The Universal Pillars of Financial Modeling: Mastering the Essentials in Minutes

Megan - 00:00:22: Today, my guest is Chris Riley. Chris is the founder of financial modeling Education, where he delivers financial modeling courses for investment banking, private equity, and FP&A, all taught in a simple and relatable style. Have you ever found yourself facing a last-minute request to build a financial model, feeling so overwhelmed that you literally couldn't think straight? Well, Chris has been there and can remember exactly what it feels like. After being up until 2 a.m. The previous night, he held his head in his hands at a Colorado Rockies game so insanely overwhelmed because he felt unprepared building a financial model. Well, today he can build in two hours what used to take him weeks. And it's not because he's smarter. It's because he now knows what to do. What most people don't realize is that financial modeling can be broken down in systematic steps that can be repeated every time. So you're not always recreating the wheel from scratch. So that's why he's created the Ultimate financial modeling Mastery Program, where he teaches everything that he wished he knew back then, a playbook of sorts, to hopefully save just one analyst from spending all weekend at the office. Chris, thank you so much for being my guest on today's episode of CFO Weekly.

Chris - 00:02:07: Hey, Megan, thanks so much for having me. I appreciate it. Happy to be here.

Megan - 00:02:09: Yeah, today we're going to be talking about financial modeling. And in today's complex business environment with its ever-changing variables, just the idea of having to build a financial model can be super stressful, but it doesn't have to be. And Chris, I'm looking forward to learning from you and your experiences. So let's get started.

Chris - 00:02:28: Yeah, sounds great.

Megan - 00:02:29: First of all, you've had an interesting journey from struggling with last minute financial modeling to becoming an expert in the field. So can you start by telling us maybe a bit about your career and then what moment or realization made you decide to focus on simplifying financial modeling for others?

Chris - 00:02:47: Sure. So the 30 second overview on me is I started my career in consulting in New York City during the financial crisis. And then after that, I went to a more traditional FP&A role at Hilton Worldwide, which was based in Virginia. And then a couple of years into that, I switched over to middle-market private equity and moved out here to Denver. And I've been doing that kind of deal structure ever since for about almost 10 years. And then in 2020, I went out on my own as a financial modeling educator and also a contractor. And so today I do a blend of contract work for clients. And I also sell financial modeling courses online, teaching people basically all the hard lessons that I learned when I was on the job in my traditional finance career. And so the moment where it all kind of came to me was first, it was understanding the big picture. When I was younger, I was so deep in the weeds on models that I didn't really understand how do things roll up and what are we actually solving for? And it wasn't until I got into private equity when we started working on smaller companies that I finally figured this out, that each of these line items traditionally roll up into some kind of three-statement model. And what that's going to do is it's going to help us predict the profitability of the company. And it's also going to help us predict the cash flow. And so once I understood that, that these small pieces link to a whole, well, that really helped solidify my understanding of what we were doing. And so as I started to build complex models, I then said to myself, now that I know how to do this, I really wish that I could record this just to make it easier for myself in the future because I got this very tricky piece to work in an LBO model finally after cranking on it for many, many hours. And I just said, why don't I record this? So I remember, and that accidentally turned into my first course. So not really planning to, I just recorded myself building an LBO model and decided to post it online. And fortunately it had some interest and a lot of people really liked it and responded to it. And so then I said, oh, you know what? Maybe there's a business here. So it was kind of going through my own struggle, getting this complex system to work. And then I decided, you know what? I can maybe help some other people do this too. So that's how it started.

Megan - 00:04:56: And before we get into anything else, who should take this course? Who are these courses designed for?

Chris - 00:05:04: Broadly speaking, it's really anybody in finance. But I would say more specifically, it'd be somebody who's working in private equity or FP&A. And what I mean by that is that's somebody who's going to be building a forward-looking forecast. Because a lot of accounting information is going to help you quantify and map out the history. But the finance function is designed to be forward-looking. And so if you're going to build that forecast, you need to know how all the three statements flow together and how to build them out either monthly or annually so that you can go back to your management team or to your board and provide a recommendation. So if you're doing any kind of what-if analysis or what's going to happen in the future, that's somebody who's a perfect candidate for a course like that.

Megan - 00:05:48: And financial modeling can be overwhelming, especially when you're working under pressure. So can you walk us through your process for breaking down a complex financial model and how you teach others to approach it systematically?

Chris - 00:06:01: Yeah, definitely. So it can be overwhelming. And I've been there myself a million times. And the first thing is just sort of understand the big picture. And again, we're trying to build a forward looking forecast. It either helps us understand the profitability of this company or the potential cash flow that it will or will not have in the future. So that's ultimately the goal. But the way that we get there, there are actually several steps that I pretty much follow every time. And one of them is just getting a handle on the historical data. And if we're talking about a three-statement model, that would be the income statement and the balance sheet. And what I'll do typically is just ask for the income statement and the balance sheet by month over the last two years or so. We start there. We need history. Then we want to put that history into categories because your chart of accounts, if you use QuickBooks or Xero or whatever it may be, you might have hundreds of accounts in there. And you want to be able to bucket those into categories like travel and entertainment, facilities, sales and marketing, or whatever is applicable to your company. So you kind of map things together. Once you have your historical data mapped, you then want to roll that up into a three-statement model and at least get the history to work. So you've got your income statement mapped by category, your balance sheet mapped by category, and you can build the cash flow statement using the indirect method at that point in time. And the reason I like to do it with the history is because you already have the ending cash sitting in your balance sheet. So if you can get your statement of cash flows to match the cash on the balance sheet, well, then you know that your cash flow statement is working correctly. And so when you flip over to forecasting, at least I'm thinking about in a spreadsheet in my head, you can drag the statement of cash flows forward for each and every column and you know that it's functioning. And so that gives you a lot of peace of mind because when you have what I call the plumbing correct, then you can just start filling in the details. You can have a revenue schedule that's going to feed back into your revenue. It's going to make your model more detailed. You can have a headcount schedule feeds back into your headcount cost. It's going to make your model more detailed or an accounts receivable assumption, either DSO or some kind of base build out where you have revenue coming in and cash going out. You can link that back to the balance sheet and it makes your model more detailed. So it's about getting the historical data, then getting the structure, and then filling in the details. And then once you have that, then building a summary and error checking, those are all outputs from that model. And you can use that to then pass that on to your team. So it really comes down to understanding that structure. And it took me a long time to figure that out. I learned a lot of that the hard way. Now, thankfully, I can kind of do it in my sleep and I do it for client work. But that's the typical process that I go through so that I have an output that I can use for my team.

Megan - 00:08:42: And who are your typical clients?

Chris - 00:08:45: So it's mostly what I'll call middle market, which is typically a company doing 250 million or less in revenue. And it's fairly industry agnostic. I've done a lot of inventory based companies. I also do consulting for startup SaaS companies. And this comes back to one of these things that I preach is that if you understand the three statements, you can really model any industry that you want because you're just changing some of the accounting structure in the three-statement model and everything else feeds back to it in terms of custom logic and details for the company. So you might have a different way to forecast revenue for a company that sells shoes versus a company that sells software. But it can still roll back up into three statements. So knowing that kind of gives me the flexibility to help a lot of different types of companies in different stages.

Megan - 00:09:34: New tools and automation are changing how finance teams work. So what's had the biggest impact on financial modeling and where do you see things heading?

Chris - 00:09:42: So for me personally, I use Excel a lot. One of the things that's really jumped out in the last couple of years is when Excel introduced dynamic arrays, which is a great way to, I'm trying to think of how to explain it in a simple way. It's a function that allows you to filter or sort data automatically without having to go through things manually like we used to do in the past. And so as you get new data into your model, if you're flowing some of that information through dynamic arrays, you can quickly and automatically create ports. And so I find it's really helpful if I'm building a 13-week cash flow forecast. If I bring in the accounts receivable report, it will automatically filter and sort any new client or new receivable that has to come in the door. And it makes my model update so much faster. So that dynamic arrays, I think they came out a couple of years ago, but they're really, really helpful in terms of streamlining your financial modeling process. And then the other one is, of course, AI. And I think that's a pretty obvious response. Right now, I don't see AI replacing work currently. It's more a supplement to the existing work that I'm doing. And I find that I'm using it as a kind of a strategic partner to help me think about the outputs of my model and does this look right? And then I also am using it to help me build more complicated formulas that I may not have thought of on my own or that I would have had to Google. And it just saves me a lot of time. And so I think in the future, AI is going to be pretty good at building templatized models. But the nuance of specific companies is still going to require some human intervention. And so I just see the AI functionality woven pretty nicely into spreadsheet programs. And it just makes everything work a little bit more efficiently and faster. So those are the two things right now, dynamic arrays and AI.

Megan - 00:11:30: Bye. And as someone who teaches financial modeling to thousands of students, what are the most common mistakes that people make when starting out? And how can they avoid them to create more effective models?

Chris - 00:11:41: So I've mentioned this a couple of times, and it's because I see this a lot. It's not understanding the big picture of what we're solving for. And so most often a financial model is within those three statements. And we're solving for calculating the profitability of a company or projecting the cash. And so once you understand that big picture, filling in the details is much easier because you build a detail, you link it back to your three-statement model, and that output gives you a playbook and something that you can do with it. So big picture is first. And then secondly, it's just not really understanding the system that we talked about earlier, the process to go through of getting that historical data first, mapping it into categories, linking it to your three statements, building a system for checking errors, and then having an output for your team. So when you don't have that, well, then that leads to poor design, which leads to error-prone spreadsheets, and then it all kind of spirals on itself. And then something just tactical, people struggle getting the balance sheet to balance, and you can actually do it with two steps. So I'll just kind of say them to be helpful. When you're switching over from actuals to forecast, if you want your balance sheet to balance, you take the ending cash on the balance sheet, and you link it to the ending cash on the statement of cash flows. And then you take your retained earnings and you make that equal to the previous period's retained earnings plus the current period's net income. If you do those two things, your balance sheet will balance so that you're confident it's working. And then everything else, like changing the AR, changing the inventory, that's just improved detail that will improve the cash going forward. So that's a common frustration that I see from people. And so that's something I try to drive home early to any student that I interact with.

Megan - 00:13:26: And I'm just curious, but going back to your statement about big picture, is that something that you can teach someone how to recognize sooner? Or is that just something that comes with professional experience?

Chris - 00:13:40: I think for me, it came from professional experience and frankly, learning a lot of lessons the hard way. And I think that's the benefit of education is you can convey that concept to a student sooner. But I think you also just need some on the job experience to understand that inherently. But I think from all the models that I've built, all the clients that I've helped and all the technology that has come and gone, I find that four things are pretty much consistent universally. It's the revenue, the gross profit, the EBITDA and the cash. And so, so long as you are keeping those concepts in mind, when you're building a model, that's the big picture that most people are concerned about. And so if you become familiar with the micro pieces of your model, and where they flow up and how it affects those four things, that's really the core big picture understanding that I think a lot of junior employees are missing when they start earlier in their careers.

Megan - 00:14:39: And how do you approach teaching financial modeling in a way that resonates with people who may not have a background in finance or accounting?

Chris - 00:14:48: So it's interesting you asked that I don't really have a background in finance and accounting. In fact, before I got into business, I was a fine arts major and a Spanish major, kind of a double major, and I wasn't really into the whole. Business thing, I got an accounting degree just because my dad's advice. It was good advice. It would help me get a job and it did. But when I got to the corporate world, I really couldn't stand the jargon, the corporate speak. I felt like everything was super confusing, convoluted, and I couldn't make sense of it. And so the way I taught myself was to try to distill that information down into something simple and relatable, because then I could finally understand it. And so I've used that same approach in my teaching. And a specific example is, I like to explain an LBO model as being very similar to buying a house, because a lot more people are familiar with buying a house than they are with buying a company. But in reality, the process is very, very similar. And so once you explain it in that way, it's a lot easier for people to understand. And a similar example would be accrual accounting versus cash accounting. I just like to think of it as accrual accounting is doing the work, cash accounting is getting paid for the work. And I'll usually walk through how one hour of consulting is the work that you've earned, but you might not get paid for that until the following month when you've processed an invoice, sent out an invoice, and waited for the check in the mail. So anytime I can bring it to something that's universal, relatable, and more real world, I find that resonates a lot better than using a lot of this cryptic finance speak that is frankly designed to confuse people, in my opinion.

Megan - 00:16:29: And you focus on models that work in real world situations. So can you share an example where a model that you built changed the course of a business decision?

Chris - 00:16:38: Yeah, so every model is designed to do that in some way, shape or form, or it changes a strategy that the business might do. That's really the whole thesis of the model itself. Let's run some scenarios and see what happens. Specifically, one that comes to mind is when I was working in P.E., we looked at a solar deal. And it was really kind of an attractive target. It was high growth. The team seemed very ambitious. They had a cool business model. But in the pitch book, we received annual financials. And that looks great on an annual basis. We ended up building a monthly financial model. And this was a big lesson learned for me that you always build a monthly financial model. Because what we didn't realize is that this business had a ton of seasonality. And it was seasonality that wasn't overly predictable. And so when you ran the numbers monthly. There were certain quarters where the company had almost no EBITDA and no cash, and it basically made the deal, we wouldn't be able to finance it. So we pulled the plug on the entire thing and said, we're not going to pass on this deal, even though it's cool. We are going to pass on this deal, even though it's cool, because the banks won't be able to finance it. And we're going to have covenant pressure the whole way. And the only way we figured that out is from taking these annual financials and building a monthly financial model.

Megan - 00:17:55: And as you mentioned, many of your students, they're involved in FP&A or private equity. So how can financial modeling play a critical role in helping CFOs make better strategic decisions and manage risks in today's volatile business environment?

Chris - 00:18:09: I think the number one thing is just being able to run scenarios. So we want in our model, we want to say, well, if X happens. Then Y is the result, and so Z is what we can do next. And I think that's the biggest value. If you want to take your revenue, let's just make a scenario. What happens if it drops by 50%? If the model is built correctly and it's structurally sound, it allows the team to come up with a plan now instead of when it's too late. And when it comes back to those big four things, revenue, gross profit, EBITDA, and cash, stress testing the model or running these scenarios sees how those four things are affected. And ultimately, businesses live or die based on the cash they have, no matter how complicated they are. And so the model helps us run scenarios to see how that affects cash, and then it helps us decide what levers we have to pull. We probably want to cut some stale software or other things that aren't as impactful before we start firing people. And so the model helps us figure out our plan of action if something doesn't quite go our way.

Megan - 00:19:14: And you teach various types of financial models from three-statement models to LBO and SAS. So first of all, can you give us a little bit of a description of how those differ? And then what is the importance of these models to their specific industries?

Chris - 00:19:30: Sure. And I'm glad you asked this question because this is a very common misconception in the modeling world that there's a type of model like a SaaS model or an inventory model. And what really is happening, the three statements are universal for all companies of all industries. When you're building something like a SaaS model, what you're really building are different underlying drivers that then flow back into the three statements. And the same thing applies for inventory. You're just building different underlying drivers that flow back into the three statements. So in a SaaS model, you're going to be building a monthly contract schedule and that's going to flow into your revenue. In an inventory model, you're probably going to be building something by SKU, its respective cost and when it's sold. But that's all just going to flow back into your inventory line on your balance sheet. So the custom logic for the different types of models is one layer below the three statements. You build all the unique things there and then you link that back to the three-statement model. And so that's actually a reason I'm working on a SaaS model right now that I'm going to be releasing soon is because of this question. People always ask, do you have a SaaS model? And I say, no. I'm just going to be creating a model that has custom drivers that then flow back into the same three statements. The only accounting difference for a software model is you do have to model deferred revenue in the balance sheet. Because in software, a lot of times you're getting cash up front, but then you have to deliver a service over a 12-month contract. And so you have cash, but you haven't earned that revenue yet. And so long as you understand the three statements and the underlying accounting that goes into it, well, then you can model it any way that you want. So it's SaaS or an inventory company, whatever it may be, it all flows back to those three statements. So you're probably getting bored of me saying this by now, but that's why that's the fundamental thing that I'm always teaching. Because once you know that, everything else falls into place.

Megan - 00:21:32: And how has your experience as a former CFO and VP in capital markets shaped your teaching approach to financial modeling? In other words, how do you balance theory with practical application?

Chris - 00:21:44: So when I was in PE, I wasn't a traditional CFO, but I did manage the FP&A function for a lot of portfolio companies. And a lot of recurring themes were kind of similar. It was understanding the big picture and how does all this fit together? And so it really does come back to the three statements a lot about how we build the structure and then link the underlying components into that model. And so I would teach something like that to an analyst level person at the portfolio companies. But then I would try to teach them, okay, well, how do we... Take the output from this model, and then communicate it into something that is actionable from our team. And so that's where you kind of go from the practical piece to what do we do with it to actually do something for the company and move it forward. So it was just... One of these things, again, learning the hard way, getting into the FP&A function of a company that I didn't quite understand, perhaps educating the finance staff on how we consolidate all this information into a realistic forecast and then using that to come up with a plan.

Megan - 00:22:51: And when we look at small businesses, they might not have the budget for even a single resource who specializes in or is dedicated to FP&A. So how can these smaller businesses compete with larger enterprises when it comes to financial modeling?

Chris - 00:23:05: So the first thing you can do if you need something immediate, you can just hire a fractional CFO, either a firm or a person, because they have the experience baked in to quickly get you up and running and build a financial model. And it's also at significantly less cost than hiring somebody full time. And there's also you save the hassle of onboarding. They're usually a 1099 contractor and not a W-2. The fractional CFO firms are super popular these days, especially after COVID. So there are a lot out there. You can shop them around and you can usually find a very competitive rate. And people have the skill sets to kind of do this business model at scale. So that's first, I would say, if you're in a bind and you're in a time crunch. If you have a little bit more time, you can definitely invest in a course because I think the people in the management team still need to understand the finance picture. If you completely outsource everything and don't really educate yourself, long-term, you're setting yourself up for some kind of failure or conflict because the CEO needs to understand how all these financial pieces fit together. And then over the long term, I would say it is helpful to eventually bring somebody in full time because fractional work is something that I love and I'm passionate about it. But you also have multiple clients to manage. And so when your company has the cash flow to pay for somebody full time, then you get their full time attention and resources and they can really take a fractional model and get much further into the details and probably build something a little bit more robust. And then they're also a full time strategic partner to the company. So I kind of go in that order, fractional course investment and then somebody full time.

Megan - 00:24:46: And going back to something you said earlier, but you mentioned once a model's completed, taking that model and deriving insights and suggesting actions based on the output of the model. Is that something you teach as well? And how hard is that to teach?

Chris - 00:25:00: Yes. So, and I'm really glad you asked that. So this is called financial storytelling. And that's a buzzword that always confused me because I say to myself, what do we mean tell a story? Like, do I have to make something up? What does that mean? So I've distilled how I tell financial stories into three steps. And so my, let's say I build this financial model, it spits out this information. A junior employee might just forward that onto your boss and say, here you go. Tell me what I need to know. What you can really do with it is communicate this story. And so what I like to do is the first thing I say is what happened? And that's presenting the data. And so an example might be our accounts receivable balance is much higher this month than it is typically. So that's part one. That's what happened. So then part two is, well, why did it happen? We need some context for that. And if we dig into the numbers a little bit, we might find out, oh, you know what? The client that usually pays on time didn't pay us. So our receivable balance is much higher than usual. And so then we say, okay, so part three is, well, then what do we do next? What is our plan? And so the plan might be, well, we got to call them up right away. First off, tell them to pay us. And then secondly is make sure we build some kind of system so that we're communicating with them monthly or we get them on autopay or something like that. So the story to me is those three things, presenting the data of what happened, giving context as to why it happened, and then coming up with a plan of what to do next. And so I usually include those three things on a dashboard, and that creates a very structured and organized conversation for the management team when you're going through your monthly update process. It's much more tactical than it is just looking at a wall of numbers and kind of hoping some insight magically appears.

Megan - 00:26:50: Yeah, thank you for sharing that. And last question, but in your opinion, what are the top three skills or characteristics that a financial modeler needs to possess to Excel in today's rapidly changing financial landscape?

Chris - 00:27:03: So no surprise, answer one is the three statements. Because once you understand that structure, you can model any company of any size in any industry. And if you know how those statements work in your head, it will really, really set you apart. And that's been the most important thing I've learned in my entire career, just understanding those three statements. Number two, I'd say is what we just talked about, that financial storytelling structure of what happened, why it happened and what to do next. It turns your financial model into a playbook that helps the operations team actually take action, as opposed to just staring at numbers and again, hoping some kind of magical insight comes out of it. And then the last thing I'd say is intellectual curiosity. There's never a substitute for somebody just looking at numbers and saying, I wonder why that is. And you kind of go dig in, you figure it out, and then you get back to the same thing. You create that financial story and tell the team, hey, I learned something new and here's what we can do about it. The beauty of that is intellectual curiosity also helps you create your own work. You're not going to be sitting around waiting for your boss to tell you what to do, because you've come up with something that can help the company. If you're always sitting around and waiting to be told what to do, you're always going to be behind. And so then you're not left with some kind of surprise. You're not going to get a 4 p.m., request on Friday to do something because you're just on your own working on something that improves the company. And then that general intellectual curiosity is going to help accelerate your career as you move up into more senior finance roles, because that kind of thinking is something that can't be replaced by AI. AI can give you some advice, but you need that human thought process and that human strategy to come into a management meeting and say, here's what I've done. And here's what I think that we can do going forward.

Megan - 00:28:55: Chris, thank you so much for being my guest today.

Chris - 00:28:57: Oh, yeah, it's my pleasure. Thanks so much for having me on. I appreciate it. I love the questions and obviously very passionate about three-statement modeling, if that didn't come across clearly. So thank you so much for bringing me on.

Megan - 00:29:07: Yeah, I really enjoyed speaking with you. And thank you so much for finding the time to be here with us today to share your experience and knowledge. And I wish you all the best. Thanks so much. Appreciate it.