A Best-Practice Financial Model. A Lean Finance tool.

Much is written about the value-add of a best-practice financial model, in terms of reducing model risk and improving financial reporting for executives; especially with commercial and business decision making. An equally important thing to acknowledge with a model is its ability also to reduce cost, increase productivity and effectiveness in an organisation. This is also known as implementing Lean Finance into your organisation.

 

Reduce cost

Given the current nature of economies across the world, many companies constantly face the challenge of improving margins and growing or maintaining earnings. Along with the tight credit markets, the current consumer and corporate lockdown with consumption makes it very hard for companies to grow sales and/or improve margins, hence activities such as outsourcing overhead functions to low-cost markets, restructuring to improve productivity and reducing labour costs are the norm in many sectors of the economy.

The very essence of a best practice financial model is such it will achieve cost synergies, which a standard or run of the mill financial model won’t be able to fully satisfy. A standard model will require timely and costly rework by employees periodically, in order to replicate the executive reporting requirements of the prior periods. As I discussed in “Reasons why your financial model has been consigned to the scrap heap”, such a model will be rendered as redundant by the company in due course anyway.

Assuming the latest monthly financials are standard or there have been no extraordinary events, i.e. the company has acquired a new business unit; updating the financials in a best practice financial model will be seamless, time and cost-effective, and straightforward. The following example of a company updating its July 2011 Actual financials from Budget; demonstrates the cost-effective nature of a best practice financial model, which reinforces its value as a Lean Finance tool to reduce costs in a company.

 

 

Lean finance and a best-practice financial model

As discussed by the UK’s Chartered Institute of Management Accountants, “Applying lean manufacturing techniques to the finance function”, there is a move by many companies to implement lean finance “tools to streamline and enhance productivity and effectiveness”. Evidently a best-practice financial model can effectively improve financial reporting, by reducing model risk and model development and operation time of a company’s spreadsheets.

A best-practice financial model will improve productivity and efficiency, thanks to initiatives like the implementation of error checks, user guides to educate new users of a financial model, and seamless updating of monthly financials from budget to actual. Further, achieving a more aesthetic and consistent financial model, in terms of adding a cover page and table of contents, structured cell referencing and worksheet flow, and font sizes/colours will significantly improve model operational efficiency.

The third element required to implement a Lean Finance discipline is productivity. A best-practice financial model will turbocharge the productivity of employees, by enabling them to undertake more value-adding analysis, forecast and sensivity/scenario analyses to better shape and improve company direction; as opposed to the unproductive non-value add of reworking legacy spreadsheets or creating ad-hoc spreadsheets, in order to simply report and analyse historical financials for example.

 

Short term cost of model development versus medium/longer term benefits of heightened productivity and effectiveness, as well as cost savings

Model development or rebuild time and its associated cost is often viewed as unnecessary by corporations, especially in the current economic environment of corporate cost cutting. However as mentioned, this short term cost to achieve best-practice financial modelling will improve a company’s time spent undertaking financial reporting and analysis, not to mention the time spent updating or rejigging existing models on a periodic basis.

Most seasoned financial modelling professionals have experienced the best and worst of financial models. They will also tell you a reasonable cost/investment incurred in achieving robust, flexible and audit-friendly best-practice financial models, will be more than offset by the cost savings, increased efficiency and productivity of employees and management in a corporation as per the contemporary Lean Finance approach.