Building Financial Model

Building a model is not hard; the most difficult task is keeping everyone honest and setting realistic goals instead of making forecasts with probabilities similar to striking a Mega Millions jackpot three consecutive times. Models are primarily decision-making tools, so it’s important to clearly define what decisions they will inform (what scenarios to account for, etc.). The rest involves using trends, talking to business partners, and applying common sense.

Revenue

• Booking: This is the fuel for the company; without it, the company can't move forward. Talk to sales, but don't take their word for it—look at historical conversion rates, recurring trends, and challenge their forecasts. Sales teams tend to be conservative with their forecasts because they know the CEO or board will ask for higher numbers. The job of a good finance person is to eliminate this silly game by providing conservative, expected, and optimistic scenarios backed by solid supporting facts (conversion rates by AE, ramp-up time for new AEs, sales distribution by AE, etc.).

• Revenue Recognition: It all comes down to ASC 606, which started after December 15, 2017, to eliminate inconsistencies in how revenue was recognized. The company just needs to ensure the 5-steps:

  • Identify the contract with a customers

  • Identify performance obligations

  • Have clear selling price

  • Allocate transaction price to performance obligations

  • Recognize revenue <- not really a a step.

OpEx

• Fixed Cost: These are easy to predict (IT, facilities, etc)

• Variable Cost: The key is to meet with each department owners and understand seasonality for usage based cost (licenses, consumption-based) and understand how they're going to their budget by vendors and reason behind it.

Cash

• A/R and A/P can make or break a cash forecast.

Other Good Practices

• Have a dedicated tab that has automated checks. There can never be enough.

• Years in columns and items in rows.

• If possible, do not conduct multiples steps in a single formula. Make it easy to debug the formula.

• Use consistent titles, column headings, font, and color schemes.

• Have a clean, well-organized design and layout.

• Do not create too many unnecessary assumptions and line items.