An interview with Christian Nauer

You need to have it, but is it useless or helpful? And are there any hacks for it?

SEF.Growth High Potential-Label Candidates have to submit a financial model as part of the application process. We asked FS Partners – The CFO Company to weigh in on the value of financial models and share their hacks in financial story telling. Christian Nauer, Senior Partner and Head of CFO on Demand, sees the main value of the model in the exercise drafting it. It forces founders to formulate hypotheses on how they expect their business to evolve. He also advocated using data to support intuitive decision making, even in unchartered territories, but torched the concept of financial “planning” as he prefers the term “map”.

You support many SEF Award and SEF.Growth High-Potential Label candidates and as such must have seen hundreds of financial models. What is your most consistent take away?

Models often only contain hard punched numbers rather than formula-based projections. But I encourage founders to include non-financial key performance indicators (KPI) as a way to project financial values. It is also common that financial models lack a detailed liquidity forecast and a balance sheet. It seems that many founders draft a model because they are told to do so. Viewed as a painful exercise, many resort to using templates and looking to be done as quickly as possible. They miss the chance to develop a powerful financial story telling tool.

If it’s not just for the sake of having it, what would you consider the main purposes of a financial model?

A financial model serves three purposes. It is a marketing tool for internal and external stakeholders that portrays the goals of the company. But it also serves as an ideation process to formulate how the business is expected to work. It will help you identifying your scaleup recipe - how the company is meant to reach its goals. Finally, it is also the basis for decision-making in trade-off situations and gives you trust in your own decisions.

At its core, the model projects revenues as a function of a series of assumptions and operational KPI. It also projects the resulting costs and how this leads to cash in- and outflows and to changes in assets and liabilities.

If it is meant to be a marketing tool, shouldn’t you keep the model rather simple than complicated?

It doesn’t have to be simple. But the model should have a very clear message. You can use your model to tell a story to investors, or any other stakeholder that is. This financial story is the core of any investment thesis, whether it’s equity or debt.

The story should answer the following questions: What will you do with the cash obtained? Where will you invest it in and how long will it take for those investments to generate positive cash flow? The model will also help you identify areas where your cash will be tied up, such as raw material, tools or launching foreign subsidiaries, for example.

If you are looking to obtain non-dilutive funding, by the way, you need to be prepared to calculate not only your cash need but also offer a comprehensive distinction on how the cash is being used. While banks will lend you money to bridge short-term or seasonal cash shortages, they won't typically fund growth investments such as hiring additional staff.

You encouraged the use of operational KPI: To be fair, founders’ business models are novel, and their ventures evolve and change over time. Does it make sense to estimate, or rather guestimate, operational KPI several years into the future? The track record of today is hardly representative of the situation of the company in, say, 5 years?!

Thank you for pointing this out. That’s a very valid comment that roots in the concept of financial planning which suggests that the resulting absolute number is the purpose of the exercise. I argue that absolute is obsolete! The resulting number is basically irrelevant as your forecast will almost definitely be off, unless by pure coincidence. That’s why I don’t like the term “financial plan” – or “budget” to use another common traditional term. I don’t think you can aim for, or plan to reach, a specific absolute value.

Of course, investors will check whether the projected revenue forecast is interesting enough. But understand that they mainly check the magnitude, making sure that your growth ambitions match their own requirements and preferences. It matters if you aim for 150m revenues in year 5 or for 25m, but it does not matter if it is 139m or 152m.

But more importantly, the financial story is not only about the goals but the journey how you will get there. I am convinced that the main value of the model is the exercise drafting it. It forces you to formulate hypotheses on how your business is expected to evolve. “If I do this, I expect this to happen”. If you increase your marketing budget, you may expect your targeted leads to go up as a function of your cost per click. This then results in an expectation of how many new customers you will get as a function of your conversion rate. This will translate into revenues forecasts, changes in cash, and so forth.

This sounds difficult. Is it feasible to formulate hypotheses given how quickly situations in startups can change?

In our FS Partners workshops, we encourage our clients to project the relationships between KPI and differentiate between leading and lagging KPI. We help our clients to prioritize and strategize more deliberately in trade-off situations by thinking of intended and unintended consequences. We also recommend clearly identifying main assumptions in a look-up table or a separate tab for an easy analysis of different scenarios. Again, the goal is not to model the exact numbers, but to project the relationships of variables to identify which leading variables are expected to have the greatest contribution. Those are your growth levers.

Also, by formulating expectations ex ante, or hypotheses, and evaluating the results ex-post it will be easier for you to recognize what is important and what to make of the results of strategic actions. By using data to formulate expectations, even in the unchartered territories of a scaleup, you will intuitively understand the results.

Ah, that sounds familiar. I recall your slogan from the FS Partners SEF.Founders Event last November: “What counts, and how do you count it, to make it count!?”

Yes, the financial model can help you orient and gain trust in your own decisions. Think of it as drawing your own map to help you constantly determining your position while identifying your next steps. It does not mean that there is only one path accepting the fact that you are facing changing circumstances. It’s like being on a hike where a change in weather could make you choose a different path, or potentially even aim for a different peak.

After identifying the logic of your business when drafting the model, it will be evident what you want to track as part of a dashboard and report to your stakeholders. By tracking progress against your expectations and observing whether the expected KPI relationships are supported by actual data, you will better understand where you are and what would you want to do next. Your confidence will grow with additional data points to observe.

And it helps you to ensure that everybody works towards the same outcome. If you use techniques such as OKR (objectives and key results), the KPI framework of the model will make it much more obvious which KPI you could use as your key results.

It still sounds somewhat intimidating to me. Any suggestions or hacks on to how to develop the financial model?

It takes a bit of courage to formulate hypotheses, particularly to suggest which variable determine your venture’s identity. But it’s not as daunting as it sounds. You don’t need to jump right into the spreadsheet but can kick it off with writing down qualitatively how your business model works.

Start with a few key variables and their relationships. For example, which variable makes you most proud of your team’s achievement. And then think of other variables that will likely positively impact that variable. Or ask yourself what you are most curious about. What do you intend to understand better? For example, are there differences between different cohorts of customers? This can be a great source of inspiration for your next strategic move. And it certainly never hurts to think of factors that worry you, churn for example, as you can develop mitigating strategies and you will be prepared.

As a next step try to identify leading variables. Revenues are often among the most lagging variables. Are there other early indicators that can validate or challenge your actions? You can gradually increase the granularity of the model and refine relationships, also over time as your venture evolves.

As you keep looking into these relationships, it will be much easier to determine whether you have reached product market fit and validate your scaleup recipe. Having worked with many founders I can assure, you already “know” what is important, even as you venture through unchartered territories. All you need to do is find a way to track and visualize your gut feeling – by drafting your own map.

About Financial Models

You need to have it, but is it useless or helpful? And are there any hacks for it?