The What, How, & Why of Financial Models

If you know me well, you know that I can geek out over a financial model. There’s something about a well built, effectively linked spreadsheet telling me how rich our company will be in 2.5 years that really revs the engines. But alas, we all know that the only thing you can count on with your financial model is that it will be wrong…most likely just one month down the road.

But fret not! The sooner you can embrace this fact, the sooner you will realize that accuracy in your projections isn’t really the point of your financial model. A financial model should help you organize and frame high level decisions, ideas, or goals by forcing you to sift through the detail of how you will execute them.

While a good financial model might be fun for me (is it clear by now that I’m a dork??), I can understand how this might be overwhelming for some. Stepping back, it might help to tackle a financial model using three simple questions: What, How and Why.

What are you trying to accomplish or prove out with your financial model? This could be anything: proving the viability of a new business; determining how you will scale your company with new investor money; analyzing how long it will take to get to cash flow positive.

How will you achieve your desired outcome? Once you’ve identified what you are trying to build, the next step is to figure out how you will prove it. This consists of the assumptions you make and the inputs within your model. I sometimes call these the “drivers”, as they steer the output or overall result of the model.

Why didn’t we achieve projected [insert any metric] results? The “why” portion of a financial model equation is best deployed when comparing actual results against the model. Comparing actual to forecasted allows you to dig deep and identify why your original assumptions were incorrect (remember, they most likely will be!). For example, Why didn’t we hit projected revenue? You might find that your variance is tactical — the company didn’t schedule the expected demos need to close X amount of revenue; OR it could be strategic — the original pricing strategy left some revenue dollars on the table.

Using What, How and Why will keep you focused on the main reason for building a financial model: helping you make decisions today in order to achieve future goals.

Yeah, yeah, yeah…that sounds great, but how do you actually build a financial model? Hmmm, methinks I smell a financial model series!! My next blog post will go into some tips to building, linking and presenting a financial model, and it just might include a template of what I use. So stay tuned…or consider yourself warned!

This could’ve been a young Ben Warren:


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