This is the first in a blog series written to all founders out there who inspire us
Many founders I meet approach financial modeling as a time-consuming and arduous distraction from their business. It’s a low-value chore they have to complete in order to satisfy outside investors or lenders, which they prefer to dispose of as quickly as possible, or hand off to someone else altogether.
I understand. In one of my earliest jobs as a financial analyst, I was assigned to work on a large financial model. The first time I reviewed it, I was flabbergasted by its overwhelming complexity. Determined not to be defeated, I carefully worked through every section over and again. Nevertheless, at the end of the first day, I felt like I was reliving the same dread I experienced when I was lost in a tree maze at an amusement park as a little kid.
It took a while for me to get the hang of working with financial models. But I have good news to share: by adopting some fairly simple rules and discarding some unhelpful myths, it’s possible to appreciate financial modeling as a helpful tool rather than a source of dread. So I decided to dedicate a small series of blogs to share the lessons I’ve learned, to make life a bit easier for anyone who might be struggling the way I did.
In this post, I start the series by identifying three common myths or misconceptions that make financial modeling so unrewarding, and offering more helpful rules to adopt in their place. These are guidelines I developed from experience to make my life a lot easier, and equally importantly, to take full advantage of its often overseen function as a highly effective tool to base one’s strategic decision-making on.
If implemented consistently, you can benefit from having a financial model that helps you in several different contexts including:
- Communicate your business to others more effectively
- Use it as a multi-purpose tool for your most important decisions
- Discover new insights you might have overlooked otherwise that can help improve your business.
Discard Myth I. Financial models serve to document financial statements and projections
Replace with Rule I. Build your unique story
Many people who have who built or used financial modeling for one reason or another learned to view it as a single-purpose tool to show their past, current, and future financial statements. Investopedia’s definition of financial modeling follows this pattern, and many other sources offer pretty much the same.
I encourage you to discard this definition as a misunderstanding that obscures the fundamental importance and purpose of financial modeling, and recommend you view financial modeling as a language or framework to tell the unique story of your business that you are aiming to build.
Like a well-told narrative, a well-constructed financial model communicates your unique story and substantiates the viability of your business’s future success. It articulates the growth objectives and communicates the path to reach them succinctly.
Therefore, good financial models do several things effectively:
- Clearly identify objectives and growth milestones
- Articulate assumptions behind those objectives
- Demonstrate unique business model elements or attributes that can prove or validate the assumptions
- Depict distinctive go-to-market priorities that support the business model.
Models that miss one or more of these, or that obscure these functions in unnecessary complications, have little value either for assessing the viability of the underlying business or as tools to enable its future success. These models look like mind-numbing collections of numbers, instead of unique and compelling stories. On the other hand, if your model can perform these functions, you can be assured that it can become your foundational instrument for every purpose including raising capital, making strategic decisions, and managing your operational performance.
Discard Myth II. (a) Complicated models are better; (b) only great experts can build good models
Replace with Rule II. Simplicity goes a long way
I often come across unnecessarily complicated models. It seems almost a point of pride among financial analysts to make their models overly complex as a way of proving their prowess. Whether by design or not, this pattern has perpetuated an illusion that financial models can only be properly built by experts with many years of experience. In hindsight it took me far too many years to realize that this illusion was the biggest factor in making financial models a misery for me and countless others.
It’s important to recognize that you have the full freedom to build your financial model the way you think is best to serve your purposes and tell your story. At the same time, simplicity is perhaps the most important factor that helps you make use of your financial model consistently. It is also the ultimate way to maintain the flexibility of your financial model so that you can repurpose or test it for any important strategic decision you may need to make.
It is necessary to have simplicity and flexibility as financial projections change, because really, who can predict the future, right?
It may seem daunting if you need to distill large amounts of complex information into a simple format. However, there are tricks that can be employed to easily zoom in on a granular level of details in a model and zoom out to high-level perspectives. My next posts will address this and other topics in more detail.
Discard Myth III. Financial models are used for only a few specific purposes and have no inherent part in operational or tactical decision making
Replace with Rule III. Usability should equal to material impact
In my opinion, the value of your financial model is determined by its usability and measured in the material utility it has to help improve your business, manage its growth, and achieve your intended success. I believe that a financial model is not fully a model unless you have included analytical components such as scenario and sensitivity analyses. These types of analyses can help keep you disciplined in terms of keeping track of your strategic goal or improving it. To your surprise, it could even lead to discover new key performance indicators (KPIs) that may help you understand new or previously obscured aspects of your business. The good news here is that it can be quite easy to build such functionality into financial models, and I’ll address this in future posts as well.
In my previous and current roles, I spent a lot of time taking apart financial models that obscure rather than illuminate the business in question, through which I often discover the main culprits are associated with these three myths. It’s all right not to enjoy building a financial model or be discouraged by it, in fact many people dislike it. My best advice for someone who might be going through these difficulties is to always make sure it works for you before anybody else, and to remember that you are the best person to tell your story because it’s your business — so treat your model like an art of language that you can speak better than anyone else, because it is true.
Image Credit: Shijiro Ochirbat
***
At Reinventure, we invest exclusively in US-based companies led and controlled by BIPOC founders and/or women founders of all identities. Our impact objectives encompass several layers including and not limited to creating capital access, creating equitable wealth growth, help maximizing founders and their employees’ wealth as well as providing support where we are able. This blog series is part of our effort to help realize a small part of our impact objectives. If you are an accredited investor and/or founder and would like to learn more about investments that can advance social, racial, and gender equity by supporting high-value companies led by women and/or people of color, please contact us to start that conversation.
Legal Notice
The information contained in this blog does not constitute, and should not be used or construed as, an offer to sell, or a solicitation of any offer to buy, securities of any issuer, fund or other investment product in any jurisdiction. No such offer or solicitation may be made prior to the delivery of definitive offering documentation. The information in this blog is not intended and should not be construed as investment, tax, legal, financial or other advice.