???????? Hi friends!

I know I’ve been sending these out on the fly of late – quite literally.

This week finds me in the Maldives spending some quality time with my (immensely) better half. It’s really the first time we’ve taken a holiday without the kids for over 20 years so you’ll forgive me for feeling a bit chirpy about where I’m at at the moment!

Here’s a quick snap of my view right now – pretty sweet right? 🙂

But before I gloat too much, whilst this view is lovely, our experience at the resort has not been – I spoke more about that in this post I’m titling ‘Trust but Verify is a Fallacy.’

In this weeks Off Balance, I’ll be chatting about:

???? What’s the value of valuing your app?
???? The CFOs Guide to Financial Modelling.
???? Apple fan boy? Not quite, but not as unhappy as I thought I’d be.

Check out this weeks Primer where I get to know Martin Sibley and understand the challenges – and opportunitiy – in building businesses focussed on the market servicing disabled people.

Also if you have any feedback or if there’s something you’re desperate to see me include, just reply to this mail or ping me online – I’m very open to conversations.

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(If you are trying to connect with me on LinkedIn, maybe read this post I wrote and make sure to start your request with “Off Balance” and, more importantly, tell me why you’d like to connect ????????)

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Now let’s get into it.

How can did I add value?

Valuation continues to be one of the things first time founders get their proverbial underpants in a twist about.

I recently talked to a founder who had asked for assistance on valuing their app.

Their accountant had told them it made sense to attribute a value to the cost of building the app on the balance sheet.

The founder wasn’t sure how to go about this, and assumed this would be necessary to raise investment.

Here’s what I learned pretty quickly after a few initial questions:

They had self funded development of the app for quite a bit less than £50k.

They weren’t going out for investment any time soon.

They were pre revenue, however had created a community app which they planned to monetise through an in app marketplace (tough).

They had a decent number of users (it was a b2b2c acquisition model in the education space – though not precisely edtech).

Their accountant had little or no experience in the tech space (and in fairness, the founder was pretty new to it all as well).

So here’s what I told them:

From an accounting perspective, you would be hard pressed to argue a usable lifetime of more than 5 years based on current accounting standards.

This is because technology moves so fast, that unless you can argue your IP is provably enduring, you’re not going to be able to carry it (leave it on the balance sheet and depreciate) for any length of time.

That effectively means that, assuming a cost to develop of approx £30k, you would be charging the P&L with £6k per year until the app has been fully depreciated.

Again, due to accounting regulations, you can’t add any intangible value (goodwill) to something you have produced internally. You can only do that if you acquire, say, another business whose assets are worth x and you pay x + 1,000. The 1,000 would be booked as goodwill as it is the value you have paid over and above the value of the assets.

But a lot can happen in 5 years, and in the tech world, you don’t value any business (especially at the earliest stages), on the carrying asset value. You might do that for a traditional business with plant, equipment, debtors and creditors, but for a tech business it’s all about the future opportunity and how much you have de-risked the business.

So the long and short of it was that I told the founder to ignore what their accountant had told them and not worry about trying to create a value for the app on their balance sheet.

But, should they have wished to value the business, there would be ways of doing that if they were post revenue or, in the case of this pre revenue business, they may have looked at equivalent community apps (whatsapp?) and worked out the value per user using public information. They could then use that to calculate the business value based on the number of users currently on the product.

This founder was visibly relieved when I told them they didn’t need to lose too much sleep about this right now, as it meant they could focus on building out the app, acquiring users and building the community.

And let’s face it, that’s far more interesting than wrangling numbers on a balance sheet.

The long and the short of it is that you don’t need to overcomplicate your thinking or your business by trying to get cute with accounting.

The only time valuing your business really matters is when you are seeking investment.

And that value? Well that’s a negotiation between you and your investor, rarely a value that is set in stone.

Off Balance

Below is part 1 of 2 posts where I dig into the financial model from understanding what it’s for to its importance for CFOs.

Financial modelling is one of the things that we get asked for help on all the time, either as a discreet project in preparation for a fundraise, or more often than not, just a core part of the initial work we do walking into any business.

Next Tuesday, I’ll talk through some of the best practices and how you go about constructing a model – what’s important and what’s not, so keep your eyes on your inbox for part 2!

Let’s dig in…

The CFO’s Guide to Financial Modelling

If there is one thing I can wax lyrical about, it’s the financial model.

Not only have I spent over two decades building them in various forms for the businesses I’ve either been running or advising, but as a small time angel, I often spend time unravelling a model to get right to the bottom of the how a founder thinks about their business.

I’ve also delivered sessions on financial modelling to a tonne of founders via cohorts at Founders Factory, The Centre for Entrepreneurs NEF+ programme as well as Morgan Stanley’s Inclusive Venture’s Lab, so I feel like I have a modicum of authority when I’m discussing financial modelling – especially in the context of growth ventures.

As it stands, financial modelling is one of the most invaluable activities that a CFO can undertake. Here’s why:

It provides CFOs and business leaders with a snapshot of a company’s financial health today and over time.

It allows leaders to think through how their business works.

It provides a plan to aid decision-making, resource allocation and the impact on the long term health of the business via the use of scenario modelling.

Whilst I won’t be attempting to walk through all of the mechanics of building a model in this piece, nor will I be showing how to construct every formula, I will attempt to give you a framework you can use when you next find yourself in need of modelling out your business.

The Role of Financial Modelling

What is a Financial Model? 

A financial model is a representation of a company’s financial performance, both past and projected.

Typically covering the main financial statements (though not always – more on that later), a financial model uses a combination of existing company data, assumptions on how certain financial levers may change over time, market data and a generous helping of crystal balling to map out a representation of a businesses future performance.

The earlier stage the business is, the less data there is and hence the more a model is reliant on informed assumptions.

As the company progresses and there is more information flowing, those assumptions are tweaked and refined to get closer and closer to an ‘accurate’ numerical representation of the business.

The reality is that for venture backed companies, your model will change constantly. Firstly as a result of moving from states of uncertainty to (more) certainty, but also due to rapid progress, the fabled pivot, market expansion and any number of other factors that high growth companies may be impacted by.

A financial model can cover any period into the future, however unless looking at a specific project timeframe, it is normal to model out a business (on a going concern basis) for 12, 36 or 60 months.

You may well imagine modelling out a business 5 years into the future is less driven by ascertainable facts than it is by an element of future gazing and you would be right.

As I am fond of saying, the only thing I can tell you with 100% accuracy is that your model will be 99% inaccurate – fun right?

Why is this and what are the implications?

Well the obvious answer is that your financial model is the map, not the terrain.

In other words it is a model of a thing, not the thing itself.

This sounds obvious but you would be surprised at the number of people who are also surprised when actual business performance varies substantially from ‘what the model said it would be.’

One of the purposes of a model is to allow users to play with a limited set of levers and assumptions (hopefully the key ones), rather than try to replicate and then adjust every element of the business.

It has uncertainty and inaccuracy built in.

One great way of thinking about this is an actual map versus the actual terrain. I am sure we have all used tools like Google Maps or its equivalents. They are great tools to navigate your way around a city, but you don’t expect them to show you every pothole, every minor diversion, every pedestrian and every traffic light.

Not only would that be too much information to ingest, if your map could provide you with all that information, you wouldn’t need a driver, you’d just allow it to navigate and drive for you.

But by providing only surface level information, it allows you to get from A to B relatively accurately whilst still forcing you to pay attention to the various obstacles that turn up from time to time.

So given the inherent uncertainty baked into a financial model, why do CFOs put so much store by them?

Why are financial models so important for CFOs?

I am yet to come across a CFO who doesn’t like a good financial model and there are a number of reasons why.

To understand these, you really have to think about the principle activities that CFOs are responsible for:

Capital Management – (Burn and runway)

Capital Allocation – (Where do we invest our dollars)

Capital Raising – (Where from and, when do we raise money)

Risk management – (What are the problems we might face, and how do we overcome them)

Now there are, of course other activities as well, but most of them fall into a subset of one of these and all within the overall category of financial strategy.

A good model will help a CFO – and other users – manage these various streams in fairly specific ways:

Capital Management: As a core component of a financial model is understanding cash flows in the business, it can help CFOs navigate and plan for periods with lower cash balances by pulling at working capital levers or looking at the capital needs of the business more holistically. Essentially, the model helps CFOs to ‘see around the corner’ at what is coming up and plan accordingly. This, of course, feeds into capital allocation, capital raising and risk management as well but it starts with understanding the cash profile of the business.

Capital Allocation: A financial model acts as a resource plan which could at one level help CFOs and other members of the leadership team when it is most appropriate to hire more people (and what the business can support in terms of remuneration). At another level, it can help CFOs with inventory management and procurement. It essentially tells CFOs how much cash is available to spend and therefore allows them to choose where to spend it.

Capital Raising: A good model will always show where cash reserves run low, as mentioned above, or where they run out altogether. This is the most ubiquitous use case for early stage / venture backed startups which traditionally are not profitable or cash generative, instead using outside capital to fund growth. So a CFO can look out for when the business is likely to run out of cash and plan for that eventuality by going to the market to look for fresh funding, whether from equity investors or debt providers. Of course, a model isn’t just good for telling you when you might run out of cash, it may tell you when you start generating cash and hence when you might want to seek out non-dilutive capital to provide a boost to growth.

Risk Management: As mentioned previously, a model is the map, not the terrain. But a good map still shows you if there is a river in your path or where elevation increases. Because the model is built on a set of assumptions, it requires whoever builds it as well as whoever uses it to think through the potential hurdles they may face along the way. Typically CFOs will manage risk through the use of scenario planning and, as those risks crystallise, they are able to steer the company in the right direction.

Overall, it is the key strategic tool that CFOs use to plan and drive the business forward.

The caveat to this, or course, is that unless a model is used and updated regularly, there is a risk that it becomes obsolete (and can do so quite quickly).

So you should always treat it as a live document and change it as the data changes.

Hopefully that serves as a simple intro to financial modelling from the perspective of a CFO. Obviously they will become critical for different reasons at different points of a business’ lifecycle.

Next week we’ll dig into some of those, alongside how you actually go about constructing one ????????

New set up, who dis.

Last week I went a bit heavy, so I thought I’d switch things up with some personal reflections – no doubt many of you will have already been Mac users for a long time, but I have been a Windows maverick for the last 25 years, so the move was tough.

But a month into my journey to the dark side into the Apple universe, I’ve got to say I’ve been more than pleasantly surprised.

Working with a Mac has been predominantly a joy.

The ease of navigation, the strong battery life, the simple and intuitive UX have all seemed like a veil being lifted from my eyes.

As I spend more time on content creation – predominantly writing – and running EmergeOne which is mainly done on zoom calls and putting in place systems for scale, I find myself less frustrated than I was with my windows device.

As James Alexander – my podcast producer – said to me when I was making the decision to switch “it just works.”

So much so, I bought the iPad Air and Magic keyboard so that I had a smaller device to work on whilst I’m on the move (as I more frequently am) – watch out for a few sneak peeks with me and the iPad on the beach ???? 

At the moment the only difficulty I have found has been deep work with spreadsheets (kinda critical for a CFO, I know).

Having to unlearn all the keyboard shortcuts I had in my muscle memory for the last 25+ years and figure out how to navigate on a Mac is not simple.

But, as they say, maybe you can teach an old dog new tricks.

So yes, one month in, I’m a convert.

I’m not so dogmatic as to say I’ll only ever use Apple devices again (you have to be flexible in life) and still have an android phone, but for now, I’m happy I made the switch and am enjoying learning how to become even more productive with a couple of devices that just work.

I hope you found Off Balance #16 useful. As always, I’d love to get your feedback and understand the sort of topics you would love to hear about.

Just hit reply to this mail or drop me a line at [email protected] and let me know ????

????And that’s a wrap for this edition of Off Balance – I’d appreciate your feedback so just reply to this email if you’ve got something you’d like to say.

???? And if you think someone else might love this, please forward it on to them,

???? Finally, if you’re a fan of the Nothing Ventured podcast, please don’t forget to like, rate and subscribe wherever you get your pods – it really helps us spread the word.

That’s it from me so until next time…

Stay liquid 🙂

Aarish