Take a look online and you’ll find plenty of low-cost or even free financial model templates available for download. This seemingly economical option requires a much lower initial investment than getting a Financial Modelling professional to build you a bespoke model, or building it yourself. If the business or situation you are trying model is extremely simple and/or your business is exactly the same as every other business, you’ll be fine with a template. However, most templates are really just a nicely formatted spreadsheet and there is a bit more to building a robust, responsive and accurate financial model than plugging a few numbers into a spreadsheet!
If you are looking for a shortcut way to build a financial model, keep in mind what a fully functional, dynamic model does that a basic spreadsheet does not. A template could be described as a car with no engine – it looks great on the surface, but there’s no performance! Below are a few features you won’t have when you use a template that are pretty important when it comes to Financial Modelling.
So, what’s wrong with using Financial Modelling templates?
All Dollars, No Drivers
What makes a really good financial model is its ability to take the business model and represent it financially. Revenues and expenses don’t just happen – something occurs that makes that revenue or expense become a reality. Drivers are absolutely critical in creating a financial model that is flexible and scalable. For example, if you were to achieve 10% market penetration, and your product is priced at $5, your revenue will be, say, $100K per month. Instead of simply stating “revenue is $100K”, we determined what had to happen in order for revenue to be calculated at $100K.
Of course the beauty of this method not only means that investors or other users can trace back to see how the revenue is calculated, but we can also run scenarios and sensitivity analysis on these inputs. What if penetration were 12%? What if we decreased the pricing by 10%? This sort of analysis is virtually impossible with a pure input of $100k.
Generic Inputs
A “fill in the blanks” template has to suit everyone and therefore in order to meet the requirements of virtually any business model, the inputs must be kept generic; Revenue Item 1, Revenue Item 2, etc. Of course you can change the titles of these line items, but what if you have different lines of businesses that need to be separated?
Similarly, “Office Rent” for example – a line item often found in a template – doesn’t apply to your company. You actually bought your building, have a mortgage (a liability, not an expense), and need a way to factor in the mortgage pay down and interest portion of each payment. An experienced financial modeller would have no problem working this into a customised forecast. If you’re using a template, you’ll have a hard time flexing to fit your needs. By the time you’ve manipulated the template to fit your needs it’s probably taken longer than if you’d just built it from scratch.
It doesn’t Fit!
Just like that that cheap “one size fits all” shirt you bought from the market, your model will probably never fit properly. It’s pretty much guaranteed that whatever number of inputs the template designer has chosen won’t be exactly what you need. While it seems a simple solution to insert or delete rows, any Excel modeller knows how deadly this can be and before you know it, you’ll end up with a model full of dreaded #REF! errors. For this reason, the template designer will have created a large number of unnecessary rows and columns just in case they are needed. Therefore, most templates contain a huge amount of redundant information and unnecessary complexity, which is confusing, takes up memory and is simply poor modelling practice.
Limited Functionality
While the standard financial reports have always been the balance sheet, statement of cash flows and a profit & loss, there are many additional reports that would be useful to your business – but not necessarily to others and therefore you won’t find anything beyond the standards in a template.
You’re not very likely to have much more than very basic scenario analysis functionality built into a template. For example, isn’t it nice to be able to change a few inputs and do a scenario analysis to find out how increasing marketing by 10% affects the bottom line? A good scenario analysis tool built into a financial model is really what makes a model really useful, as you can easily see what impacts changing not just one but multiple variables has on the company.
So, when is it OK to use a Template?
Templates are great for very surface level projecting, or “back of the envelope” calculations where a high level of precision is not required. However, if you’re serious about your modelling, you’ll want it done correctly and as accurately as possible. It is nearly impossible to find any “fill in the blank” template that will meet your specific needs, and between the work you’ll do adjusting it and frustration you’ll experience, you’ll undoubtedly wish you’d just had the model custom built from the beginning!
Great article! I completely agree on the risks of purchasing templates, whether online or otherwise.
Regarding templates, there are two other points worth mentioning:
As a consultant, the need to have standardized formats and a few basic pre-fab components (I’m thinking of cover sheets, disclaimer macros, etc.) is obvious. But modellers, in my opinion, should shy away from relying too often on our own templates or “standard models” instead of looking at each business problem as something new for which there are unique, fully fit-for-purpose solutions. Templates tend to give an excuse to think less about the actual problem.
An extension of this is making sure that the customer (internal or external) is fully aware that each model is unique and shouldn’t be rehashed for every new project in order to save money. It doesn’t take a large difference in contracts or term sheets to render a previous model irrelevant. This is in most disclaimers, but former clients that I had while at previous employers (3+ years ago!) still give a ring occasionally asking for help on why an older model doesn’t accurately portray a new investment.
Briefly: This article not only applies to purchased templates, but the limitations of templates in general!
ModelSheet offers a new product category, called “customizable spreadsheet solutions” that you can customize at three levels.
1) You fill in a web form to customize the solution for your situation. You can change time lines, dimensions (such as lists of products and product families) and turn on/off optional features. At the end, you download a conventional Excel workbook.
2) You can continue to edit the customized Excel spreadsheet, like any spreadsheet.
3) You can engage the vendor to make further customizations that are not part of the published customizations.
Customized spreadsheet solutions free strategists from mundane spreadsheet work so they be more creative, just the way CAD systems free engineers from drawing blueprints, so they can focus on more creative designs.
ModelSheet applauds the use of consultants to help devise the best plan possible. Customizable automation increases the energy that consultants can spend on key issues, instead of doing manual spreadsheet tasks. In fact, ModelSheet is experienced in consulting with and without analysis tools (http://www.modelsheet.com/consulting-business-analytics.aspx).
We recommend that training firms expose clients to customizable spreadsheet solutions. This technology does not change the fact that a person with a strong grasp of the concepts will do a better job than a person who is not so grounded.
Julius / Danielle,
A large part of Corality’s business is to perform financial model audit of third party financial models which has given us a rather solid database of error frequency within different types of financial and operational models. It is always very clear to us when a model has been developed by amending a ‘template financial model’ or a model initially developed for a different project or transaction as the error frequency is drastically higher. This is not only due to the fact that it is hard for an Analyst to keep track of all necessary changes in the model but also because of the inherent higher complexity of these templates.
To ensure a high level of flexibility in the template, modelers often unnecessarily resort to long and complex formulae which then makes the model slow and complicated to update for future projects when performed by someone else. As a function of this we often find what seem to be simple errors in updated ‘Template models’ which we rarely find in models developed for a specific project or transaction.
My recommendation is in line with Julius’. Have a base template which contains everything except the calculations as they should be tailored to the current purpose. If your organisation has a limitied budget and no have in-house capability to develop custom financial models then I would recommend spending the budget on either recruiting someone who has or putting someone in training. Working with template models is a waste of time and is likely to cost you more in the long run.
Regards,
Rickard