CFO Talk: The CFOs Guide to Financial Modeling/Modeling in a Crisis

In this CFO Talk guests Lance Rubin and Giles Male cover what CFOs need to know about modeling.

This fast changing discipline is becoming a critical aid in strategic planning, scenario building and areas you will be surprised to learn about. They highlight non-technical skills, such as, storytelling, relationship building and business acumen as important aptitudes for successful modelers to possess.

These experts reveal a common error finance leaders make - burdening our talent with routine tasks that stunt the development of value adding skills like modeling.

Lance and Giles explain what a best in class modeling function looks like and include tips on how to build one.

Steve: [00:00:02] Welcome to CFO Talk. I am your host, Steve Rosvold, Chief Learning Officer at CFO.University. Joining us today are Lance Rubin and Giles Male. Lance is the founder of Model Citizn, a firm that uses advanced technology and financial modeling to deliver answers to the most complex questions asked by their clients. Giles Male is a director at Clarity Consulting Services, a firm that delivers professional level Excel training and financial modeling skills to its customers. Today, our topic, The CFOs Guide to Financial Modeling/Modeling in a Crisis, speaks directly to CFOs and finance leaders. Welcome, Lance and Giles. It is a thrill to have you on the show.

Lance / Giles: [00:00:44] Pleasure to be here. Thanks, Steve.

Steve: [00:00:48] We had a little conversation on cricket and baseball, so we are all sported up and ready to roll on this fun CFO talk. So, we’ll jump right into things. Either one of you, tell me, what is the most effective way CFOs are using models to create value for their companies.

Giles: [00:01:06] So I will start off with this, I think from what I have seen, Clarity has got more of a focus on SME’s, to be honest, so it may not just be the CFO. We see models used in two areas. One is this sort of reporting, backward looking, number crunching area, still heavily reliant on Excel. I think where it’s used really well is where that process is made as efficient as possible. So turning the wheel month by month is made as automated as possible. That leaves more time for the value adding insight work that a CFO can do. Then you get into the forward-looking side, the more exciting stuff. When that’s done well, it’s through really robust models, Excel models usually in my world, and that is really good scenario modeling, really good sensitivity analysis, maybe getting into the world of Monte Carlo simulations.

Steve: [00:02:05] That is becoming so important. That’s why I am so excited to have you guys on. That whole area of forecasting is becoming so important. Before the show, we were talking briefly about why this has become important. With Covid-19 and the pandemic, people are moving from monthly models to weekly models. How have you seen that impact in your business’s and with your clients? And, how are those problems getting solved?

Lance : [00:02:34] Yes Steve, it’s a great question, and I guess, like Giles said, that shift to more forward looking is probably more pronounced than what it has been. Backward looking is useful, but we know that one of the biggest challenges you have is forecasting the future. If all you have ever done is a growth rate base, so taking last year’s number times a percent, then you very quickly realize that that’s actually completely flawed in a pandemic because the rules have changed. Business models must change. And what happened last year, in fact, what even happened last few months is almost irrelevant because things are changing so quickly and management are making such big decisions very quickly. I think the frequency of modeling has become a lot higher and the dependency on modeling to make really big decisions has also increased. These are not just you know ok, should we change the price of something? These are like should we get rid of half our staff? Or should we invest in going virtual? Or what are we going to do with our lease that’s going to expire? Should we renew it or should we just all work from home for the next year or two years? These are big decisions. They need to have a model. Otherwise it’s sort of ‘back of the fag packet’, shooting in the dark sort of stuff. And you know the results when that happens?

Steve: [00:03:57] A lot of times we think of the forecast as the model. That is kind of what we use modeling for. You listed a whole bunch of different things. Are you seeing an expansion in modeling for decision making and the way people are using that tool to make more decisions, not just the forecast and budgets and things like that?

Lance: [00:04:21] The answer is yes. There is a great saying by George Box, all models are wrong, some are useful. The reason for that is that the answer is not in the forecast. The answer is in a tool that helps you to look at many forecasts, many different options of the future. In this world of uncertainty and gray, you need a model to really help you stress test all those different scenarios. We are currently working on a very large redevelopment of property asset, which has largely been a retail property asset with cinemas. And of course, who is going to the cinema at the moment. Who is going into food courts at the moment. So we’ve been engaged to, pretty much in the space of four weeks, which is a very, very tight time frame, redesign a two hundred million dollar property site and rearrange it in parallel by looking at the development cash flows and the development Gantt charts and timing. We have got to do all the financial modeling on that and all the debt equity tax. Investors are going to go out and come in. You can see how that can become very complex very quickly. There was an urgent phone call saying we need your help. It is a great time for modelers. But also, it’s a great time to really capitalize on this as educators and trainers, which is partly why we decided to join forces.

Giles: [00:05:58] I have got an example of that as well. Just to give you a slightly different angle from the SME world in the UK. We have worked with a brewery in the UK and in lockdown, they had to completely pivot their business. The modeling was not amazingly complex in terms of debt and equity or using technology to enhance Excel. What it was, was some pretty robust and simple cash flow forecasts. The scenarios were so meaningful because we cannot continue to make our money with our retail contracts or wholesale contracts. We are going to have to work locally. We are going to have to distribute our products in a different way. It was not the standard easy scenario with 10 percent more revenue or 10 percent more costs. It was, we are actually going to have to pivot our entire business and see what that means.

Steve: [00:06:54] That is a very good point in this whole crisis. The idea of coming up with more inputs to evaluate. I think of it as a pivot. . We are going to have to look at more inputs, so the models have to be more flexible.. That is part of the value of modeling, isn’t it? Thinking of what questions I have to ask? Which questions are most important for the model to answer? The number of questions we have to ask and answer has been growing through this crisis. That is where I think you guys and what you do becomes so valuable for CFOs and companies in general.

Lance: [00:07:30] Hopefully, when it’s done well. The idea with good models is that if you are switching your drivers and your assumptions, you should have that confidence that nothing breaks. That is the key bit.

Steve: [00:07:43] Good point. Let’s roll the clock back a little bit and put things in perspective. How has modeling been changing over the past decade? And, is that trend going to continue?

Lance: [00:08:02] Steve, I probably should take this, given I focus on the changes in modeling and certainly modeling tech. If you go back when I started my career in financial modeling, almost 15 years ago I first started building financial models at an investment bank, called Investec. Modeling was primarily found in the investment banking community. So, we would be building models for corporate finance or mergers and acquisitions. Our models were very much what I call deals modeling or transaction modeling. There would be a particular buyout or valuation modeling. So, it was quite specific as to what it was used for. Therefore, the skills were quite limited to just those at an investment bank. Generally, the moment you step outside of that, it is kind of then just the Wild West of spreadsheets. I think the Wild West, sadly, is still there, but the number of people outside of the core investment banking sector that actually can build decent models has increased.

There are certainly people becoming aware that financial modeling is an important skill and, in fact, it’s becoming a professional skill in its own right. I think we are seeing people like Gile’s as an example where expert modelers are now working with small and medium sized enterprises (SMEs). No one was working with SMEs building models 15 years ago. There might be very, very few people, but I am not aware of that many. Whereas now there are all these modeling add-on apps with cloud accounting. Modeling has definitely become something that people are more aware of. In more recent times, the technology to support modeling has helped boost its usefulness. However, because not everyone can build a great Excel model people are looking at other solutions. They are looking at other tools. And some of those tools are probably OK for most cases. But for the case that Gile’s mentioned and the one that I mentioned, Excel is still going to be the go-to tool because it’s going to allow you to customize for any sort of scenario. Whereas a lot of these tools just fuse growth rate based on volume and don’t ask the right questions. It doesn’t allow you to get that full flexibility of the problems. The other big thing is the errors, the focus on errors in governance around spreadsheets has definitely been heightened. I guess you only have to listen to the recent one with the UK, you know, tracking and tracing where they lost 16,000 cases. It is quite phenomenal how the errors have not gone away. They are still there. There is a greater awareness of the importance of resolving these type of issues. And of course, the argument about Excel being dead is still alive and kicking. No one is winning that war because we know that Excel is here to stay

Steve: [00:11:11] Well, that’s great. The governance is improved, we are getting SMEs involved, we’ve got more people recognizing its value, and so it’s good. What are the big changes in the next five to ten years that CFOs should expect to see in modeling?

Lance: [00:11:55] There is a high degree of automation. And I think if you look at that, there’s a tech vertical I like to call it, a slice of modeling technology called modular spreadsheet development. There are other technologies around analytics and visualization for modeling, but this particular vertical on modular spreadsheet development means that I can build a really robust model at lightning speed. What would take days or weeks to build can now be built in minutes. So, I think that’s going to accelerate the use of models and the value they deliver. There has been very low adoption to those tools at the moment. There are currently two tools in the market, Modano and Openbox and they are certainly changing the perception of what is the value of modeling. Right now, the perception is that it is really hard to build and therefore the value is in the build process, not in the using. I think that’s going to change in the future where the value is in the use of models, but it’s sort of chicken and egg, right, because you can’t use it until you build it. So I think for a long time, people are going to resist that change because they’re going to say, well, you know, you need someone with great skills and knowledge to build a model. And I will argue that, yeah, you still need someone, but you do not need someone with 15 years of experience. I am hiring actuaries out of university and in six months they can build a model as good as if not better than an investment banker who has been doing it for 10 years.

Steve: [00:13:25] That is a great lead into my next question which is, what skills should CFOs be looking to develop in their modelers and in their modeling teams?

Giles: [00:13:37] So I can probably pick that one up a little bit and I think Lance has just touched on it. It is far more than just having fundamental Excel skills. I mean, you would expect a good modeler to have good Problem-Solving skills and fundamentals. However, I say that and then the majority of the SMEs that I work with, even the fundamental Excel skills, are seriously lacking for the average finance professional. So even those first steps on a journey of development are not covered for most people. Then the other side of this, I think, is the softer skills. You see lots of very technically gifted modelers who can get to really clever solutions. But when it comes to sharing insights and communicating and influencing a group of stakeholders or a CFO or clients, then you see lots of very good technical people fall in that area. It’s this much more holistic view of being a good modeling professional, I think.

Steve: [00:14:45] Is that in communication skills, like being able to talk to somebody or is it creating the visuals that help people understand what the model is telling them?

Giles: [00:15:03] I think it’s both. And Lance, I’m sure in a moment can pick up more on the technical side. The first part of good communication is listening so the modeler can properly scope the project with their client. So scoping a model, whether it’s as part of a project team or with a client, involves a huge amount of active listening and you can’t just sit there and expect to be told all the right answers for what you’re going to do. You have to engage with the person you are listening to and ask the right questions and lead them at certain times in certain directions. So that’s a really important skill, listening. Then, presenting your insights after you have built the model is important. It is not just visually putting together the right content but being able to communicate the key points and share your insights. I will let Lance pick up on the ways you can add to that technically nowadays.

Lance [00:16:01] Steve, Giles is spot on. It is not just the visual to me, it is the storytelling and the creativity. So how do you lead someone into this journey of decision making where you take them from what they know now, which is probably a very small part of the tip of the iceberg to exposing the biggest story behind the tip of the iceberg and explain the so what and now what and all of the questions they have. It is your role to engage and lead them through that journey and through that story.

So financial models need to be great storytellers.

Now, I don’t think many financial modelers would resonate with the word story because they feel like that’s kind of lying or telling stories is not really part of it. They want it to be just about the facts. It’s the way in which you communicate it. And some of the technology that I use allows you to do that interactively so you can actually touch and drag the visual and drag the charts and get the answers straight away without touching Excel. So that’s the sort of exciting stuff which I am very passionate about, because just like Tom Cruise does in The Minority Report, where he’s swishing through stuff like you could swish your way through to glory on a model by touching a bar chart, which is growth or revenue or conversion rates and seeing valuation or seeing cash flow or seeing other charts move at the same time as you’re doing that. So, it’s incredibly powerful, incredibly engaging for people. I think that’s what is needed. You need to convert complexity into simplicity without losing the message. That is not always easy.

Steve: [00:17:49] You guys have such a great way to put it. You both have really captured this idea of making it exciting, making it fun, making it insightful. Understanding how to describe the situation is really important and then telling the story. I am picturing a stage with the modelers on it. When you can get people to buy the seats in that auditorium, you have created the stories that are compelling enough to draw an audience.

I really like the way you guys have phrased it. To be a great modeler is not just the Excel piece. Good communication skills are also required to be effective.

Today, What type of models are in biggest demand? I immediately picture forecasts, capital spending, some of the things you talked about earlier. What are the most common models you are seeing built today?

Lance / Giles: [00:19:02] There is one in particular that we have seen interest in. Social benefit bond modeling. We’ve seen quite a lot of this in Australia because our society is trying to tackle PPPs, which are public private partnerships. So it’s a partnership between the public sector and the private sector, government and non for profit organizations’ do PPPS for roads, toll roads and hard assets.

We have been doing this for the last two to three years and we’ve just closed one recently around disadvantaged youth that don’t attend school. Our model forecasts the impact that has on society and homelessness. Modeling is starting to be used more than just, as you say, for cashflow. I mean, cashflow is always important, but commercial profits and balance sheets and all the rest, now we are talking about social issues. We are probably one of the leading modeling consultancies in Australia and have done the most of these sort of models. It is incredibly empowering for myself and my staff who work on these projects because they know at the end of it that could potentially save someone’s life. We could potentially change the future direction of society and that is pretty empowering as well. When starting my financial modeling career, I would never have thought we could construct models that would have this type of impact.

Steve: [00:20:50] That is great. It opens my eyes to a whole different world of how modeling can be used. But the outcomes have more than just a financial impact.

In the scenario you describe above, you don’t know the impact of your investment until later. So, to make this work do you need a lot of data? Is this a cross between modeling and data analytics?

Lance: [00:21:28] You hit the nail on the head. It plays a huge role. I think that’s part of the challenge around the data, because quite often there will be people saying certain things and certain metrics and key hurdles. So, what happens is there’s various trigger points that kick in at various measurement periods during the bond.

So, the point of the PPPs is to raise money to pay for the project. We issue a bond, a debt instrument that pays a coupon with principal repayment based on those measurement points. So, data is incredibly important at those measurement points to work out, is this program successful or not? If it’s successful, then the coupon ratchets up or ratchets down. Giles mentioned earlier the scenario analysis and sensitivities, which is pretty much or should be in most models in this case, it is critical.

So data is important, but you don’t need the data to build the model, but you absolutely need the data to run the program because you need to measure at that point in time, to determine if we are successful or not. You cannot necessarily measure everything and it’s a control group that you are putting through a program. There’s anecdotal evidence of what this will do for society, like not having to build more hospitals if people get sick or, you know, other infrastructure assets that you need to develop. So, I think all these aspects and the measuring of those data points become incredibly powerful, but also quite political. So, you get into this really interesting debate between politics and data and modeling and society. Right? It’s a really sort of nice little melting pot of complexity, which is kind of weird space to be in as a financial analyst.

Steve: [00:23:13] That is quite an example, it opens the mind to what these models can do. I have been a practicing CFO my whole career and thinking it’s all about a financial outcome. PPPs have a whole different aspect to them that I didn’t expect. Thanks for sharing that.

Giles: [00:23:35] I have a different anecdotal story for you from my experience. So the answer to your first question, What type of models are in biggest demand? The most common thing I see is people looking for ways to automate the exporting of actual results. We see a huge amount of manual copy paste work that we solve for SMEs with excel add-in tools. I’ve built some crazy models. One was trying to estimate the number of commercial washing machines a hotel group needed based on the size and weight of dirty laundry from hotel rooms and the number of vans being used in the number of deliveries to a commercial property. It was a nightmare to try and work out. I had to run scenarios for a mobile gin bar. So how many bottles of gin did they need? Scenarios where how many people at an event have got alcohol problems, which was an interesting one to build as well.

Steve [00:24:36] Sounds like we are trying to fix a social ills there too. Good, good program. I guess the sky’s the limit when it comes to modeling for decision making. If there is a decision to be made, there may be a model behind it. Can you guys just tell me before we get into the final part of our discussion, how should CFOs be preparing their businesses to take full advantage of modeling? What are the benefits of modeling? And what advice would you give them? Maybe, Giles, from the SME standpoint and Lance from some of your more enterprise clients?

Giles [00:25:14] It’s not just an SME standpoint, to be fair, I think there are lots of absolute superstars hidden in finance teams who are swamped. I touched on it a couple of times now, but they’re swamped with turning the wheel manually, very repetitive processes that are error prone and they do not need to be nowadays. You look at even with Excel, what was called Power Query, there are so many tools and Excel is only going to keep getting more and more powerful. We can use these new tools to help people create more time and space for these people to do more of the value of adding insight work. So, I think there are two things. Number one is identifying those opportunities. And then on the other side, it is pushing individuals, finding these superstars and pushing them to take ownership of their development and giving them the opportunities to do so.

Steve [00:26:16] I like that. And one level up, the CFOs, there is the part of recognizing how valuable modeling is. And I agree with you there are probably people, with these really hidden assets, that are so stuck in their daily grind trying to do cut and paste and all that, that we don’t let them shine. But even before that, what message would you give a CFO on why modeling is really a place where they should be focusing?

Lance[00:26:51] I think the key thing for me is CFOs should be influences at the highest level in organizations and I find it astounding that CFOs will influence without a model. How do you influence robustly and how do you have the confidence that you are influencing the right outcome if you don’t have a model? Like how do you know? I guess people will say, well, nobody knows. Therefore, why do I need a model? And the point is, it’s not about the absolute. It’s not about this is the answer. It’s about the relativity. It’s about this, again, something else. If all else is still the same and stays the same and we know that nothing ever stays the same, there are many moving parts, this is the likely outcome.

So being able to sort of influence and engage and move the organization forward, I think if a CFO isn’t concerned about cash flow in today’s times, then I don’t know what they are concerned about. If you are worried about cash, then the first thing you need to think about is what is on my balance sheet?. How strong is my balance sheet? Is it robust? Steve, you and I had that discussion around P&L, cash flow and balance sheet on social media not too long ago. And I think having a financial model that does not have a balance sheet, that just focuses on profit and loss means that you’re missing a very substantial part of the equation in terms of cash flow. Of course, cash is a balance sheet item. Cash flow statements are the movement in the cash, but it is a balance sheet item. So for a scarce resource in cash, we need to have robust models. I think CFOs are used to the way it’s always been done. One of the challenges this pandemic has shown, firstly the word modeling, you’ve heard epidemiologists talk about modeling on the virus and how do you get out of a pandemic if you don’t consider the various measures that you have to put in place to curb the trajectory of the virus. I think it’s the same thing for CFOs. We have to move away from the sort of downward sloping cash burn or profitability decline. How do we do that and what are the levers we can pull? Looking at staff, looking at other operating costs, looking at levers and sales and all these sorts of things. We probably don’t have it in our teams, the CFOs, and so we don’t even know how to identify it to Giles’s point. But also no one’s ever shown us. I think when I start showing CFOs the sort of stuff that we do, they get blown away. They are like, wow, you can do that in Excel. I just think that they do not know what Excel is capable of, let alone Power Query or dynamic arrays. There’s a whole range of other innovations Excel is working on but most finance professionals are still stuck copying and pasting. The CFOs themselves are probably doing that. So I guess it’s about getting focused and understanding the value you can add if you’ve have a great set of insights you can serve up to your board.

Steve [00:30:16] You guys are combining forces and doing some work that is really exciting for CFOs related to developing modeling skills within their team. Will you take a couple of minutes to talk about Full Stack Modeller and what you are creating that will benefit the CFO?

Giles 00:30:43] So there are three companies. My company, Lance’s company and then our other partner, Kenny, who comes from a project finance background. So, again, very comprehensive, complex financial modeling. Across the three of us, we have got a really broad set of bases covered. The main thing I would say about Full Stack is it’s specifically not supposed to be exclusively for professional financial modelers. This is something where we can take a budding modeler, somebody who is relatively early in their Excel journey and guide them all the way through the foundations of Excel, advanced modeling and all the tech that Lance is so passionate about. We also look at soft skills, trying to help people understand that their personality type and how they can engage and influence and listen and things like that. It’s a real passion project for us. Once it’s live, it will be an active online community with tons of premade content and then also lots of live weekly events for all of our community.

Steve [00:32:03] Great.

Lance [00:32:06] Yeah, thanks, Giles. Why now about modeling? That’s exactly the thing that the three companies got together and thought about. Well, if not now, when? It is an opportunity. We can see the amount of pain that sits in teams that are having to do models or updates every month or every quarter, but every week or sometimes every day. So, I think we’re seeing it, we’re hearing it and we’re responding. I think one of key things Giles touched on, you can be great at Excel, but if the only thing you are good at is Excel, then you’re missing a whole range of other skills that are not only good for your organization, but good for you as a person to develop and grow professionally. One of the things I am passionate about is the personal canvas, like a business canvas. Having a look at where you are going, where you’ve been and understanding that, is really important for you. If you are a spreadsheet jockey and you’re sitting late at night rolling spreadsheets forward, you’ll look back on your career at some stage over the last 5 or 10 years and say, you know, I’ve been running the same spreadsheet, I’ve been doing the same process for 5 or 10 years. That is not that inspiring. We want to break that cycle. We want to break this up and say there are better ways to do things. There are things you can do to automate that process and also do not be afraid of that automation. Even though that’s what you’ve been doing for the last 5 or 10 years, there are all these other skills that we can show you and teach you around communication, around influencing. Also, you could do passion projects around social issues. If you’re really good at it, then you could go and help a not for profit and you could really do some amazing stuff that’s applying your modeling skills for good, not just for capitalism.

Steve [00:34:02] It sounds like a really good program. I have not heard of anything like this before. I understand it is a membership, year long program. You will teach getting better at Excel and then also get into these softer skills and higher level modeling skills. Good on ya both.

I really appreciate what you guys are building for CFOs. I know a lot of CFOs who have this skill set more or less ad hoc in their group. If they lose somebody, they are in trouble. If they don’t have it then they are thirsting to get it. I really appreciate that you guys are putting this program together. I am excited to watch it grow and looking forward to supporting you in that growth. It is a discipline that will really help our finance community.

That wraps up today’s CFO talk. Thank you for joining us Lance and Giles. I sure appreciate it.

Lance/Giles [00:34:49] Pleasure. Thanks, Steve.

Steve [00:34:51] CFO.University is a community of member scholars, companies and trusted advisers committed to the professional development of chief financial officers.

Learn more about us at www.CFO.University.

Until next time; enjoy, learn, engage and stay safe.

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