Are you avoiding using financial indicators to steer your ship? You know you should be looking at cash flow, inventory, profitability by project and more, but it takes too long.

Ironically, when this happens, it’s often because your financial model is way too complex.

If you are not using your forecasting model, you may need to lighten it so it can become part of your smart operational cadence. Moreover, what type of model you should be using depends on your business’s stage.

In the first article, we covered a simple model for the Startup Phase, when you need to pitch an effective financial model that attracts investors and is realistic for how little actuals you know at that point. Now your business is growing and you’re moving into the Initial Traction Phase.

Phase 2: Initial Traction Financial Model Adds Details

The difference between the Startup and the Initial Traction Phases are all the things you’ve been learning while getting up to speed. You have a better sense of your customer. You’re learning about your cost of acquisition. You’re also figuring out what it takes to make your product or deliver your service. You’re running into operating hurdles like, “OMG, our reject rate coming off the production line was way higher than we expected.”

It’s time to add this new information to your forecasting model.

Suppose you’ve just discovered that for every product you build, costs are 20% higher than expected — you’re throwing away one out of five products because they didn’t meet your tolerances or your specs. Sure, you have plans to get that percentage down, but right now, you can no longer say that your reject rate is only 1% in your forward-looking model. You’ve got to come up with a better assumption to show that your COGS are higher than you thought they were. How does this impact your cash outlook?

The objective of this early-stage model is that you’re dialing in scalability and profitability. You’re learning. Every month when you see your actual numbers, you’re learning something new. You’ve hired people, you’ve seen some new aspect of customer acquisition or you have new insights into COGS, inventory, sales efficiency or whatever it is. When we make these adjustments with a business, we call it the “re-forecasting process.”

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Of course, you can continually adjust priorities based on what you learn. Your management team shares: ‘Hey, this trend is changing, that trend is improving, and this other trend is declining.’ Now it’s time to incorporate this formally by updating your financial model so your team stays on the same page. Get granular! For example, get in the weeds by products or by customer segment.

Now you’re dialing in unit economics even better. You’re dialing in your cash flow and your capital. You’re being much more diligent about when you heading toward a cash crunch, or when you will need more capital and where you will be when that happens. You know what your business looks like now. In this stage, you are improving and adding variables to that business model. You’re improving its accuracy.

In this Initial Traction stage, you may still be trying to figure out if you’re “a one or a zero”—whether you’re going to survive or not. But you are honing and moving toward the stage where you think you will make it. You may decide to raise one more round and then switch into operational mode.

The Initial Traction financial model can last quite a long time. When that improved model stops working, however, you have shifted into your Operational Phase.

Phase 3: The Operational Model Gets Accurate

In this phase, your objective is evolving, and it’s twofold. First, you are moving from launching and surviving to optimizing your operations, cash flow and profits. Secondly, you are taking what you’ve learned and starting to plan and project better. You’re getting management involved in meeting budgets and targets, and you’re setting up controls. You’re operational, baby!

1. Optimization. In this phase, you’re testing the effects of your actions and learning how you can optimize them. I just talked to a $30 million company yesterday that was hyper-focused on margin. They were wondering, “How can we get another 1% of margin?” They are running different promotions and observing the impact of each one around margin and demand.

Your organization is starting to grow, too, so you have added department- and project-level components into the model. You may have much more granularity within, say, a marketing group, or within a customer success group in terms of renewals and renewal patterns. There’s more to look at, and that’s a good thing.

You’re also starting to use your forecasting model to monitor spending. Not only backward-looking spending, but now forward-looking. You may be asking, “How should we be spending money in different areas? What does that spending drive, how is it happening and is it effective?”

In this third phase, you are looking at your numbers in a very purposeful way. You’re focusing on spending wisely and noticing when it gets out of control. That’s why you need to operationalize your model.

Even incentive comp plans can be designed to hit your goals. At this point, when you start seeing goals and budgets, your models need to figure out how you want to build your incentive driver. You ask yourself, “What are the goals we are trying to achieve with this big new incentive comp program?” If you’re going to pay out $250,000 in incentive comp, you really want to make sure the plan achieves your goal!

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2. Management and Control. When you’re trying to manage people’s forecasts — for instance saying, “Okay, R&D, what the heck are you folks doing? Why are you spending money on marketing? What are you going to be doing with that?” — you now have an organizational structure in which more eyes and ears are into the forward-looking plan and the detailed components. So the last piece here is management and control.

That’s where a good financial model can keep key people on the rails much more than a budget will. A budget is usually done once a year. Sometimes fundamental things happen in the business to cause new decisions and make the budget obsolete. For example, “We’re going to pivot a bit here on manufacturing because this product or a core ingredient is not available for nine months. Without that revenue, we can’t do these three things.”

The Operational Model focuses more in real time with the management team. It adds more granularity. What goes into it exactly is going to vary tremendously by every single type of business, but that’s the overview.

You don’t want to build an Operational Model when you’re at the Startup Phase or even at the early stage of Initial Traction. You need simpler models at that point, and now you understand why.