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The Brode Report  |  June 2010

David Brode profile   Hi, this is David Brode. Welcome to our relaunched newsletter, The Brode Report. I will be sharing monthly with you my thoughts, ideas, and experiences around strategy & finance with a focus on financial modeling.

The main article this month is about scoring financial forecast models. How does yours stack up? Please share your feedback; I'm always happy to hear from you.
 
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A 25-Point Financial Model Scorecard -
How does your financial model measure up?


When we begin working with a new client they typically share their current financial model and want to get our view on its strengths and weaknesses. We developed a standardized evaluation methodology in response: the Financial Model Scorecard. We have previously published bits & pieces of this scorecard, but we now have the most up-to-date version with over 8 years of application in the field.

The scorecard evaluates models based on the four messages the model must convey to investors when seeking capital. These four messages are:
  1. that the CEO and their team are trustworthy & smart
  2. that the investor will make lots of money,
  3. that the revenue plan is solid, and
  4. that the capex and costs are well known so that future profitability seems realistic.
And so without further ado, here's the scorecard:

The 25-Point Financial Model Scorecard

I. High Financial IQ (9 points)
  1. Professional looking IS/BS/CF
  2. Standard use of financial terms
  3. BS balances and properly in sync with depreciation, amortization, net income
  4. CF properly ties out cash
  5. Period detail is reasonable
  6. Tax calc is accurate
  7. Working capital reasonable (AR, Inventory, AP days)
  8. Capex reasonable
  9. Debt ratios reasonable
II. Clear Investor Returns (6 points)
  1. Funds requested
  2. Pre-money valuation/% of company given
  3. IRR to investor
  4. Investment multiple to investor
  5. Exit time frame
  6. Exit valuation reasonable
III. Credible Revenue Forecasts (6 points)
  1. Market size/penetration/share analysis
  2. Customer/average price analysis
  3. Pricing over time is reasonable
  4. Units make sense
  5. Sales productivity analysis
  6. Sales & Marketing spending to revenue analysis
IV. Proving Profitability (4 points)
  1. COS/COGS variable with revenue; Opex reasonably variable with revenue
  2. Capex metrics scale appropriately with revenue or customers
  3. Rev/HC is reasonable
  4. EBITDA margin is reasonable
Add up the scores and multiply by four to get a score out of 100 possible points.

Scorecard screenshot
The 25-point scoreboard in action.

It's been eye-opening to use a standardized approach: models that at first look pretty solid wind up scoring 36 out of 100. Of course, this doesn't mean that the model is bad. Instead it points to *where* work needs to be done to get the model to a point where numbers are not a roadblock to doing a deal. Every model doesn't need each of the items. Some items are for internal use only and have information that typically isn't released until later in the process, i.e. certain cap table details.

Where Do Most Models Fall Down?

The worst fail the High Financial IQ test entirely. We've all seen of models like this, where it's just so awful that you can't even evaluate the business. Further, itís clear that the work is not fundable in its current form.

The next major dividing line is between models which are static as opposed to dynamic. The most basic static models present one basic scenario, with most of the revenue and expense numbers hardcoded. Hey, it's a start, but it doesn't let investors understand the true economic dynamics of the business model. In some businesses, 10% decrease in revenue would cause a 7% of revenue decrease in expenses. In others it would cause a 1% decrease. These dynamics are what's measured in the Proving Profitability section, and this is the section that takes a real modeler to build.

Finally, companies regularly overestimate revenue and underestimate sales & marketing expenses. The crucial interplay between marketing, price, and volume is easy to miss in the early stages of a company.

So Ö how do you stack up?

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