Does Your Financial Model Scale Up?
Here’s a test of any financial model. How well does it scale up?
By that, I mean can your model handle:
1. Any swings up or down in revenue
2. Changes in key assumptions
3. Going out another year or two
Some models are built too rigidly. Key formulas are hard coded. There is not enough flexibility with sales or key related operating expenses.
The result:
1. The model is out of date almost as soon as it is distributed. A few changes are needed and suddenly the numbers no longer make any sense.
2. It is a lot more effort to keep up the model. More formulas have to be changed with each change requested in the model.
3. It is more prone to error. There are a lot of hard coded formulas to check over.
4. It needs more time to review.
So when building your financial model, or reviewing the model that someone else has built for you, consider how well the model will scale up. Ask some of the following questions for example:
1. If revenues doubled, would the results look like a hockey stick that nobody could support?
2. What would happen if a key cost of sale went up 15%?
3. If you were to add another year to the model by just copying over the current formulas, how strange would the results look for that new year?
That’s a good test for how well a model can scale up. It may not take much extra time and the benefits are well worth it.
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