Financial Modeling Golden Rule: Separate Inputs and Results – Bulls-t!

I’ve been doing financial modeling long before it has become a separate discipline. I have devoted 18 years of my life to this great discipline. If I should name one financial modeling golden rule that I don’t agree with the most, then it will be this one.

Most of the financial modeling courses and industry specialists recommend to separate Inputs, Calculations and Results where possible. While there definitely are many arguments that support such approach, I think that there are as much counter-arguments as well. In my opinion such approach works OK for summary-level models that rely on historical financials (eg. valuation models). It is not good  though if you want to go deeper into the operations of a company.

Most of my clients are mid-size companies and they are using the models designed by my team for their operational-level planning, eg. budgeting. 99% of the time these companies are using monthly models rather than yearly models.

Separating inputs, calculations and outputs just doesn’t work in such cases. What are the inputs for a corporate budget model? How do you project sales and COGS? You just can’t make an assumption like “OK, let sales growth be 2% vs. the last year” for an operating model. Depending on the industry there will be various inputs like price per unit, number of units sold, total sales per store, average discount, etc. The financial modeling golden rule that we discuss just doesn’t produce a good result for the client  in such cases.

Here is an example from a sample budget model for a retail company that I am using in my training on corporate budgeting. These are the inputs that are relevant to sales projections – sales per store, split by product group per store and mark-up for each product group. It seems only logical that the calculations are performed on the same sheet.

Another example – payroll calculations for salesmen. I believe it is much more convenient to put the assumptions on the same sheet, next to the calculations. See example below:

Basically, the structure of the operation-level model dictates to organize it by organizational functions, not by Inputs-Calculations-Outputs principle. In such case, there will be assumptions about the salary system of the company, the payroll calculations and the output (total payroll expense) all on the same page. In my opinion this is much more logical than making a huge Assumption page for all sections  of the model.

My financial modeling golden rule: Mixing inputs and outputs

The input section of our models then contains just the most important factors that heavily influence the output of the model. After the first draft of the budget has been created, it allows managers to easily play with the numbers to get the desired outcome of the model.

And yes, we have violated the financial modeling golden rule again! We have mixed the inputs and the outputs as  well. In my opinion a chart showing the resulting cashflow next to the input section is just more user friendly. I don’t want the users of my models to click back and forth when it is not necessary just for the sake of being compliant with the financial modeling golden rules.

You can review some of the demo versions of operational models in this section of our CFOTemplates.com website: https://www.cfotemplates.com/services/budgeting/

About the author:

Andrew Grigolyunovich, CFA, CFM is currently ranked #12 in the Financial Modeling World Rankings

He has qualified twice (2016, 2017) for the Finals of ModelOff Financial Modeling World Championships, sponsored by Microsoft. His best result is 5th place worldwide in the finals of 2017.

Andrew’s company AG Capital CFO Services provides outsourced financial modeling and FP&A services to businesses and other consultants around the world.