions
Even without historical data, you can estimate future revenues based on market research/comparables, and expected sales trajectories. Consider revenue streams like direct game sales, subscriptions, or in-game purchases.
Budget for ongoing costs such as salaries, rent, marketing, and development expenses. Don’t forget to include recurring expenses like software subscriptions and server costs.
Plan the best, worst, and most likely financial scenarios. Use industry benchmarks and market analysis to gauge potential outcomes for game launches and other revenue-driving events.
Step 4: Build Your Financial Statements
- Income statement: Start by forecasting revenue and deducting estimated expenses to calculate your expected net income or loss for each period.
- Cash flow statement: Model your cash inflows from operations, financing, and investing activities. This statement is crucial for understanding cash burn rates and when additional funding may be needed.
- Balance sheet: Project your assets, liabilities, and equity. Initially, assets might include cash on hand and initial capital investments, while liabilities could include startup loans or credit lines.
Remember! assets = liabilities + equity
Step 5: Linking and Integrating
Use spreadsheet formulas to ensure that changes in one statement are automatically reflected in the others. This will allow you to adjust assumptions and immediately see the impact on all financial statements. For example:
- Net income from the income statement affects both Retained Earnings on the balance sheet and is the starting point for Cash Flows from Operating Activities on the cash flow statement.
- Purchases of assets in the cash flow statement should reflect as asset increases on the balance sheet.
Tips
Constantly review your model to ensure it realistically reflects possible financial pathways and shows a clear route to sustainability. Regularly challenge your projections by adjusting the assumptions based on new market data or feedback from potential investors.
Be conservative with initial sales forecasts and factor in ample time for development and marketing work. Buffer for unforeseen expenses, such as protracted development time. Finally, new studios often struggle with cash flow timing; meticulously plan for when cash inputs and outputs occur.
Conclusion
You’re on your way! Your financial model will be a massively useful tool when you approach lenders or investors and for internal planning. Don’t worry about your model being perfect—most indies don’t do this work, so you’re well ahead of the game. You can and should revisit your numbers often, and you’ll learn along the way what aspects serve your studio best.