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Financial Modeling: It’s Just a Bunch of Numbers

Jonathan Reynolds . July 14, 2017

When I was in college, the brothers in my fraternity would formally meet for dinner on a weekly basis (and we generally would not be welcomed back to that establishment). Now that we’ve graduated, matured and have full-time jobs, we get together for dinner only once each quarter. And for some reason, there’s an ongoing joke that we are board members of a fictitious company. So, to keep the joke going, I created a board deck for our 1Q17 meeting. Below is the slide that summarizes the financial situation of the company. 

 Blog_JR Finance Model_053017.png

While this next comment may seem a little harsh, it’s meant to be an exaggeration: At the end of the day, the financial forecasts that I come across are just a bunch of numbers. 

Of course, there’s often a ton of thought and logic behind the numbers, but if the financials are forward-looking, nobody really knows how accurate they actually will turn out to be. And as others have pointed out, we don't necessarily expect your numbers to be accurate. More importantly, I strongly prefer to work with financial models that are:

  • Easy to follow and understand
  • Dynamic and informative
  • Reflective of the entire organization’s initiatives

Depending on the size and stage of the company, the financial model will serve different purposes. At the same time, the following guidelines apply to a model for any type of company.

 

Hall of Mirrors vs. CEO Math

At Edison, we engage entrepreneurs an average of 29 months prior to our initial investment. That means they generally don’t have a CFO upon first getting to know them. So, the CEO very well may be handling the Finance function, which is why the company’s receipts are stored safely in a shoebox and the financial model is maintained on a piece of graph paper – aka “CEO Math.”

On the other end of the spectrum is an ambitious finance professional who has created a robust model with 50 tabs, each cell referencing the 50 other tabs (and for some reason, it has dollar signs and something called “SUMIFS”). When the model gets to be that complex, as a fellow co-investor puts it, “you can get caught up in a hall of mirrors.”

Essentially, the numbers float from tab to tab, and if there is an error within the model, good luck finding it. Personally, I don’t mind the hall of mirrors, but I’m not the only person reviewing the model. So, I’ve found it paramount to find an equilibrium between CEO Math and a Hall of Mirrors to create a financial model that both represents the detailed activities of the company, but is simple enough for non-finance executives to work their way around.

 

What happens if…

I’ve had the opportunity to review a financial model with both external (Edison Partners) and internal parties (the Management Team), so I’ve posed and fielded questions from both perspectives. From both angles, the questions generally start with “what if…”

For internal purposes, the model needs to be dynamic. What I mean by that is if I change the sales team’s assumed quota attainment rate, I expect to see the impact to revenue, cash, AR, deferred revenue, sales commissions, and if you’re an all-star, the marketing funnel and hiring plan.

When sharing your financial plan externally, I recommend following the KISS Principle. Print the forecast to PDF, review the plan to ensure it makes sense from a high-level, do a few sanity checks (does the balance sheet balance?) and anticipate those “what if” questions from external reviewers. And whether I’m reviewing the model through a static PDF or a dynamic excel workbook, I want to be able to see the entire company’s story.

 

Is that a financial plan or an operational plan?

One of my big breakthroughs in understanding the purpose of a model was when Kelly Ford critiqued one particular company’s: “It’s a financial plan, but it’s not an operating plan.” When I listen to a CFO describe their financial plan, I’m generally thinking about financial metrics: revenue, EBITDA, cash burn, and, if applicable, SaaS metrics.

But that’s just the output of the model. Financial statements represent a language that we use to communicate a company’s performance, but they don’t provide enough depth to have a full understanding.

Linking the financial plan to the operating plan (and ultimately, the company’s strategic plan) is essential to driving organizational alignment. The CFO needs to proactively meet with the heads of Sales, Marketing, Product, and Operations to ensure accountability for specific contributions that are interdependent within the company’s financial model. A dynamic model will communicate what happens when those specific contributions are not made.

 

And regardless of the fact that your financial projections are just a bunch of numbers, be careful about who you are showing those numbers to. Who knows? The financial forecast could get leaked and end up in my fraternity’s second quarter board deck…

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