Learn to love your financial model
I have a guilty secret – I love business planning models.
There is something beautiful about how a good financial model represents a business. A slick presentation and engaging website are wonderfully visual but the financial model is the real deal – it shows a path from where you are to success, to profit, to value. You can play with it and ask it questions. It goes a long way to making the prospect tangible and I love that.
Not everyone gets excited about fields of numbers but I still think any business founder should learn to love their financial model. Don’t be fearful, embrace the exercise and keep coming back to the model regularly with a view to constant improvement.
Fundamentally, I don’t think there is any better way of understanding what you really have as a business, how it can realistically become a success and where the dangers lie.
Here are my tips for making financial modelling an exercise that adds real value and becomes an exercise you love…..
- Keep it simple. I distrust models which are overly detailed. Each of the assumptions should mean something to you and should be something on which you have a view. As you progress and your business matures, you can always introduce more complexity
- The building blocks of the model should reflect how you think about your business. If you think about clients in three categories then model it as such. If the modelling exercise is pushing you to introduce additional categories then perhaps you need to adopt those categories more generally.
- Make sure the model is taking you far enough into the future to reach your objective. The outer years are likely to be speculative, but you need to be charting your way to success and even a speculative model is helping you understand what needs to happen to make your project work.
- Model cash very carefully. It is all very well modelling revenues and costs, but the biggest danger to a growing business is running out of cash. Make sure you have a realistic and up to date cash projection – especially if funds are tight. For instance, make sure you are realistic about how quickly clients settle invoices, or how quickly a funding round will close or when R&D tax credits will actually be received. Stress test the model by pushing out receipts and increasing costs.
- Use actual data as far as possible. Your projections will be more meaningful if they are extrapolations of observed data. What do your current clients tell you about your sales cycle? Use that as your starting point for projecting the sales cycle going forward.
- Remodel frequently. You should set your model up so that you can update it each month for actual data. Alongside accounting data (revenues, costs, cashflows) a good model should include non-accounting data like numbers of leads, size of pipeline, product usage.
- Don’t ignore uncomfortable implications. The model may be telling you that you are in trouble well before you are running out of money. This has happened to me. It was deeply uncomfortable, but the model did not lie and engaging with the issue allowed us to find a rescue in time.
- Don’t be a slave to the model. In particular, be prepared to rethink how you model the business. It is easy for the model to fall out of step with the business. You will constantly be pivoting – perhaps changing the revenue model or the ways in which you think about clients. From time to time you may need to make significant changes to your model to make it more useful – be open to that possibility.
- Use the model. It has something to say about practically every major business decision. What happens if we make that hire in three months rather than next week? How are we affected if our sales cycle pushes out from four months to five months? Where would we be if we lost our largest client? There are other uses for the model (eg helping with fund raising) but its fundamental value is to help you run the business better
So – dive in and learn to love your model. I wish you the very best of luck and would be fascinated to hear how you get on.