Issue 12 - Musings of a Modeller ??

Modelling Tips

Sitting down to think about building/designing your financial model can seem like a daunting task. The first consideration is to understand what you are trying to achieve. In its most basic form a model is the financial representation of your business now and in the future. It is also a guide of how you view your business, what it will take to achieve the financial future you have planned and a clear understanding of the key drivers and assumptions that will make it successful.

When do I need to think about building a financial model?

If you are at the earliest stages of your business, where you are pre launch and still working on your MVP, the need for a model is less obvious than when you have proved your product works and you are looking at scaling your business. The most important part of the process when creating a model is the structure and thought process that goes into designing your business and to evidence your level of understanding of what it is going to take to achieve your goals.

The win here is when the process of building your model unearths new assumptions, questions and issues you hadn’t previously been aware of and are then able to address (quickly).

There is no better time to think about your business model than right away to help you validate decision making. Thinking through your assumptions will improve your knowledge of your business and strengthen your decision making immediately.

How do I approach building a model?

When building out a financial model, firstly, before breaking the business into line items and discrete sections, take a step back and look at the business as a whole and make sure you understand what you want to achieve as a business and the use cases of the model / the projections you are building. Starting with the end in mind will help you lay the right foundations and flow to get there.

What do we need to achieve over X period…

> in order to get the vendors set up on our product

> to be in a position where we have hit the metrics needed to raise our next funding round

> so that we can hire the sales & marketing team we need to achieve X

The objective is never to be exactly spot on with the numbers, the goal is to evidence to yourself and others that you have a very good understanding of the areas that will directly impact the success or failure of your business and that you have a plan for delivering against these areas successfully.

It’s commonly accepted that investors don’t care if your projections prove to be wrong. What is important to them, is a focus on your assumptions and the thought you have given to the solution you are providing your customers and what the market is doing. 

There are lot's of tools and templates available to help you actually construct your spreadsheet with the most appropriate tabs and how best to link it together to show the metrics and reports you need. Alternatively get in touch and we can walk you through a good approach and work on it with you.

Types of model 

A good financial model covers off two main areas:

> Well thought out assumptions and projections of the future state of your business

> A clearly structured, understandable, dynamic spreadsheet 

Bottoms Up Model

The bottoms up model is used when creating your forecast from the data available to you with ground level thinking, such as footfall, downloads based on customer sign ups, marketing/advertising conversion rates etc.. data on a person basis. You then build on any assumed behaviours and spend/usage patterns etc off of this data. This approach is based on a set of individual assumptions that allow you to change a specific driver easily and quantify the impact this has. 

Some investors prefer the bottom up approach as it is based on real data and not the information that is provided by businesses on market size etc that comes from the top down approach. The bottoms up approach uses first hand data and your knowledge of your company that protects against it being out of context of the data used in the top down view, which may only apply in certain circumstances.

The bottoms up approach is less dependent on external data and more dependent on specific company based information and data sets. The bottoms up approach begins with micro / inside-out views and builds towards that bigger macro level view. This means the forecast is based directly off of the assumption drivers of the business and you will be gut checking and macro checking the end results against the macro market data, to evidence that it fits neatly inside of what is possible to achieve. 

Top Down Model 

The top down model of forecasting your future financial performance comes from market level data and assumptions placed on what can be achieved from the current market opportunity and behaviour. 

Using the top down view you work from a macro outside-in perspective towards the micro view and impact on your business. This typically starts with industry estimates and these are narrowed down into targets for your business. 

This method helps you define your forecast based on the market share you would like to capture within the timeframe of your forecast. The typical tools and approach to this is in the TAM, SAM, SOM methodology. It is important here to show how you will capture this market share and make your plans very understandable.

Blended View

The trick is to substantiate and defend your short term objectives [6 - 24 months] and to make sure your longer term targets [2 - 5 years] demonstrate desired market share and macro level growth plans that fit in with the appetite of the founders, investors and other stakeholders. This is a blend of moving from the bottoms up approach for your immediate next steps and building momentum, transitioning to the top down approach for a longer term view and what is achievable, bigger picture. 

Working with your model

>Your model will play a key role in all major decisions and discussion in the founding team and with stakeholders

>Your model will evidence the interplay with revenue growth, cost changes and cash in the bank / cash flow, which will be very useful data points for all business decisions

>Your model will evidence the projections built around key drivers/assumptions that are critical for fundraising discussions

In most cases when having meetings on business issues and discussion points, it will require you to be high level in one sense and then to be able to freely move into the granular detail when needed. If you’ve taken the time to think through, challenge and agree on the assumptions and drivers for your business, then your most critical conversations will be far more productive and will give you a strong advantage in the constant battle for funding and acquiring talent to help you realise your business goals. 

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We hope you have enjoyed this article and have picked up a few takeaways that will help you when it comes to thinking about building your own forecast business model. If you wanted to ask any questions on this or run anything past us, please don't hesitate to contact us.

Remember - if you want to collaborate on an article or would like to hear more about specific topics, please do not hesitate to get in touch and we will get it on our roadmap.

We're looking forward to sharing the next issue with you in 2 weeks.

Team ihorizon 

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Articles to date:

• Issue 12 - Musings of a Modeller - tips and considerations to think about when building your business model
• Issue 11 - Transfer Pricing - Services between companies under common control
• Issue 10 - Capital Allowances - The new super-deduction
• Issue 9 - Pitch Deck Refresher - What should you be thinking of including in your deck
• Issue 8 - EMI Options - Engaging your team through EMI options
• Issue 7 – Growth Shares – How they could work for you as an incentivisation strategy
• Issue 6 – Brexit – Post transition period updates to impact on VAT & Tax for our clients
• Issue 5 – Client Spotlight, our friends at DataForm on their sale to Google
• Issue 4 – Navigating the new SME R&D Tax Credit Cap as a Startup
• Issue 3 – Brexit – Impact on VAT & Tax for our client base
• Issue 2 – Focus on Financial Management Information - How to read your reports
• Issue 1 – Launching ihorizon Sigma, our R&D product
• The Launch

Strength in Numbers is curated by the team at ihorizon, a firm that supports startups with accounting, tax and commercial advice and services. The team who contribute cover disciplines such as R&D, Financial Management & Control, Financial Modelling, Fundraising, Tax Advice, Structuring, VAT, Personal Tax Issues, Grant Funding and Corporate Compliance. 

For more information about ihorizon and how we work with our clients across all service areas, take a look here and get in touch.