A well conceived model can be a crystal ball showing you potential futures. And you control how good your crystal ball is.
“The only thing we know for certain about the model is it’s wrong”
I have said the same thing and it’s true. We all know that the numbers three months out, let alone three years out won’t match the model. But that doesn’t mean the acts of creating and reviewing the model is wasted. In fact, they are essential.
Humans are great at straight lining and terrible at compounding. We can easily imagine trend lines far into the future, but we suck at understanding how compounding effects play out over time.
When Bill Gates says ‘we over estimate what can be done in a year and under estimate what can be done in ten’ he is talking about our lousy ability to understand compounding effects.
While people are bad at this, Excel is exceptional at it. It’s why models can become wildly optimistic. Revenue and profits can hockey stick as the compounding effects take hold.
So models can help us see possible futures but distort those forward visions by exaggerating the effects of certain variables. This is the point where many make the mistake of throwing up their hands and walking away. “The only thing we know for certain about the model is it’s wrong.”
But this is the moment where the more experienced find the true value in the model because the model is revealing the impact of various levers on the business. The questions to ask are:
Which assumptions in the model are having the biggest impacts?
How do changes in those critical variables compound?
Is this really how the business works? Are the assumptions things we really do or just arbitrary concepts?
Can we take actions to influence these assumptions or are they largely beyond our control?
How well can our team influence the critical variables?
Answering these questions requires discipline. And here the model builders and reviewers often make a critical error in judgement. They build the model that gives them the answers they want. They check that box, print out the summaries and charts, wipe their hands of the exercise and get back to ‘what’s really important.’
Don’t be that person. Take the next step to honestly answer the above questions, weight the importance of the various assumptions and then see what the model provides. It doesn’t need to be fancy or detailed. You have done the hardest part which is truly thought through how the business really works to the best of your knowledge.
Your reward will be a vision of the future worth working towards or a vision you absolutely want to avoid. And if it’s the latter, you now have the tool to help you figure out how to get to that future you want.