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Marching boldly into the future

Rob Bayliss Rob Bayliss

Rob Bayliss, Head of Financial Modelling, explains that credible financial models and forecasts should be built from layers of detail, not simply from extrapolating recent history.

Past performance does not guarantee future results

Imagine a business that has had a great time lately. Just as a sunny day yesterday and the day before doesn’t guarantee a sunny day tomorrow and the day after (at least in this country), three years of past success does not guarantee three years of future success. Recent success does not grant magic momentum to forecasts for the next few years.

Layered forecasts in an Excel financial model

Rather than marching into the future looking backwards, in financial model design we have an opportunity to stop and think about how forecasts should be broken down. That is, the layers at play.

For instance, we can consider:

  • how much of revenue or profit is contracted in, and over what period
  • what customer churn rate the business faces, how quickly customers are being acquired and how quickly they will need to be acquired in the future in order to meet growth targets
  • which parts of the business are growing most strongly or are most profitable
  • how the pipeline works and what’s going on in the market.

Building out your forecast (in a clear and transparent model) to show the thinking can help demonstrate that the business can grow in the future. The layers of the forecast could show that the business:

  • has alighted on a high-margin opportunity in a market that’s growing strongly every year, and currently has only a small share of that market
  • employs a fabulous sales force and sales management team, and has rapidly increased that whole effort
  • carefully tracks its pipeline and the successes that come from it, and can show its sales pipeline has increased in size
  • has existing customers who love the business and rarely leave.

Telling a granular story (we’re thinking layers and lines in an Excel spreadsheet) is much more credible and convincing than a simpler approach which takes a base number and just adds a percentage of broad-brush growth.

Placing a ruler across the top of history does not endow that history with a momentum of its own. It's much better to march into the future looking forwards, with all the ammunition you need to justify strong growth forecasts.

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Case study

We recently worked with a client whose business ran with many long-term contracts and needed to model future growth plans.

The simple thing to do would have been to take the total of his contracts, apply say an expected 5% revenue growth, and quickly extrapolate the total into the future.

Digging into this, every customer and contract was different. Our client knew all 50 of them and could talk to you about each: whether they were big or small, how profitable they were and how they could grow.

Building the Excel model, it made sense to layer up those individual contracts, thinking carefully how to balance the detail and levers with the need for a model that was accessible and insightful. Filling in assumptions, he could tell each story knowing he had the commercial narrative to back it up.

The overall result for the expected future revenue growth for the portfolio of contracts wasn’t far from the simple 5% outcome but was better supported with granular assumptions. Our client, and his stakeholders and funders, could vary the performance of critical contracts, and see where the bigger exposures lay.

Our work here, with real thought around model layers, drove insight and integrity and helped build a successful fund-raising process.

Rob Bayliss heads our team of deal modellers that pull together beautiful forecasts for clients with important decisions to make.

To discuss modelling or forecasting in more detail, please contact Rob Bayliss.

Note: this post is part of the series "How confident are you about your financial forecasts"