Modeling backwards
I was just watching an amazing video by modeling expert Chris Reilly on how he maps out financial models before building them.
And it made me realize something about how traditional Big-Co FP&A is totally different from building financial models for startups
And how Finance best practices - in general - should be different for startups than they are in big companies.
It all comes down to this:
It's backwards.
In Chris's video,
He starts his modeling map based on the Raw Data (your historical statements)
Next, he goes straight to building a 3-statement model (P&L, BS, and CF)
He then builds a forecasting layer between the two (he calls this a Sub Schedule)
Next up, he makes a control panel, from which he can control the model
And finally, a summary view that can be sent around to leaders, investors, etc.
All in all, a brilliant breakdown of how to build a model for an established business.
... But it's actually a disastrous one if you're building a model with an early-stage founder.
Here's what goes wrong if you apply this to a founder's startup model:
Your raw data is likely non-existent, not trustworthy, or not intuitively connected to the founder's job
A 3-statement model is often OP for a founder who isn't comfortable with finance who really only needs a P&L + a few Cash Flow and Balance Sheet lines. Remember, they may not have a full-time Finance person on their staff for years
If your forecasting layer is only one projection factor per line, you're likely not capturing the full complexity or impact of big business levers
There's no thought process around how and where you'll maintain Assumptions, which as the most important data in a startup model
And by keeping the summary view design to last, you're building a model without considering what you'll be using it to SHOW.
Here's how we need to do things differently in startup land:
First, we need to think about WHY you're building this model and what we'll need it to tell us. Startup models need to be SIMPLE, which means we need to go in knowing we'll need to pick our battles.
Then, we think about our variables and assumptions: How do we think this company will make money? What will be our biggest costs? How many products will we sell? What kinds of metrics do we think will be important for us to keep track of?
Next, we map our math. How do the variables we just explored map to a P&L? What is the equation that describes how we'll generate revenue? Variable costs? Fixed costs?
Then, we bring it into Excel and think about how we'll get these calculations to flow into our forecasted expanded P&L statements (3-statements optional)
And then finally, we can add data. Once the startup is actually operating and has some data we can trust, we'll inject the actuals into our forecasted P&L for a rolling forecast and adjust our assumptions accordingly.
So if you're an FP&A expert who's only worked for big biz
Or you're a founder who's about to hire one,
I'd think twice before jumping right in to building a Startup Model.
My team has spent thousands of hours rebuilding great FP&A models
That were unfortunately terrible startup models
Built by newbie FracCFOs who came from a flashy logo.
And startups just don't have that kind of cash to waste.
...Believe me: I see it in one of the few Balance Sheet lines that should always go in the model :)
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