F1F9 eBooks

BUSINESS
ANALYSIS
LIFECYCLE
FROM THE BUSINESS CONCEPT
TO THE FINANCIAL MODEL

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If you cant describe what you
are doing as a process, you
dont know what youre doing
W. Edwards Deming

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FAST FINANCIAL MODELLING

THIS
GUIDE F Useful, practical information about FAST financial modelling, managing
modelling projects and good modelling practice.

BANKING & ADVISORY

BA Targeted at, but not exclusive to, banking and advisory practice areas,
exploring modelling topics like credit analysis, debt structuring etc...

PROJECT FINANCE
PF Focussing on the kind of transactional modelling typically associated with
the development of infrastructure, PFI and PPP projects.

ENTERPRISE REPORTING & ANALYSIS

E Useful information and practical guidance on the apllication of modelling
discipline and standards to improve business decision making.

ENERGY & NATURAL RESOURCES

EN Insight and practical guidance on the aplication of good modelling practice
specifically related to these often complicated business areas.

FAST FINANCIAL PF PROJECT

F MODELLING BA BANKING
& ADVISORY FINANCE

E ENTERPRISE ENERGY &

EN NATURAL
REPORTING & ANALYSIS RESOURCES
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Contents
8 1. THE BUSINESS SITUATION

8 1.1 UNDERSTAND

9 2. CONCEPTUAL MODELLING

10 2.1 ENGINEER

10 3. SPREADSHEET ENGINEERING

13 3.1 ANALYSE

13 4. MODEL INSIGHTS

14 4.1 INTERPERET

15 5. MANAGEMENT

15 5.1 COMMUNICATE
 F

ABOUT F1F9
At F1F9, we provide financial modelling and business forecasting support
to blue chip clients and medium-sized corporates. We also teach financial
modelling skills to companies around the world. Our clients have access to
high quality, low-cost modelling support delivered by 40 professional modellers.

We co-developed the FAST Standard that allows modellers and non-modellers

to work together and understand financial models. Transparency is the core
value that drives our modelling and our business activities.

SPECIAL THANKS
The Business Analysis Lifecycle framework was developed by Tom
Grossman. Like all works of great insight it now seems obvious. However,
when we first came across it, it was a real moment of revelation for me.
It makes clear and explicit what had been unclear and implicit previously.
At F1F9 this framework has helped us to explain what it is that we do
(spreadsheet engineering) and what we rely on our clients to provide us
with (conceptual models). In our training business, it has helped us as we
explain to our students the different skills that they will need if they are to
add value to their modelling assignments. We are deeply grateful to Tom.
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Most people seem to start at the beginning.

That is, they start modelling by entering some
inputs into a spreadsheet, and work forwards
towards whatever it is they think they want to
compute. We call this input oriented modelling.

Input oriented modelling is analogous to building

a house without blueprints. If the house is small,
and similar to another house you built recently,
and you genuinely know exactly what you want,
you can get away with this approach.

However, it does not scale well to larger or harder

models, and over-reliance on this technique
can cause problems.

Tom Grossman, 2005

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REAL WORLD MODEL WORLD

BUSINESS CONCEPTUAL
UNDERSTAND
SITUATION MODEL

ENGINEER

SPREADSHEET
COMMUNICATE
MODEL

Analyse

MANAGEMENT Interpret
MODEL
INSIGHTS INSIGHTS

The Business Analysis Lifecycle

by Tom Grossman.

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1. THE BUSINESS
SITUATION
At F1F9, we think of spreadsheets as a laboratory: a place
for analysts to test business hypotheses. The purpose of the
spreadsheet financial model is to understand something about a
specific business situation: should we invest? Should we change
our capital structure? Should we undertake a project? Can we
afford to hire more staff? By how much do we need to cut costs?
Since models exist to provide answers to these questions, the model should be built
with the questions in mind: output oriented modelling. Somebody in the business asks a
question. The analyst responds with: well need to model it.
In order to model it, you first need to understand what it is that you are modelling.

1.1 understand
In order to understand what it is that you are modelling, it is a good start to consider
what makes it risky. Here are some classic risks that might be relevant:

This deal is a one off there are no precedents;

It is has huge political significance;
It involves numerous key stakeholders and how they work together is not yet clear;
Nobody trusts the demand forecasts;
There are ten thousand lines of raw data to accommodate;
Cost estimates have a margin of error of + / - 30 per cent;
The financing structure is not yet clear; and
The terms under which revenue is generated are complex.

Risks might fall under different categories. So project risks are risks that apply once the
deal has been signed. We have seen project risks classified under seven main headings:
construction; design; technology; demand; relevant cost; third party revenues and residual
value.

Procurement risks apply up to deal close. These include the risk of approvals not being
granted, overruns in budget estimates and financing not being available on favourable terms.

Modelling risk deserves its own category and we encourage modelling team to undertake
their own assessment.
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2. CONCEPTUAL
MODELLING
We have taught analysts from hundreds of companies to
build financial models. Financial modelling proficiency re-
quires skills that take time to acquire, develop and perfect.
Sometimes the difficulties students have are related to how to build their model.
More often, difficulties relate to what it is they need to model.

Once the modeller understands how a particular area of a business works commercially,
it is much more straightforward to create a spreadsheet model.

We recommend that students begin with a sound conceptual understanding of what

it is they must model. If they are confident that they understand how an area of the
business works, they may press on and open up Excel. If not, they should spend the
time required up front to acquire that understanding.

Conceptual understanding may be acquired by talking to people within the business

who do understand the business situation, or by creating flow diagrams that set out
the commercial and financial ingredients of the business.

It is helpful to start with the line item being modelledfor example Revenueand
to keep asking the question what drives that? until you cannot go any further. The
sample flow chart below shows what this might be like.

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2.1 ENGINEER
Just as a key part of assessing the business situation is to understand the risks asso-
ciated with that business situation, so a key part of assessing the conceptual model is
to understand where the complexity lies. A good modelling solution will be engineered
with complexity in mind. Lets consider some conceptual models and identify where
the complexity lies.

Interest needs to be added to a bank account and interest is chargeable on interest:

A identifying an appropriate balance for interest calculations is what makes this complex
and that is all conceptual. The spreadsheet solutions can be both appropriate and simple.

Dividends are tested against distributable profits and cash before distribution: matching
B the detail of the test with a particular jurisdictions legal requirements is what makes this
complex. The complexity is conceptual.

Costs charged to the income statement are paid six months later: this business situation is
C easy to understand, but the spreadsheet engineering is not always straightforward. Most
solutions fall back on complex Excel functions such as HLOOKUP, OFFSET or SUMIF.

Forecast inflation rates vary and sub contract agreements have their own indexation pro-
D visions that need to be aligned with the main project model: this business situation is not
always easy to understand and the spreadsheet solution is frequently complex.

A good modeller on determining that complexity lies in conceptual understanding will

shut down Excel and start sketching: mind maps, wiring diagrams and graphs. The good
modeller will consult with colleagues, test their understanding through dialogue and ask
others to describe how they have addressed similar challenges.

A good modeller on determining that complexity lies in the spreadsheet engineering

will seek out structures and coding that they have used in the past, will weigh up the
benefits and pitfalls of using complex functions and will test their work on a reviewer.

Frequently, there is a trade-off between flexibility and transparency to be made.

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3. SPREADSHEET
ENGINEERING Equipped with an understanding of how the business works and
an assessment of risk and complexity, you can now create a
spreadsheet representation of the business.
It can, and often should, be different people responsible for conceptual modelling and
spreadsheet engineering. These are very different skill sets and it is rare that one person is
good at or even interested in both. A sensible separation of conceptual and engineering roles
will assist in consistent models being built regardless of sector or commercial complexity.

At F1F9 we do not pretend to understand the commercial reality of every business that
we are engaged to model. What we bring is rigour, efficiency, flexibility and scalability
to the modelling process. Our clients bring the commercial understanding of how their
businesses work, and knowledge of what hypotheses they need the model to test.

We use a collaborative Agile methodology to allow the conceptual modeller and spread-
sheet engineer to work closely together.

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10 PRINCIPLES OF AGILE FINANCIAL MODELLING

Whereas the conceptual modelling relies on commercial, accounting and financial knowledge,
the spreadsheet engineering requires rigorous process and the application of standards.

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At F1F9 all of our models are built to the FAST modelling standard
which gives us the following benefits:

CONSISTENCY All of our models are built the same way. This is essential for
the collaboration between conceptual modeller and spread-
sheet engineer that lies at the heart of the Agile approach.

EFFICIENCY Our model build process does not rely on one single mod-
eller. As we write this in late 2013 we have more than 40
modellers in the team. Because they are all building models
to the same standards, modelling becomes a team activity,
rather than an individual one.

RISK REDUCTION Models are easier to read, making them easier to review.
The collaborative, Agile process means that more people
are looking at the model during the build process, which
helps to reduce risk.

MODULARITY No two businesses or projects are exactly the same, but

there are many areas that are similar. The modularity of
FAST models allows us to reuse code blocks where the
conceptual model for a particular part of the business is
the same as we have modelled previously.

RESOURCES
If youd like to find out more about applying the FAST Standard to your modelling the
following resources might be helpful:

DAYS
TO BETTER
FINANCIAL
MODELLING
31 days to better financial modelling. A free introduction to the basics of FAST financial
modelling through 31 free short tutorials delivered daily to your inbox.

www.financialmodellinghandbook.com
The Financial Modelling Handbook. An online resource of FAST modelling guidance.
 WWW.F1F9.COM 13

3.1 ANALYSE
FAST financial models are built with model reviewers in mind.
As model reviewers investigate the calculation sheets of FAST
models, they will find on any particular row either:
A link to a single source calculation or input; or
A single source calculation.

This link based approach is simple, consistent and means that a FAST financial model
may be analysed and reviewed using no more than 4 keyboard shortcuts. These are:

Ctrl + [ to jump back to the source of a link;

F5, Enter to jump back from the source to the destination;
F11 (quick chart) to get a big picture view of calculations; and
Alt M P to throw up trace arrows on a calculation

4. MODEL
INSIGHTS
The purpose of the model is not to show off your knowledge
of Excel. Its to create insights into the business hypotheses
being tested. This requires analysis.
A common complaint we hear from senior business people is that building the model
takes so much time, there is not enough time left for the analysis.

Although an Agile methodology and the application of modelling standards help to get
a better model more quickly, the amount of analysis available will always be time limited.
In other words, it is the job of the analyst to produce as much insight as possible
in the time available.

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The following recommendations may be useful in this regard.

ESTABLISH A Good base case values should be based on reasonable

REASONABLE BASE CASE estimates. These estimates should lead the model
to produce reasonable outputs. Senior people in the
business will generally have a good feel for what
reasonable outputs will look like. A high level review
of the base case is a good sense check.

PERFORM SENSITIVITY A sensitive input is one where a change in the base case
AND SCENARIO value will produce a significant change in an important
ANALYSIS output. It is surprising how frequently plus or minus
5% from the base case passes for sensible sensitivity
analysis. Its important to look carefully at what reasonable
best and worst case scenarios look like.

WHERE POSSIBLE, Monte Carlo analysis is where inputs are defined

MODEL THE as a distribution, and the model is run hundreds or
DISTRIBUTION thousands of times to understand the impact of
the range of possibilities across all the inputs. This
method recognises that the future is a range, not a
point. However it is not always possible to do this
kind of probabilistic analysis, and the output is not
always readily understandable to others. Where it can
be done, using software like Crystal Ball or @Risk, it
provides a much richer insight into the risks being faced
by the business, and therefore guidance into where
management attention should be focused.

4.1 INTERPRET
Key to model interpretation is a focus on answering questions
that will keep senior decision makers awake at night. Here are
some key interpretation questions to keep in mind:
Does the project always have cash adequate for its needs?
Are the resources adequate to achieve the revenue predicted?
Is the project over resourced?
What happens if demand forecasts do not materialise?
Are minimum expected rates of return being achieved for key stakeholders?
Are growth assumptions in line with industry expectations?
Are operating margins in line with industry expectations?
Are investors achieving cash returns in the most sensible way?
What role does efficient working capital management have in improving returns?
How ambitious is the tax structuring?

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5. MANAGEMENT
INSIGHTS
One F1F9 client, David Sugrue, is using FAST financial models
to developer solar projects in the US.
This is how he uses FAST financial models to gain management insights:
On Thursday, I used the model to have three very important conversations: one
with myself; one with a potential business partner and one with a solar financier
(who is also very skilled at modelling).

The conversation with myself was hugely useful as the model helped me solve
some complex bits of solar financing that had confused me.

The conversation with my potential business partner was huge because I could
show him exactly how much money we could make on each type of commercial solar
sale I propose we target. I am keen to exploit commercial solar systems ranging in
size from 20 kW to 150 kW. Up until now, without the model, he had been doubtful
of the potential profitability of this segment. Now he is convinced.

Finally, the conversation on Thursday afternoon was with a very good friend of mine
who happens to be very successful in solar finance. I proposed my business model
to him via the model and he was immediately intrigued. I am going to see him next
week with the intent of getting him as a backer for my next solar venture.

5.1 COMMUNICATE
Its essential that the analyst speaks about the business,
and not about the model Tom Grossman
The Business Analysis Lifecycle model divides the world in two the real world,
and the model world. Analysts, and financial modellers in particular, live in the model
world. It is a well-ordered world where A leads to B, and where businesses can be
neatly represented by calculation blocks and inputs.

Most people do not live in the model world. Communicating with people in the real
world can be a challenge for those who live in the model world.

It is important for analysts to do the work of turning model insights into business insights.
Managerial insights are aimed at people who are familiar with the business, and the
industry in which the business operates, but who are not familiar with the model.

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A key skill that allows an analyst to progress to more senior appointments is the ability to
communicate insights about the business based on analysis of the model. The following
recommendations may help:

REMEMBER THAT THE The future of any business or project is a range of possible
FUTURE IS A RANGE, outcomes. The question is, how likely is each outcome?
NOT A POINT When you present the results of your modelling as a range
of possible outcomes it helps everybody to think through
the risks, including the unknown unknowns.

Just because your base case model is showing an IRR of

14.2345% - dont be tricked into thinking that this is what
is actually going to happen.

The only thing you can say with any confidence about your
base case is that it is not going to happen.

TALK ABOUT THE In truth people do not want to hear about your model. It
BUSINESS, NOT THE is your job to translate what the model is telling you into
MODEL business insights, and then communicate them effectively.
Spending time walking somebody through your spreadsheet
is rarely a good use of time. Unless they have asked for it
specifically, and even then...!

DONT BELIEVE YOUR You are smarter than your model. When you are running
MODEL sensitivities or changing your model, make sure you have
a hypothesis first about how the model is going to react.
If the model does not react in the way that you expect,
your first position should be that the model is wrong.

Models are wrong more often than we like to think.

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When you find yourself rationalising what the model is

telling you, rather than looking for reasons why your model
does not react in the way that you expected it to, alarm
bells should be ringing.

THINK ABOUT WHAT Interesting to model does not mean interesting to your audi-
INTERESTS THE ence, and it does not mean that it is material to the business.
AUDIENCE, NOT Just because something was interesting to model does not
WHAT INTERESTS YOU mean that it should automatically go into your presentation.
In fact, it is a pretty reliable indicator that it should not go
into your presentation.

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ASK SO WHAT? Every slide must have a so what?. If you do not know what
ABOUT EVERY SLIDE the point of a slide or graph is, drop it from the deck. Ask this
YOU PUT IN FRONT question of every piece of information you put in your deck.
OF AN AUDIENCE Some analysts think that if you just present enough data
then people will get it. If you are that analyst then you
are not going like this: but when you make a presentation
youre telling a story. The analysis does not speak for itself.
You have to speak for it. While you want to show data, your
audience is longing for insight. You want to chart every line
in your model, your audience wants to understand what
decisions they need to take.

And while we are on the subject of charts:

1. Label your axes
2. Avoid chart junk
3. Use the appropriate chart for the type of data you are
presenting. If you dont know how to action points 2 or 3,
Stephen Few will teach you
4. Avoid pie charts. Always.

B.L.U.F Bottom Line Up Front. Lead with your conclusions. If the

purpose of your presentation is to ask for an investment of
$1.5 billion dollars in your infrastructure project, start with that.

Say The purpose of my presentation is to ask for $1.5 billion

to invest in Project X. We are going to talk you through the
rationale for the project and we are then going to look at the
key risks, and how we are going to manage those risks.

In college youre told to end with your conclusions. In

business you have to start with them. Dont talk for 20
minutes keeping people guessing about what it is that
you actually want them to do.

DONT BLUFF The only acceptable answer to a question you do not know
the answer to is I dont know the answer to that question.
No matter how slick you think you are, your audience can
smell your bluff a mile off. They will then apply a bluff
discount factor to everything that comes out of your mouth
from that point onwards.

Conversely, if you do not know, and you are honest about
it, it builds trust. Unless you do not know the answer to any
of the questions they ask, in which case you should not be
making the presentation in the first place.

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RECOGNISE OPTIMISM Your audience want reassurance that you understand the
BIAS risks of the business venture you are modelling. Always
telling them that everything is going to be OK is not going to
cut it. Your infectious enthusiasm for the sector is going to
make your presentation more enjoyable (see the final point),
but it is not going to persuade anybody to part with $1.5
billion unless they know that you know where the risks lie
and how you are going to manage them.

DONT READ FROM It is a slow and painful death for your audience. If the
YOUR SLIDES presentation is worth doing, it is worth doing properly.
Learn your material. Or do not turn up.

PUT SOME LIFE INTO IT Do not phone in your performance.Get out in front of
your audience. Use a remote slide clicker - they cost a
few dollars. Make eye contact with every single person
in your audience, in turn, and keep on doing it. Vary your
voice. When you are making a presentation, you control the
energy in the room. If you are not putting energy into the
room, you are taking it out. Choose.

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COPYRIGHT
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 F1F9 eBooks

F1F9 builds and maintains financial models used

by leading corporates, advisors, banks and funds.
We also train our clients to build better models
themselves through courses delivered worldwide.

To discuss how our team can help you improve

your corporate modelling and forecasting call
Lynn Martin on +44 203 239 8575
or email lynn.martin@f1f9.com

20-22 Bedford Row, +44 20 3322 2722

London WC1R 4JS www.f1f9.com