Financial modelling: revealing the key drivers in your business
Financial modelling is a diverse tool for improving the efficiency of your organisation. But before you dive headlong into the modelling process it’s important to truly understand your business — and that means taking a step back to understand the key elements that drive the business.
So how do you identify these key drivers? And how does this modelling process improve the understanding you have of your company?
Simon Williams, Finance Business Partner at FD Works, explains the FAST approach to financial modelling and the value it adds for you and your leadership team.
Why use financial modelling?
Financial modelling is an incredibly helpful tool for any business. It helps plan when (or when not) to spend money in the business, allows you to understand your business cash-flows and assists with scenario-planning, decision-making and providing information to investors.
In short, good financial modelling gives you clarity around which direction the business is heading in — and gives you the information needed to deal with any challenges.
How we model using the FAST methodology
At FD Works, we apply the FAST model when working on financial modelling for your business.
FAST is a way of analysing your underlying business model and efficiency, built around four essential attributes that an effective business model must include.
This means your business model should be:
- Flexible — to be effective, the structure and style of models require flexibility for both immediate use and the long term.
- Appropriate — models must reflect key business assumptions directly and faithfully without being cluttered with unnecessary detail.
- Structured — rigorous consistency in layout and organisation is essential in retaining the model’s logical integrity over time, particularly as a model’s author may change.
- Transparent — Effective models are founded on simple, clear formulas that can be understood by other modellers and non-modellers alike.
The reason we use the FAST model is because we want anything you do (or anything we do) within that model to be easily understood by other people. So we follow a certain set of techniques that keeps things standardised and telling a clear story about the business.
This modelling process is all done from within a Google Sheets or Excel spreadsheet, and using the FAST approach keeps things clean and auditable in the spreadsheet. Anyone can dive into your model and see what the business is doing — whether that’s your management team, a venture capitalist group or a high street bank you’re looking to get funding from.
Knowing why you’re in business
Knowing WHY you’re in business is a critical element of creating an effective model. It may sound like a really simple thing for a business owner to know, but people can sometimes find it hard to give a simple explanation of that ‘why’ element.
As Simon Sinek, the motivational speaker and consultant, points out in his renowned TED talk, you can break down the knowledge many people have of their business into three levels.
- The What — nearly all businesses will be able to tell you what they do. Whether it’s manufacturing a bicycle, selling coffee or providing a software service.
- The How — some businesses will also be able to the explain processes, systems and logistics of their company (the ‘how’ of what they do)
- The Why — very few businesses can quickly communicate the ‘why’ element. Why am I making bicycles? Why do I serve coffee to people? Why am I writing software?
What we do at FD Works is get our clients to start thinking very hard about the ‘Why am I in business’ question. Once you know the ‘why’ element, that then drives everything else in the model, so it’s a crucial thing to understand and to work into the modelling process.
Successful businesses are the ones that put the ‘why’ first.
A great example of this would be Apple. Their key driver is making products that are simple and easy to use. It’s not directly related to technology or to making big profits. What they do is make people’s lives easier. Everything else — the R&D, the innovation, the profits and the global reach of their brand — all comes from that core belief: that Apple exists to make our lives easier.
Stepping back to define your key drivers
Considering the ‘why’ of your own particular business lets you factor this into your model and start defining the key drivers in your business model. To find this central vision behind your business means stepping back from the day-to-day running of the company and taking a more analytical and objective view of the business.
Some questions to consider will include:
- What does your business do — what do you make, sell or provide as a service?
- What are you trying to achieve — i.e. what are your key goals and objectives?
- What do you want to get out of your financial model — in other words, what are the key numbers and outputs that will help you run your business more efficiently?
It could be that your motivation is to make more money, or to penetrate a new market. By taking a step back and thinking about these fundamental questions, you’ll find the key drivers that will input into your financial model.
To put that into context, if my business is a Software as a Service (SaaS) business where I must make £10,000 of sales a month to turn a profit, achieving the right number of monthly subscription sign-ups from new customers becomes one of my key business drivers. In our experience, no matter what industry you are in, or how complicated your business is, it’s possible to identify one or two key items that will drive the rest of the business.
Turning your drivers into a workable model
Once you’ve defined those key drivers, you can start plugging them into your financial model.
If we use the example of the SaaS business, with your drivers built into the model, you can start thinking about how many subscriptions you’ve sold in the past, and how many you want to sell in the future. If my cost of sales to achieve a sale are £20, I can factor that into my model, and add on my profit margin so I’m bringing in a monthly revenue per customer of £50, for example.
Once those variables are added into the model, you can start using the model to make a real difference to your business: for example, consider the impact of running a 20% off promotion, and the impact that would have on potential sales vs the impact on your overall sales revenue. As you identify potential additions to your model you can develop the complexity of your model, but it’s really important to get those simple drivers identified and forming the core of your model.
There will be other elements you have to factor in, such as labour costs and overheads etc, but the key drivers are the variables that will truly shape your business, so it’s vital to understand these foundational elements.
Learning to understand your business
Sitting down with you and your management team to talk through the how, what and why of your business is central to us building an effective model of your organisation.
We recently worked with The Career Portal to produce a detailed model for their medical eLearning and tutoring business, giving them a tangible model to forecast their finances, as co-founder, George Rendel, explains:
‘We gave FD Works a remit to create a sophisticated and dynamic financial model for a complex business proposition. We needed this done in a short period of time, in order to support our ongoing fundraising efforts.
Simon and the team got to grips with the nuances of the proposition extremely quickly and turned around an excellent first iteration of the model within a week. They were then extremely responsive and efficient in adding new functionality and making any adjustments we requested. In the end, we got a highly credible financial model that impressed sophisticated investors, delivered under intense time pressure at a fair price. We were really impressed!”
By understanding your business, the core belief that drives it and the key drivers that feed from this central ‘why’, we can build a FAST model that’s a truly accurate model of your business. By combining the simplicity and flexibility of the FAST model with the core truth that drives your company, we help you get the best possible overview of how your business works.
That helps you, but it also helps us to understand the pain points in your business, and the areas where there’s room for improvement and added efficiency or profitability.
Adding real value: why it’s more than just a model
These modelling conversations add real value and help to define your business.
They’re enlightening for you and your leadership team, allowing you to see your cash-flow position, know what you can do financially and make more informed decisions. And from our perspective, it gives us a huge amount of useful information about your business and the areas where we can help you improve, innovate and attain extra value.
It’s also not just a financial model. Once you dive into your completed model, it explains precisely how your business runs, what your future prospects look like and how your business plan measures up in a variety of scenarios.
In essence, going through the modelling process helps you to:
- Define the ‘why’ and know exactly why you’re in business
- Understand the key financial and non-financial drivers that stem from your core belief
- Show you the costs of the tools, people and resources required to run the business
- Help you manage your financial and strategic thinking so you achieve your key goals
Revealing the internal workings of your business
Hearing the term ‘financial modelling’ can sound quite scary if you’re a small business owner who’s not trained in accountancy. But our job, as your business adviser, is to help you see that this modelling process is not just a number-crunching exercise.
Going through the FAST financial modelling methodology helps you to understand your business in a far more practical and logical way than before. The process allows you to step back, take an X-ray of the business and see (possibly for the first time) the superstructure or skeleton that the whole company is based around. And the outputs from this model provides you also invaluable information when it come to talking to banks, investors and funding platforms.
When you can see the true structure, and have those key drivers pinned down in detail, it allows you to look at the business with new eyes. The opportunities for improvement will jump out at you, and the areas where the business is being held back will become apparent.
And, with our team of financial experts on hand to advise you, you know you’ll have the insight, guidance and proactive support to take your business to the next level.
Modelling the future of your business
Talk to FD Works about how financial modelling adds value for your business
