How Incrementalism Drives Sustainable Financial Modeling
Intuitively, we know that small changes—whether improvements or deteriorations—can have significant impacts, given enough time. Making minor but effective changes is much more practical than relying on a once-in-a-lifetime breakthrough or taking asymmetric risks with low chances of high payoffs.
Success, therefore, usually arises from small gains and consistent efforts over a long time. If you’re into fitness, you’ll know that you can’t bench press 225 pounds or run a 5-minute mile after a few hard sessions—it takes minute, progressive effort over many months (or years). The same applies to mental pursuits. Chess is a game of logic and patterns; you simply can’t become a Grandmaster overnight.
From an organizational perspective, the key takeaway is the concept of “incrementalism.” Incrementalism is a method of working that attributes results to small yet meaningful incremental changes instead of rapid and substantial jumps. This concept is particularly applicable to financial modeling.
Modeling is a process that takes time to apply optimally to your business. It is unlikely that you will be perfect from the start. Taking a long view, with a resilient, flexible mindset, is the key to continued improvement and eventual mastery. But honing your skills—and your tools—doesn’t happen overnight.
Here’s how to apply the concept of incrementalism to your modeling journey to extract the most value for your organization.
The challenges of financial models
Financial models can be as straightforward or as complex as you want them to be. Nonetheless, there is a fine balance between overcomplicating your model, extracting maximum value and insights, and optimizing practicality and accuracy. Consider the following challenges modelers face:
- Nailing the scope. You need to understand why you are building the financial model and what you are trying to achieve. What insights are you looking for, and in how much detail? These details are essential to establish, as you can’t work toward an outcome without a clear idea of what it is.
- Collecting data. Another variable is data. You can’t model scenarios unless you have sufficient, accurate, and complete data on which to base it. Challenge your organization to use existing data in novel ways, or establish new requirements for sourcing the data you need to achieve the scope of the model.
- Assumptions. Financial models are only as effective as the assumptions and inputs they are given. Varying assumptions wildly dissolves the integrity of the model’s outputs, so implementing a suitable range of variable assumptions is critical.
- Model flexibility. Financial models should not be limited to predetermined ranges or specific expectations. The operating and economic environments can change rapidly, and your model must be able to keep up.
- Interpreting outputs. Presenting insights in a meaningful manner is one of the most difficult challenges to face. You must be able to make intelligent use of your model’s outputs, synthesizing them for their intended audiences. Synario makes this much more straightforward; however, the same principles apply.
- Structural integrity. While you should take all these challenges into account, underlying any changes is the accuracy of the logic and calculations taking place. In short, the model must work as planned.
Why long-term planning is so difficult
According to KPMG, long-term-oriented companies perform better than their peers and experience more stable financial performance. However, planning for the short term is often more straightforward than long-term planning. There are fewer steps involved, it’s more measurable, and achieving goals is usually faster. While it may come with different stressors, you’ll know if you’re on the right track sooner rather than later.
Long-term planning and strategic thinking come with a new set of challenges. The future is unpredictable, and any efforts made today might not reflect the future environment. A financial model may be accurate and responsive under current conditions; however, without future improvements and iterations, the model may lose its effectiveness.
Here is where the concept of incrementalism becomes applicable. Making small yet strategic adjustments naturally corrects and accounts for short-term improvements while moving closer to the long-term goal.
Of course, applying incremental changes isn’t straightforward—how do you know what to change and by how much?
Vary one core model component incrementally
According to McKinsey, organizations must be adaptive and agile. Top-performing companies are those most open to continual change and improvement. You can begin this process of regular adaptation and improvement once your primary financial model is functional and used to deliver insights to stakeholders.
Do not take a scattergun approach. Instead, identify the core components of your model. This could be done by separating business units, functional input sources, or reporting segments. Select one—and only one—component to focus on at a time. Being selective allows the organization to measure the return and improvements from changes to one isolated subset of variables.
Dedicate a few months (ideally an entire quarter) to making incremental changes to the chosen model component. Regularly review the output and make changes accordingly. By the end of the chosen period of experimentation, you will have a clear view of how that model component has improved—for the benefit of the wider financial model, the long-term goals of the organization, as well as the stakeholders of the insights generated.
After this is done, you’ll select another area of the model to optimize. It’s an iterative process of continual improvement. You may find that changes in one area negatively impact those in another. What matters is that you always stay in control of the variables. If something doesn’t work, you know why and how to revert the changes.
Apply SMART goals using feedback from multiple users
Seeking to make meaningful improvements blindly is not a viable strategy. The best organizations optimize their financial models through collaboration and clear goal setting, working from the ground up. No one is an expert on every area and variable of the business—not even the CEO.
Synario is designed as a collaborative application where all applicable users are encouraged to add their opinions and unique perspectives into a model. Multiple wide-ranging inputs on aggregate generally provide a superior future view than the sum of each individual’s thinking.
This idea is based on the idea of creative cooperation, in which the benefits of teamwork and respect for different perspectives generate value above and beyond what would be expected from simply agreeing. There is no correct singular model; what matters is addressing any insufficiencies to drive the incremental improvements we’re looking for, no matter how large or small they are.
One framework to solicit cooperation and transparent targets is SMART goal setting. SMART goals are specific, measurable, achievable, relevant, and time-based. When setting a goal, whether that be a model improvement or a certain future capability, each stakeholder should understand specifically what the desired outcome is and how it will be measured.
The goals should be achievable (aspirational, but not out of reach), relevant, meaningful, and, most importantly, time-based. If the timeframe for incremental change and testing is left open, there is little urgency to test and reflect on critical changes. Setting SMART goals keeps everyone in the organization accountable.
Prioritize based on the financial impact
Another factor to consider is the prioritization of competing goals and intended changes. There is a limit to how much can be achieved with an incremental approach in short periods. It takes time to make adaptive changes that make sustainable, long-term improvements. Harvard Business Review discusses the need for effective prioritization—particularly in the context of a ‘Hierarchy of Purpose’—often headed by financial results.
One of the most common approaches, therefore, is to prioritize areas of the business that drive vital financial outcomes. Focus on areas and changes that will lead to the most significant financial benefit. Financial returns are also more easily quantifiable and more likely to win organizational approval and a mandate for further experimental changes.
The process is ongoing, adaptable, and full of challenges along the way. Synario is designed to make the journey as rewarding and insightful as possible. If you would like to learn how Synario can help you drive incremental benefits to your organization, get in touch with us today.