BUSINESS

10 Ways to Make Your Financial Model Easier to Understand

10 Ways to Make Your Financial Model Easier to Understand

I’m going to hazard a guess and say that as a business owner, you have had to look at many spreadsheets and business analytic reports. You would be hard pushed to find many people that find this an enjoyable task; they are notoriously difficult to understand and require a lot of time and effort to be spent before the findings become clear.

Undertaking a task that is inherently challenging and laborious more than once doesn’t make sense,it’s inefficient and eats into our levels of productivity. It is therefore critical that we find a smarter way to deal with financial modelling. If you are finding it a complicated task, the likelihood is that it’s going to be indigestible for those who are viewing it – this spells trouble when those people are potential investors.

Let’s go back to basics. What is financial modelling?Financial models are mathematical calculations that link variables together to represent a version of the performance of the business, financial asset or project that is presented in a clear and simplified format.  So how do you make sure that the model is going to be easily understood and your efforts see a return? We offer some tips below.

  1. Build for your Audience

Are you presenting this model your team to evaluate business performance or to secure further investment? Speak to your potential investors or business partners and determine what it is that they deem to be important within the model. It will be a waste of your time to build a complex model with a large volume of assumptions and variables when your investor just want to see a 36-month forecast that uses 12 months of historical data. 

  1. Be Consistent

Your model should instil confidence, not apprehension. It’s good practice to be consistent on every part of your spreadsheet from calculations (obviously) styles and formats, decimal places, time series columns and header indentation. Consistency is key and will go a long way to enabling your audience to view the document with clarity.

  1. Use Historical Data

Believe it or not, many businesses do not always include historical data within the financial model. Your model should always begin with historical data and move into projected data. This will help your audience to understand how the assumptions that you’ve made relate to business reality.

But what if there is incomplete historical data?

Eddie Tang from Above Consulting offers advice, “When building financial models/future projections, you generally have to deal with incomplete information. You will need to make assumptions and use comparable information from public trade companies or other companies in the same industry/market to come to your numbers. Try to find companies as similar as possible to your company in terms of what you do. You do not just copy their numbers, rather, you use them as a benchmark and reference to calculate and come to the numbers that are appropriate to your company.”

  1. Think About Print

Your audience or investor may not bring a laptop when they come to view the information you have prepared. Take it into consideration that your model may be printed in order for the projections and historical data to be discussion points.  To make this a seamless discussion for all parties, be sure to include some basic elements; titles, page breaks and page numbers on footers make it easier to understand if the model is viewed in a printed format.

  1. Invest in Software

By using software that is designed to specially build financial models, you can streamline the modelling process and build a clear picture of the profitability of the business. The software tends to still sit within Excel, and will perform the analytical calculations using industry standards. This means that you can concentrate on the quality of data and the variables rather than waste time building individual project profitability reports.

“Being proficient in performing the analysis during financial modelling is not a skill that comes automatically” Explains Jen Westerbladh from Data Partner, “To help to develop an organised way of cash flow modelling, investment planning and capital budgeting you need to look for a solution that will facilitate your investment and valuation analysis in one result. 

  1. Formatting

Basic pointers can really help format your model when it comes to numbers. All numbers over a thousand should be entered using a comma. Consider decimal places with regards to what it is showing; if you are showing customer acquisition, then it’s considered to be too precise to use two numbers after the decimal point. It’s worth speaking to an expert, undertaking research or using aforementioned software to ensure this is right.

Another tip is to keep your font to a minimum size of 10 points to ensure the piece can be easily read.

  1. Highlight Assumptions, Drivers and Output

By creating an area at the top of the document when you begin to build it, it will help in a number of ways. It helps the audience to understand what YOU believe to be drivers of the business it also helps auditing of the forecasts and any tweaking that is required to be performed. 

  1. Auditing

As previously mentioned, it’s critical that your model allows for easy auditing and testing.

“The conventional wisdom is that 95% of spreadsheets have at least one error in them”, REFM report, “That’s pretty scary. The severity of the error can be anything from harmless to high-impact. Checking every single cell in your spreadsheet is a modern form of torture. That said, it can save you from making big mistakes or presenting faulty analyses to potential stakeholders.”

  1. Simple Genetics

Often, colour coding is used as a way to distinguish formulas and constants. But did you know that 8% of men are colour-blind? Using a variety of font and fill colours is unnecessary, particularly if the document is printed, as it’s likely to be in black and white anyway. Differentiate your projection sheets and output sheets by using grey and white fill colours to make it easy to navigate for everyone.

 Transparent Capital

It’s all very well showing calculations that look like: start cash + revenue – expenses = end cash, but there are other elements that need to be factored in. Use a cash flow statement and balance sheet to ensure that points such as disbursements and cash collections are factored in.

Financial modelling isn’t a task that sits at the top of many business owners to list of priorities -but it should be. Undertaking this task can provide clarity on business performance, help you to establish the direction to take to improve the current status and also entice investors to give a capital injection. Getting to grips with financial modelling is really in your best interest in the success stakes.

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