It usually starts with a question from the CFO: What would happen if our company did X? X is never simple, and neither is the solution.
Enter financial models.
Financial models condense complex questions into numbers and graphs. There are multiple useful applications for these solutions. Are you trying to raise capital? Set up a budget or forecast? Get a valuation? You need a compelling financial model.
Analysts who have created financial models before know how much work goes into them. They’re often painstaking, tedious, and complicated.
But they don’t have to be. There are now tools and shortcuts that can streamline the process, giving you the ability to focus more on analysis and less on the automatable.
Let’s start by exploring the background of financial modeling.
Why build a financial model for your company?
It’s important to understand the end goal of your financial model before you start the process. While many of the tools remain consistent between various financial models, the data you choose to highlight will differ depending on your objective.
In general, financial modeling can be used for both internal and external company applications.
- External: For companies seeking a valuation, raising capital, or entering into a merger or acquisition
- Internal: For companies who considering growth, budgeting, forecasting, and capital allocation
Once you’ve established the end goal, you need to understand what goes into making a complete financial model.
The financial modeling “recipe”
There’s more than one way to bake a cake, but almost all cakes have the same key ingredients. The same is true with financial models. Financial models usually have all of the following ingredients:
- Revenues: What you’re selling now and what you could be selling in the future.
- Cost of goods sold (COGS): What your products cost to get out into the world and what they could cost. Operating expenses (OPEX): What your company costs to run and what it could cost.
- Personnel: Your team, including direct labor, sales and marketing, research and development, and administration, and what greater or fewer team members would cost.
- Investments: Where your money is and where it could go.
Much like a cake, all of these ingredients interact with one another to produce something greater than the sum of their parts. That’s why financial modeling can become very complex very quickly.
Consider how one input affects another. Increased revenues may necessitate hiring more personnel. More personnel means renting more office space and increasing operating expenses but also potentially lowering the cost of goods sold. This may give you the opportunity to invest in new projects.
Financial models can help you build a smart, multi-dimensional forecast for the future of your company. But given their complexity, the way you build them makes all the difference.
How to build a financial model for your company
Step 1: Asking questions
Questions are rarely as simple as “What’s the budget?”
Let’s use the example of a university that wants to build a new dormitory. New construction is usually expensive, but the question isn’t binary. There’s more to it than “should we build it or not?”
Begin with a single detail: how many floors and rooms will the dorm have? Obviously, the bigger the building, the more it will cost to build. But that one variable impacts all the other ones.
- A larger dorm creates the ability for more students to live on campus, increasing revenue.
- For X more students, Y more personnel are needed, including cleaning staff, campus security, and dining hall workers.
- Your operating expenses also increase based on building size. Heating and cooling may be a fixed price per floor, whereas the cost of food in the dining hall increases for every 10 students you add.
Also—what are the incremental costs of building a new dorm? How much money does each student bring in? Where are the cost breaks in student food?
The list of questions goes on, but the goal remains the same. You’re trying to tell a financial story. No one can predict the future, but you need to validate your assumptions.
Once you’ve identified the right set of questions, you need to start finding the right answers.
Step 2: Gathering information
Most financial models begin by pulling from the same sets of documents. Baseline documentation usually includes:
- Assumptions and drivers
- Income statement, balance sheet, and cash flow statement
- Timelines and schedules
- Valuations Risk and sensitivity analyses
- Any accompanying charts and graphs
However, these documents won’t tell the complete story on their own. Using our university example, it’s important to know the trending numbers and patterns for each data source.
Let’s assume the new dorm allows 600 more students to live on campus. This number is only viable for one semester at a time. Student retention rates can change this number dramatically, depending on how many students leave each semester and how many transfer students join.
Each variable has its own conditions. Once you have established a pattern for each of your variables, it’s time to build the financial model.
Step 3: Building the financial model
There are two ways to build out your data:
The spreadsheet model
The Synario model
Option 1: Excel Spreadsheet Model
Many companies leverage the spreadsheet model because financial analysts are comfortable working with spreadsheets.
It makes sense—spreadsheets are excellent tools for calculating simple, two-dimensional algorithms. If you’re working with a balance sheet or a company’s valuation, spreadsheets are a fitting solution.
The problem begins when you try to build financial models in spreadsheets. They are rarely simple or two-dimensional. Once you start factoring in complicated questions (e.g., building a dorm), it becomes a multi-dimensional nightmare. Yes, it’s possible to use spreadsheets (many companies do), but it becomes an ineffective patchwork model that is ultimately sub-optimal.
Multiple scenarios require multiple spreadsheets to execute properly. With the ever-changing nature of information and data, assumptions can pivot on a moment's notice. With spreadsheets, you often can’t just change one factor to accommodate these needs. Even if you understand it perfectly, the math is daunting, you must be meticulous, and it may take hours accounting for a minimal change.
So, how can you make financial modeling more streamlined? You need to rethink the spreadsheet.
Option 2: Synario Model
We were tired of the limitations of spreadsheets, so we created our own variation that allowed for multi-dimensional analysis.
Our patented solution gives spreadsheets an added dimension by adding layers and objects. It works the same way PhotoShop does (or, if you’re a bit older, the way overhead projectors do). Rather than having to change cells, you change objects with adjustable parameters.
Using our university example, you can create objects for each element of the new dorm: scaling up rooms, new student revenue, additional staff, etc. You establish the relationships between each object and set your goals. Then, you’re ready.
With Synario, you can create multiple permutations with just a few clicks. Our solution utilizes a Photoshop-like interface with different “layers” and sliders that you can turn on and off in whatever combination you want. This allows you to effortlessly explore multiple scenarios with little effort (and none of the manual overhauling you’d need with Excel spreadsheets).
This not only streamlines the process, but it also gives you more time to play around with the data. You can focus on analysis over math and projections over re-doing your work.
Step 4: Presenting your financial model
Synario also has the advantage over spreadsheets when it comes to presenting data.
While spreadsheets do allow you to make graphs based on cell relationships, any small changes to the data will result in backtracking to recreate graphs from the ground up.
Synario handles graphs the way it handles data. Seamlessly create graphs, with multiple permutations and easy adjustments for factoring in new data. This is a great way to present the data. In a meeting with the CEO? Change the graphs and figures in real-time to accommodate meeting insights.
Build financial models smarter and faster
Financial modeling can help you see the best way forward as a company, or potentially avoid a disastrous money trap. But why waste needless hours building your model in a spreadsheet when you could create a dynamic model using Synario?
If you want to see how Synario can produce financial models that are smarter, deeper, and faster, let’s get on the phone.