Josh Aharonoff
Sep 21, 2023
Welcome to another exciting episode!
In this edition, we'll simplify complex financial statements, explore the crucial Chart of Accounts, and discover the art of designing effective financial models.
What we’ll be covering in this edition:
The Universe of Financial Statements 🪐🌑☀️
Learn about the Chart of Accounts 👇
How to design your Financial model
Let's dive in...
Take a journey through each galaxy to learn more about business!
🌌 THE PROFIT & LOSS
This galaxy is filled with planets, asteroids, and moons all designed to tell you one thing:
how profitable is your business
It is separated by the following planets:
🌑 Revenue → your income
🌕 Cost of Goods Sold → the cost to deliver your income
🌕 Operating Expenses → the cost to operate your business
🌑 Other Income → income not related to your core business
🌕 Other Expense → expenses not related to your core business
This galaxy brings us to what may be arguably be the most important planet in our galaxy…
🌍 Net Income → your net profitability… taking all income accounts, and subtracting all expense accounts
But the constellations found in the galaxy of your P&L is just one part in the vast universe of Financial Statements…
which brings us to what may be the most important galaxy of them all…
🌌 THE BALANCE SHEET
This galaxy was orchestrated by the heavens to tell you one thing…
What is the net worth of your business?
It is separated by the following planets:
🪐 Assets → items of economic value that the business owns / substantially controls
⚫ Liabilities → amounts owed to creditors (hence it being a black hole!)
🌐 Owners Equity → amounts owed to the owners of the business
Before you put your telescope away 🔭…don’t forget about one very important galaxy
🌌THE STATEMENT OF CASH FLOWS
This galaxy…like the other galaxies…was orchestrated for one purpose…
To explain where your cash is going each period 💰
Some scientists use their telescope to study this galaxy using the DIRECT method…
while many scientists point their telescope to this galaxy using the INDIRECT method
It is separated by the following planets:
🌘 Cash from Operating Activities → cash related to operating your business
🌘 Cash from Investing Activities → cash movements related to long term assets invested by the business
🌘 Cash from Financing Activities → cash movements related to funding the business
As the saying goes…nothing in the universe happens by chance…
and we are all CONNECTED.
The financial statements are no different.
Take a trip through a wormhole in the Profit & Loss, and you’ll find yourself traveling through space & time into the balance sheet...
🚀 Where Net Income will connect you to Retained Earnings
Travel at the speed of light from the cash flows to the distant planets of both the P&L and Balance Sheet…
Follow these routes:
🚀 Net Income, Depreciation, Amortization → Cash from Operating Activities
🚀 ▲ in current assets / liabilities → cash from Operating Activities
🚀 ▲ in long term assets → cash from Investing Activities
🚀 ▲ in debt, or contributed capital → cash from Financing Activities
Congratulations!
You’ve completed your voyage across time and space.
Got anything to add about the amazing universe of Financial Statements?
What is the Chart of Accounts?
The Chart of Accounts is a list of your General Ledger (GL Accounts) that make up your financial statements (specifically, your Profit & Loss and Balance Sheet)
Your Chart of Accounts can make or break your financial statements
When set up poorly they…
☹️ Confuse the reader
☹️ Don’t tell an accurate picture of what’s happening
☹️ Make it challenging to draw insights
Here’s are some tips for avoiding these mistakes:
➡️ Understand WHO the readers of the financial statements are
Before we can decide how our financial statements will look, we must understand who is consuming this data.
Your job is to make this data easy for this audience to consume!
➡️ Apply the proper balance between DETAIL and SUMMARY
The readers of the financial statements should be able to grasp what’s happening with the business, with just the right level of detail…
not too much, and not too less.
Avoid using accounts that can be grouped into one while maintaining the same significance
and avoid using accounts that are too general that would require further commentary to understand
➡️ Include SECTIONS
Your financial statements should have a proper order where the readers can understand key accounts and how they relate to one another.
Combining accounts into sections can help improve readability, allowing the audience to grasp what’s happening more quickly
➡️ use NUMBERING
Most Accounting Software will sort your chart of accounts alphabetically by default.
This may not cause much of an issue, but can become challenging to organize as your chart of accounts grows.
Adding numbering helps you maintain greater flexibility in your ordering, and when set up properly, can help the reader spot out patterns in how certain accounts are numbered
➡️ Set up DEPARTMENTAL TRACKING
Understanding what you’re spending money on is helpful…
Understanding WHO is spending that money is even more helpful
That’s where departmental tracking comes in
Here, you have 2 options:
1️⃣ Utilize a “class” for each transaction
2️⃣ Add each department as a new section on your Chart of Accounts
Those are a few of my suggestions for keeping your Chart of Accounts healthy & clean
What would you add?
Preparing the right schema for your financial models is the foundation to a model that gives you the information you need, when you need it.
I’ve seen 100s of Financial Model’s in my career…
and while they all can differ from one another, this structure can be applied to ANY business model.
The mainly come down between Source Tabs, Inputs Tabs, and Output tabs
SOURCE TABS
Your model often times will start with an export / connection to your a number of source data such as:
→ your existing P&L and Balance Sheet
→ your headcount details
→ your customer details
These source tabs should be designed in a way where you don’t need to edit their format, making it easy to refresh / resync
INPUT TABS
Once you have your source data, it’s now time to design your inputs.
It’s common to consolidate as much as possible with your inputs into just one tab.
This makes it easy for your readers to understand all the assumptions that go into your model, allowing for a centralized location where everything can be tweaked.
Sometimes though, you may have too much information to fit on one tab.
That’s where your other input tabs come into play, which will then all push to your centralized drivers tab
OUTPUT TABS
Now that you have your source tabs…
and you’ve tweaked your assumptions on your input tabs…
it’s time to present your findings.
The most important findings will be the output for your 3 financial statements
It’s also common to divide up your output tabs between DETAILED outputs (IE, your full P&L, Balance Sheet and Cash Flows)…
and SUMMARIZED outputs
→ Summary Tables
These tables help you summarize your detailed outputs, such as a summary P&L, summary Balance Sheet, or summary Cash Flows
I like to start here and analyze big movements from one period to the next before drilling into the details
→ Dashboards & Reporting
Now comes my favorite part of a model…
Your Dashboards & Reporting.
This is where you woo your audience with beautiful visuals that summarize the key information
For more information on how to prepare these dashboards, check out my course on CFO Dashboards & Reporting
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It’s common to also include a table of contents with your models so that the readers can understand how everything is laid out, and where the edits can be made.
Remember…your models are not just for yourself - they will almost always be reviewed and tweaked by outside parties.
The more coherent & clear the structure of your model is, the easier it is for you to manage and nail your projections.
Those are my tips for how I design a financial model.
How do you design your models?
I hope you gained valuable insights into EBITDA, Month End Close processes, and Revenue Forecasting with this week's edition of Legit Numbers!
If you have any questions or need further assistance, feel free to reach out. I reply to all my emails personally :)
Till next Thursday!