Financial models are an important way of predicting a company’s future performance. By identifying key business drivers and making assumptions about how they will develop, you can create a picture of future revenues, expenses and more. While this may seem like a simple enough exercise, many business owners and CEOs struggle to create useful financial models.
To better understand how to create good financial models, and where they often go wrong, SaaS Mag spoke with Adam Tzagournis, CEO and Founder of FlowCog, a SaaS business that created pre-built financial models for SaaS companies.
The Problem with Spreadsheets
“Throughout my entire career, I’ve always been doing consulting on the side,” Tzagournis, says during our phone call. “For founders and executives, through different freelancing platforms. I’ve worked with all different types of companies, brick and mortar stores, e-commerce businesses, SaaS companies.”
Most recently Tzagournis had been working as Director of Finance at Stack Overflow where he was building out their financial modeling capabilities. He started his career as an Associate at PwC in New York after graduating from Ohio State University.
“The only thing that was consistent at these companies,” he continued, “was that none of the financial models that I was inheriting were consistent. They had formulas everywhere. There were numbers hard-coded into spreadsheets that you didn’t know were hard-coded. Maintaining the model from month to month became a nightmare, unless you were the person that built it.”
Tzagournis understood that financial modeling was a collaborative process. To understand the direction a company was heading in, whether it was a 5-person startup or a company of 200 people, one might require information from the marketing department, the product team, or the finance department, and if one didn’t get it, the model would suffer.
“Everyone had their own home-grown financial model. There just wasn’t a piece of software that everyone was using. Most finance and accounting teams are still doing modeling in Microsoft Excel and the big problem there is that, Microsoft Excel, Google Sheets, any spreadsheet software, is literally a simplified programming language. So, unless you are approaching the spreadsheet from the perspective of a programmer, a software architect if you will, it is going to be hard to put together something that is sustainably coherent and cohesive.”
The Impact of Poor Financial Modeling
Spreadsheets create a lot of problems for financial modelers, and even people with the correct, programmatic mindset can still fail to capture the full complexity of the business they are modeling for. As an example, Tzagournis explains how almost every company he’s been at has failed to reflect the way in which hiring plans can change with revenue growth. Hiring and growth can feed off each other, and management’s strategy in this area can radically change the outcomes of a financial model.
When spreadsheets fail, and in-house talent is not able to build out a financial model with convincing results, they will often turn to professionals who better understand the complexities of financial modeling. The problem is, many people or businesses offering these services take months to implement their financial models and run up huge costs in doing so. To avoid this predicament many businesses will just decide to create a more simplified financial model, and at first this will seem like a good solution. “But when you bring those projections into a board meeting or into an investor call, what happens is the investor says, ‘Great, you’re going to grow 40% next year. How’d you come up with that projection?’ And if the response to the investor is, ‘Well, we came up with that because we took last year’s number and we multiplied it by 1.4, which is 140%.’ That’s not really an explanation. I call that the top-down approach. As opposed to the bottom-up approach of saying, ‘Well, the reason why we arrived at a 40% growth rate isn’t because we waved a magic wand. It’s because we predict we will invest $X in marketing spend into the top of the funnel. That funnel will then generate X number of leads, which will convert at X percentage rate (based on historical data) into this set of opportunities. When our sales representatives reach out to these prospects, some of which will end up as customers.’ That reasoning is a whole lot stronger.”
Just a few common things that Tzagournis says most financial models fail to incorporate are:
– Retention rate change over time
– The lag between marketing spend and return on that investment
– An accurate lifetime value of the customer
– The possibility of upsells and downgrades in service
A Better Way
Tzagournis set out to create a product that could apply financial models to businesses at different growth stages and could make sure they not only covered the common pitfalls people fall into when data modeling but could also use the product to explain to investors exactly how they have reached their conclusions.
“Early-stage founders may not want to put that much time into building out financial models and thinking about each of the hundred or so possible inputs. So, part of the trick is to simplify everything for them, but to also offer them that layer of service, if they need it. A lot of early-stage series A and series B companies don’t have a CFO.”
“[Our product] is almost like having a CFO, a package where I’m the one that walks the founder through how to think about the inputs. I will go through and talk out loud, almost in a stream of consciousness, fashion and say, ‘From what I know about your business, what you’ve told me so far, this is how I would think about these inputs. I’m going to enter these in and we’ll see what the outcome is and we’ll go back and iterate on it together.’ The product is self-contained with instructions so the user can navigate on their own. I’ve shrunk down the onboarding flows and hidden the complexity from the user for ease of use. However, if the person using FlowCog doesn’t have experience critically thinking about the fundamental key drivers of a business, it can be helpful to have someone that speaks that language, so that’s where I fit in.”
As we have seen with many SaaS entrepreneurs we have spoken too, it’s useful having a strong product, but having a consulting arm that is able to reach out to customers and have in-depth conversations can create a well-rounded service.
“Once they see me thinking out loud, how I’m completing the different inputs, they start to understand.”
One of the most important aspects of what Tzagournis has achieved is how his product is able to scale up or down with the business. “If you are just starting out and you do not yet have a team of sales reps, you can turn off that functionality and the model adjusts accordingly. When the time comes to expand the model, it can all be done easily without having to build out a new model. Spreadsheets are not good at catering for these kinds of changes.”
In an attempt to highlight the costs saved by using a tool to do this work instead of a dedicated CFO or outsourced team, FlowCog has included an ROI calculator on their website – a handy little selling point that many other SaaS businesses could benefit from. If you are interested in simplifying your financial modeling, or checking out a SaaS business that has put a lot of effort into their messaging and customer service, then take a look at FlowCog and let us know what you think.