Flawless Financials the Financial Forecasting Online Newsletter from Minotaur Financial and David Brode October, 2005 Sent monthly (or so) to over 500 subscribers. Please pass on Flawless Financials to those in your network. To leave Flawless Financials, follow instructions at bottom. * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * This month: Operating Companies: Seven Rules for Modeling * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * Creating a strategic planning model for a pre-operational start-up is often easier than creating a model for a more mature company. There’s no report format to match, no actuals to consider, no existing forecast to compare against. My recent work has taken me inside large operating companies; I’ve taken note of seven modeling rules, which I share below. Rule #1: Organize Data From Them Companies are prolific producers of spreadsheets, actuals reports, briefing books, and analyses of every imaginable topic, so it’s easy to become inundated with paper and electronic documents. My trick is to simply log documents. For paper ones I put a number on top and keep a master list of documents with brief description. For electronic documents, I rename the file so that “09052005 Revenue Analysis.xls” becomes “^G. Revenue By Product 09052005 Revenue Analysis.xls.” This way I can find the document quickly (because it’s easy to find “G”), I know what it is from the description after my letter, and I can still refer the client to their file because it preserves the file name. Sometimes my description will include who sent me the file, but I also know that I can get that by searching my email. If I’m working to replace an existing forecast model, often those models have dozens of worksheets with long or similar names. In that case, I rename the worksheets to begin with “1,” “2,” etc. so that I can refer to the sheets by number. It makes navigating those huge workbooks much easier. Rule #2: Follow The Money To understand a company and build the model, I always start with revenue. And on revenue, my bias is to do units x price. So my classic order of battle is revenue, COS, opex and capex (capex first if the business is capital intensive), debt, and the rest of the balance sheet and income statement below EBITDA. There are exceptions (e.g. when AR becomes critical), but this order works 90% of the time. Rule #3: 80-20 Within Each Category Analyze actuals to find what is 80-20 important in each category. Operating companies add more and more lines of detail over time but it’s rare for them to simplify. Modeling is an attempt to find the balance between simplicity and explanatory power. So find the components of revenue that account for 80% of the dollars and see if they share drivers. For the remaining 20%, often it’s a flat segment anyway and can be lumped into “Other Revenue” and forecast with a simple growth rate. And this rule holds true in each category: find the big hitters and concentrate the analytical detail to explain them, not some minor 5% category. Rule #4: Tie Out, But Not To The Penny There is a natural margin of error in forecasting. If comparing to another forecast, link the results in and calculate a percent difference, but don’t feel compelled to tie out exactly. In the end you’ll start changing assumptions and you won’t want to tie out. Initially, I just want to see that the two models give roughly the same results so I can gain comfort with the new one. Rule #5: Be Open To The Learning I often see contradictions between sources and go back to the client to ask questions. And then different people inside the company will have different solutions. A key skill is to listen and try to understand the truth—often shared— between what initially appear to be irreconcilable data points. Rule #6: Document Choices When I’m first presenting a new model, everyone wants to know why I chose a methodology or where I got certain data. So I’ve taken to creating a narrative document for each section (Revenue, COS, etc.), which explains the thought process and documents the sources I used. Clients love this, and I’m not sure why. Maybe because it’s easier to read a linear page of text than to hunt through a multi-sheet workbook? Rule #7: Just Do It In the end, you have to test a model to know if it’s working well. So the only way to test a model is to use it in a live, deadline situation where you need results. Trust me, you’ll find the errors and limitations in a hurry. This is where a good model shines, because a good model is flexible enough to be fixed and changed quickly so you meet the deadline. Until next time, David Brode -- Minotaur Financial Removing Financial Issues as a Deal Roadblock * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * NEWSLETTER ARCHIVE AVAILABLE Make sure to visit the Minotaur Financial website for the Newsletter Archive at http://www.brode.net/resources/ * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * http://www.brode.net mailto:David@Brode.net 1919 14th Street, Suite 510 Boulder, CO 80302 (303) 444-3300 * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * ABOUT DAVID BRODE I’m a financial modeling specialist. Over the last fifteen years I’ve completed dozens of models and certainly thousands of versions to support corporate development, M&A, strategic planning, and debt and equity transactions. These models have raised over $1B in debt and $100M in venture capital and private equity. Over time I’ve consistently revised software tools and work processes to get the job done quickly and well. If you have a financial forecasting issue, I’d love to help. * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * (c) 2004 Minotaur Financial, All rights reserved. You are free to use material from the Flawless Financials newsletter in whole or in part, as long as you include complete attribution, including a live web site link. Please also notify me where the material will appear. The attribution should read: "By David Brode of Minotaur Financial. More articles on financial forecasting can be found at http://www.brode.net " * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * Are you struggling to convince others to do a deal which you think is a no-brainer? To discuss how you can take numbers off the table as a deal roadblock, call (303) 444-3300. I'm very accessible and glad to help. * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * DO YOU LIKE THIS NEWSLETTER? You are welcome to share this email with colleagues who would benefit from better numbers. Your feedback is always welcome and appreciated. Write in to mailto:feedback@brode.net. * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * PRIVACY POLICY: I never rent, trade, or sell my email list to anyone for any reason whatsoever. You'll never get an unsolicited email from a stranger as a result of joining this list. To SUBSCRIBE FREE to this newsletter, send an email to mailto:subscribe@brode.net. And you'll get Minotaur's Financial Forecasting White Paper in the deal. To be REMOVED from this list, send an email to mailto:remove@brode.net. (Please note that this message needs to come from the email address that originally subscribed. If you need help determining this, please email mailto:David@Brode.net.)