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How To Improve Your Financial Model (And Your Business)

How To Improve Your Financial Model (And Your Business)

Improving a financial model

Now that you’ve built your financial model, how do you make it stronger?
We can broadly split these into two categories: changes to the spreadsheet, and changes to the business itself.
Let’s start with changes to the spreadsheet…

Since readers of this guide are spread all over the world, I’m not going to focus on the Australian taxation system.
Instead, I’ll just say this: Learn the laws of your country, and make honest, transparent decisions.
If you’re a sole trader, you’ll already have some familiarity with the tax system, but for those of you who aren’t it’s worth doing some reading on how a new business has to pay tax.

This includes topics like:
What is/isn’t a work expense?
How much tax do we pay on profits?
What cuts/perks/discounts are available in our industry?
When (and how) are tax payments made?
What level of record keeping is required?
How does Goods and Service Tax (GST) affect our business?

Please don’t take advice from your dodgy uncle who makes ethically questionable tax moves.
Yes, he can probably “save” you some money.
No, it’s not worth bending the law.

Full Staff Costs
A staff member costs more than just their salary.
Depending on where you live, there are factors like superannuation, payroll taxes, annual leave, sick leave, professional development, etc.
This might be somewhere between a 10% - 30% increase on what you’re paying in salaries, so it needs to be factored in.
You might have budgeted $500k in salaries, but it will require you to actually spend closer to $650k.
This may affect who you hire.

Financial Model Contingencies

It is frustrating to see managers and entrepreneurs cling to budgets that were initially estimates and fabrications.
Your business will encounter unexpected costs, and just because they don’t match your budget doesn’t make them any less real.

It’s worth building in a contingency line for the inevitable troubles.
Even if you can eventually claim them back on insurance, it still requires cash up front.
We use a rough figure like 5% of overheads in our new ventures, it’s imprecise but you’ll be glad you have some wiggle room when things get tough.

Measuring Effort and Reward
Not every opportunity is worth pursuing.
When exploring new projects or grants, don’t get distracted by the size of the prize – also look at the likelihood of winning the prize.

For example, in my team we use a combination of deal/grant size, multiplied by the probability of winning the deal/grant.
This helps us prioritize where we spend our time, a $100k deal at 60% probability is worth more than a $250k deal with 15% probability.
Obviously this involves a lot of guesswork, but it’s worth building your own equivalent.
It can help you determine if it’s worth writing grant applications, since you’ll be sinking 10-20 hours of time into a proposal that might not be worthwhile.

Visual Overcrowding
The spreadsheet that you devise is probably not very useful for showing other people.
Your numbers are telling a story, and if it’s a jumbled and overwhelming story then your audience will tune out.
Give your important figures prominence, and build in white space around your important blocks of information.
By guiding the reader’s eye with colours and easy-to-read data, you also help create a clear narrative, which will prompt them to ask good questions.

Testing one change at a time

These next points refer to the business, rather than the spreadsheet:

Testing One Change At A Time
It is very tempting to make a lot of changes, then measure their cumulative impact.
Whilst this feels efficient, it removes the sense of attribution – you can’t tell which changes were most valuable.
That means it’s hard to know which changes can be doubled, and which should be undone.
Experiments are best done in a way that is controlled and measurable.
By remaining diligent with each change, you’ll isolate the genuine improvements and avoid misattribution.

Setting Go/No-Go Points
When your heart is set on a new project/product, it’s very easy to read any signal as being a positive indication.
It’s worth setting dispassionate go/no-go points ahead of each experiment, e.g. We’ll launch if we can raise $45k on Kickstarter.
The alternative is to let the sunk costs sway you into proceeding with a flawed idea – overlooking all of the no-go signals and sinking in more money.

Identifying and Defending Against Delays
This might sound obvious, but you’d be stunned at how often delays threaten new businesses.
It might be a delay in your supply chain – the time it takes to get product/service A to your customer.
It might be a delay in cashflow – your investors or suppliers take 90 days to pay you, leaving a tight cashflow situation.
It might be a delay in your team’s ability to deliver – taking longer to set up the critical roles and deliver on your Value Proposition.

The solution is to be prepared, and to think through each scenario ahead of time.
Perhaps it’s in setting up “plan B” options, or changing the terminology within your contracts and invoices.
Murphy’s Law says that if it can go wrong, it will go wrong, so it’s worth being proactive and creative in prepping your backups.

Dependencies On a Single Customer
It’s very tempting to get swept away chasing “the big fish”.
It’s also tempting to take a breather once you’ve caught “the big fish”.
Unfortunately, financial security does not come from one big fish; rather it comes from being situated above a lake full of big fish.

If your organisation is reliant on one customer, then that customer holds all the power.
That will reduce your ability to raise prices, increase order sizes or negotiate favourable terms (leading to the payment delays mentioned earlier).
Your business should be able to function without your top customer – either by being able to attract a replacement, or through a series of medium sized customers.
Otherwise that big fish could end up capsizing the whole boat.

single key staff member

Dependencies On Individual Staff Members
Do you have people on your team who are irreplaceable?
What would happen if they left?
This is a common risk amongst new enterprises – they have talented staff on their initial team, but once they leave, the business can’t find (or can’t afford) proper replacements.

When we look at staff costs in a financial model, we’re not just looking for what salary is paid today, but rather the replacement cost for someone else doing the same role.
Being able to pay (close to) market rates is what gives you the ability to scale up your team in the future, either through organic growth or through establishing a second location.
It might also be worth redesigning your service delivery model to no longer require as much specialist staff interaction, or creating ways of training up new staff to make them more versatile across the business.

Identifying and Defending Against Sensitivities
Your business will have some elements that are “sensitive” – that is, small changes have unusually large impacts on performance.

Earlier we looked at the business selling $1 widgets that cost 90c to manufacture – highly sensitive to production costs (an increase to 95c means profits will halve).
Other businesses might be sensitive to price increases (like petrol stations or mortgage brokers), sensitive to staff departures (Tesla losing Elon Musk, Apple losing Steve Jobs), sensitive to order volumes (car dealerships, restaurants) or sensitive to quality drops (Melbourne cafes, mobile phone companies).

The important thing is that you know what your sensitivities are, so that you can proactively reinforce them.
It might be through building your customer pipeline before things become urgent, or actively recruiting for additional team members.
It might be through vigilantly monitoring production costs, or implementing a Toyota style focus on quality control.

Financial models are good for identifying these sensitivities – simply start adjusting numbers up or down, and see the impact on the bottom line.
Any area where a small adjustment creates a large swing will require your attention.

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