This is the second in my series of posts on how to build financial models in Excel more easily. The first post is here. This post focuses on the business model.
- Build the Business Model For an investor to understand your business, they must understand the business model. The business model explains the revenue, pricing and sales and distribution model, i.e.the growth drivers in the business. Therefore, your Excel financial model should make it clear and easy to understand these three critical parts of your business. For example, for a bus company I would probably detail each of the following revenue assumptions--buses in operation, trips per day, operating days per month, bus seating capacity, occupancy percentage per bus, and revenue per passenger. If the business was seasonal, I would add a seasonality factor to be applied against occupancy. I might alternatively build the model driven by sales or more precisely customer acquisition cost. If my monthly budget for customer acquisition was $12,000 and the per customer plan was $4, then I will have 3,000 customers per month. From the number of customers, using the revenue build logic above, I would back into how many buses and trips I need to operate. Many people build their models and focus on matters outside the business model, such as taxes, head office expenses, advertising, etc. While these subjects may have to be included, invest your time and logic in clearly explaining the three key parts of the business model.
- Sophisticated Investors Analyze the Variability of Revenue and Cash Flow Investors initially want to understand the size of the market opportunity and what the growth drivers are. They also want to understand the effect of a change in a growth driver assumption on cash flow. In order for this to be easy for the investor you need to do two things. First you have to anticipate correctly what assumptions the investor will want to analyze. Secondly, you have to put these key investor assumptions on the assumption tabs so the investor does not have to read through ten tabs to find the variable he wants to adjust. If you want to make it even easier, build a matrix which sensitizes two key variables for cash flow or revenue. (One or two matrices maximum.)
By the end of this second post on Excel tips for financial modeling, you should be realizing by now that good modeling is all about the logical structure of your model and the assumptions tab. Most of the time in building a model should go into identifying the key assumptions (variables) related to the growth drivers and the logic of how you are going to organize the model. This work involves no real knowledge of finance or accounting. As I tell my students: Financial Plan=Logic+Analysis+Excel.