Financials make a lot of loud and ambitious entrepreneurs go strangely quiet.
The people with big visions, good stories, hard-earned momentum suddenly freeze up, hoping to spend as little time as possible in a spreadsheet until they can move on to the “real work”.
That’s a shame because financials are for their benefit.
It would be like an athlete refusing to look at the scoreboard; a scoreboard doesn’t harm you, it just tells you where things are at, decreasing your chances of making a blunder.

Financials aren’t a chore and they’re not for other people, they’re for you.
Is it a chore to look at the dashboard of your car?
Of course not, the dashboard is there to serve the driver.
The numbers and indicators tell you what you’re currently doing and how much longer you can keep going – all designed to make your life easier and avoid catastrophe.
There’s no benefit to trying to “trick” your fuel gauge or make your speedometer look more pleasing, they’re just telling you the facts so that you’re equipped to make good decisions.
But you also don’t need twenty indicators and icons on your dashboard either, you want enough to be able to take in the relevant information at a glance.
That’s what we’re trying to do here.
Best of all, unlike your car, you can customise what information you’d like from your personal dashboard – no sense in clogging it up with metrics you’ll never care about.

Beginning With The End In Mind
Rather than building a complex, generic financial model, it’s better to start with the question “how can financials serve me well in the future?”.
Some of them involve looking at the past, some the present, some the future.
That might include:
·      Knowing how much money we have right now
·      A sense of how much money we’re due to make in the next year
·      A reminder of any big cash expenses that are around the corner
·      Clarity on which of our products and services are making the most/least margin
·      Early warning of when we need to start recruiting, repositioning, or releasing staff members
·      A constant intuitive sense for how healthy the business is today
·      Some educated guesses on different scenarios that might play out in the future
·      The ability to answer questions on “the normal things a business owner should know”
·      The ability to test different possibilities and hypothetical changes
·      Something I can share with my team so that I don’t have to verbally explain the numbers

That’s looking like a good list – why would you not want those?

Different Models Tell Us Different Things
The dashboard on your car has a few different indicators:
·      Speedometer: how fast you are travelling
·      Tachometer: how hard the engine is working
·      Fuel gauge: how much fuel/battery is remaining
·      Odometer: how far the car has travelled in total
·      Trip meter: how far the car has travelled recently
·      Temperature gauge: how hot/cold the engine is
·      Engine light: something about the engine isn’t quite right
·      Door light: one or more doors isn’t properly shut
·      Seatbelt light: someone’s seatbelt isn’t on properly
·      Headlight icons: which type of headlights are currently on

My guess is that some of those are relevant for you, and some aren’t.
e.g. those driving a manual car probably care more about the tachometer, people with frequent passengers care more about the door and seatbelt indicators, people on long haul trips care more about the fuel gauge and engine temperature.
What you care about will be tailored to your situation, and the same goes for your financials.
Rather than downloading a generic template from the internet, you’re better off creating a set of models/indicators/reports that you need to look at frequently, and not clutter your view with details that don’t mean anything.

There are three traditional financial statements, plus a few other real-world models that can be valuable for a business owner.
The three traditional statements:
·       Cash Flow: where and when do the dollars move in and out of the business?
·       Profit and Loss: how much money do we make, spend and keep each year?
·       Balance Sheet: what do we own and what do we owe?

Each of these tells you slightly different things, and if we only looked at one of them, we’d get a warped sense of reality.
If you’re running a company, you’ll need to get comfortable with reading and/or making these yourself.
Maybe your accountant/accounting software produces the report for you, but you still need to understand what the numbers are telling you.

Then there are more casual ones:
·      Back of the Envelope: rough numbers for your revenues and costs, usually without detailed references, excel formulas or precise figures.
·      Unit Economic Model: dissecting where the money goes each time you sell one unit or serve one customer.
·      Margin Mix: the combination of Cash Cows, Small Margins and Loss Leaders in your business, and where the ratios of these three might need to shift in the future.

These are particularly useful in the startup phase of a business or in a strategy review process – you don’t need to re-check them every week.

Which of those six do you need for the next year?
Which are you already confident in producing and reading?

Maths and Assumptions
I’ve long held that financials are just maths and assumptions; equations and guesses.
That means you want to get good at the equations or formulas that drive your business, and start making better and better guesses about important numbers.
These make up the bulk of your profit and loss model; you’ll want an assumptions table that holds all of your guesses, then some “working out” rows that lay out the equations.
By building them separately then linking them up at the end, it becomes easier to update your figures without re-doing the maths; just enter the new assumption number and the maths will instantly re-calculate.
This is sometimes called “soft coding”, it takes longer at first but it saves you a lot of time and headache.
By contrast, “hard coding” is when you type a number into a spreadsheet with no sense of where it came from or when it should change.

Let’s say you’re selling handmade bookmarks online, sending them out via mail, and wanted to know “how much will we spend on postage next month?”.
You can hard code a number and guess “$400 per month” as an average figure.
Or you can soft code it and break it down to “number of orders x (cost of a stamp + cost of an envelope + cost of labelling).
That might be “200 orders x ($1.10 + $0.25 + $0.45)” = $360
Pretty close!
But what happens when things change?
If your order volume triples, or the price of stamps goes up, or if you get a cheaper bulk order of envelopes and labels, the hard coded number of $400 stays the same, while the soft coded number automatically adjusts to the new situation.

It can be fiddly to think through “what’s the formula for how much we spend on…”, but by doing the maths now, it makes it easy to answer tougher questions in the future.

Assumptions are more straightforward, but crucial to get right.
The simplest format for this is a table with three columns:
Assumption – Amount – Source
i.e. what am I guessing, what’s our best guess today, where did that number come from?
Or from the earlier example:
Stamps - $1.10 – based on the Australia Post price August 2022
Envelopes - $0.25 – based on box of 100 for $25
Labelling - $0.45 – based on roll of 500 for $225

All of those are easy to calculate, but they can sneak up on you.
Ask a random Australian “how much is a stamp these days?” and they’ll guess the last number they remember (probably 50-60c), add a bit for inflation and guess 75c.
They’re wrong, and it’s not a big deal in the short term, but as a business gets bigger these mistakes sneak up on you.
For example, if we were guessing how much you’d need to spend on an admin person, we’re essentially guessing “(Admin annual salary + admin person on-costs) x how much admin person time we need”
If you get any of those three assumptions wrong (salary, on-costs, hours), you’ll be off by potentially tens of thousands of dollars.
e.g. guessing $45k per annum, no on-costs, employed 0.4 FTE = $1,500 per month
Versus $58k per annum, $8k per annum of on-costs, employed 0.5 FTE = $2,750 per month
The second figure is not “too expensive”, it’s reality and is probably a good decision, but it’s also nearly double the first guess.
So as the situation changes, you can update your assumptions table and the rest of the model will adjust accordingly.

Drivers
The next things you’ll want to understand are called “drivers”.
Drivers are what push or influence a particular number – what made it the way it is?
So for our earlier example, why did we sell 200 bookmarks this month?
Was it from 200 individual customers?
Was it from a promotion or campaign?
Did we ramp up our Google Search traffic or social media presence?
Did we add some wholesalers or distributors?
Did we add some salespeople?

We want to understand what’s going on beneath the surface, so that we can work out what might need to happen to change these numbers in the future.
i.e. if we want to grow to 400 sales per month, what would drive that change?
Now, what I often see from my clients is a ramped-up growth trajectory with numbers climbing steadily by the month.
Ok…
Maybe that could happen?
But why?
What’s changing in month 4 that makes you go from 290 orders to 330 orders?
It’s definitely possible, but what caused it?
Put another way, if you can’t explain what drivers are going to change, why would we assume that the numbers are going to change?

I like to think of Homer Simpson misunderstanding why his investment was going well:
“This year, I invested in pumpkins. They've been going up the whole month of October and I got a feeling they're going to peak right around January. Then, bang! That's when I'll cash in.”
And as his broker chastises him:
“Homer, you knuckle-beak, I told you a hundred times: you've got to sell your pumpkin futures before Hallowe'en! Before!”
As a number increases, we tend to celebrate it and immediately attribute it to our plan working well.
In reality, that number could have increased for all sorts of reasons, which we need to understand in order to keep our progress going.

The way to find your drivers is to pick a figure and ask “why is that?” repeatedly until you find the root cause.
That’s the driver.
e.g. our costs are higher than last year, because our wage bill is much higher, because we hired three new team members.
Therefore, number of team members is a cost driver.

Jaws
When I used to work at ANZ bank, our senior managers would often track the company’s performance by the “jaws”.
This is a graph made up of two squiggly lines, one shows the growth in revenue and the other shows growth in expenses.
Hopefully, your revenue is growing faster than your expenses, or at least keeping pace.
These two lines get further apart or closer together, like a top and bottom jaw.
As that jaw closes, your business gets bitten – costs growing faster than income is an early sign of trouble.

You might still be making a good amount of money, but over time the negative growth will erode your margins.
There were probably 100 different metrics we could have focused on, but for a bank this was the one that mattered.
Maybe it’s a good one for your dashboard?

Nice vs True
I work with a lot of people who have just assembled their financials, and I always start by asking them: “So how are you feeling about the numbers?”.
Not “How are they looking?” or “How much are you making?”, I’d rather start by searching for their motivation and their headspace.
Usually the answer is “Uh, not feeling great about them”, and that’s ok.
It’s because they were hoping to see nice numbers – numbers that made them feel confident and on-track.
My aim is to help them build true numbers, and honest numbers are sometimes reassuring but often conflicting.
Deep down, their first impulse is to try and make the numbers nicer rather than truer.
What we try and develop is a desire to make the numbers more accurate, knowing that we can then take actions that will make the accurate numbers look better.
I’ve never seen it done the other way around – starting by painting a positive fantasy, then hoping that the business brings that fantasy to life.

Financials aren’t meant to be trivial figures and charts, they’re here to make you better at your job.
It’s possible to twist almost any set of numbers to tell whatever story you like – just cherry-pick the ones that contribute to a happy narrative, and conveniently ignore the rest.
That’s not the point.
You want your financials to make you better, and you get better by having insights into the past, clarity on the present and early indicators about the future.
There is no upside to being ignorant about the numbers.
George Box said “All models are wrong, but some are useful”.
What would make a model useful for you?