Building Sound Financial Models

1. Building Sound Financial Models Adam B. Harris Principal Calacles Consulting Group www.calacles.com My name is Adam Harris and I am the Principal and Founder of Calacles Consulting Group. Calacles was founded in 2006 by accident; it was one of those business ideas which evolved on its own -- without the numerous business plans drafts, complicated financial models or huge marketing budgets. I found a need and offered a service. I quickly began to help local emerging business formulate business successes through qualitative and quantitative financial models. Financial models which were perfect translations of their business plans. Now the goal of this presentation is to share with you my experiences and my understanding of what is required for building �MONEY� ready financial models. My name is Adam Harris and I am the Principal and Founder of Calacles Consulting Group. Calacles was founded in 2006 by accident; it was one of those business ideas which evolved on its own -- without the numerous business plans drafts, complicated financial models or huge marketing budgets. I found a need and offered a service. I quickly began to help local emerging business formulate business successes through qualitative and quantitative financial models. Financial models which were perfect translations of their business plans. Now the goal of this presentation is to share with you my experiences and my understanding of what is required for building �MONEY� ready financial models.

2. Narrate Ask yourself, what story does the business plan need to tell? The first step is story telling. For my springboard business, PRH, our story was that we were attempting to market a new consumer medical device into what was at the time a quickly converging industry for home health care products. We built an affordable home hearing test, in a handheld device form, for less than $100. And because many features of our device were not patentable our goal was make some noise in the marketplace and hopefully be bought out.The first step is story telling. For my springboard business, PRH, our story was that we were attempting to market a new consumer medical device into what was at the time a quickly converging industry for home health care products. We built an affordable home hearing test, in a handheld device form, for less than $100. And because many features of our device were not patentable our goal was make some noise in the marketplace and hopefully be bought out.

3. Translation A good financial model is simply a translation of business plan wording into numbers. All good financial models are simply a translation of business plan wording into numbers. With PRH, I was required to illustrate financially how we were going to make noise and position ourselves as a potential acquisition target. This required transforming a complicated marketing plan into believable projections and showing research-backed estimates for monthly operational expenditures. All of these determinants ultimately would drive our bottom line. All good financial models are simply a translation of business plan wording into numbers. With PRH, I was required to illustrate financially how we were going to make noise and position ourselves as a potential acquisition target. This required transforming a complicated marketing plan into believable projections and showing research-backed estimates for monthly operational expenditures. All of these determinants ultimately would drive our bottom line.

4. Goal Build a financial model with variables and links between variables, creating the ability to easily manipulate both variables and links to tell your business story. Because no one wants to reinvent the wheel I advise you all to build models from the ground up. Variables, factors, determinants are what drive your business. Because financial models are simply a translation of your business plan; all elements are related or interconnected, what I call LINKs. By referencing variables, factors and determinants together you can build a very powerful tool which can be manipulated quite easily. Because no one wants to reinvent the wheel I advise you all to build models from the ground up. Variables, factors, determinants are what drive your business. Because financial models are simply a translation of your business plan; all elements are related or interconnected, what I call LINKs. By referencing variables, factors and determinants together you can build a very powerful tool which can be manipulated quite easily.

5. Benefits Flexibility in allowing for month to month operational changes Clarity in showing client return on investment calculations. Agility in building visualizations for pitches One of my clients actually uses their financial model as a sales tool because we built into it the revenue projections a ROI calculation for their potential clients. I have had other clients use their models for monthly operational management or for building visualizations for investor presentations. Models are meant to be flexible. One of my clients actually uses their financial model as a sales tool because we built into it the revenue projections a ROI calculation for their potential clients. I have had other clients use their models for monthly operational management or for building visualizations for investor presentations. Models are meant to be flexible.

6. Build Putting it all together. How to begin�How to begin�

7. Deduction I personally begin with top down research. It will show you how large or how small the market really is. It will show you who your competition is and how do they price comparatively. *This type of data research will act as guidelines when building projections from the ground up. I am not talking about making assumptions on market size and potential market penetration. I am talking real data research. One way top down research can help you out is through market scale and important pricing data which ultimately will impact both your sales and marketing strategy on your bottom line. The last thing you want to do is present bottom up projections to an potential investors revenues that exceed the overall market size. This however is just the beginning. I cannot tell you how many people make the mistake of stopping here and building their models off this marketing sizing data. I personally begin with top down research. It will show you how large or how small the market really is. It will show you who your competition is and how do they price comparatively. *This type of data research will act as guidelines when building projections from the ground up. I am not talking about making assumptions on market size and potential market penetration. I am talking real data research. One way top down research can help you out is through market scale and important pricing data which ultimately will impact both your sales and marketing strategy on your bottom line. The last thing you want to do is present bottom up projections to an potential investors revenues that exceed the overall market size. This however is just the beginning. I cannot tell you how many people make the mistake of stopping here and building their models off this marketing sizing data.

8. Induction Your research needs to be taken one step further. That step is bottom up analysis. By focusing in on critical business factors, you will quickly determine what are the driving forces of your business plan strategy. This is where you determine, how, which and to what extent variables, factors and determinants prove your business concept makes financial sense. For Example: Effectiveness of Sales & Marketing or Elasticity of your Pricing. For Example: What drives sales? Is it online ads? If so what are the CTR for ad placements? If you are selling a product or service : Where does Competition prices their product? How will that impact your sales? By pricing my Widget at Y how will that action reduces my net margin? Your research needs to be taken one step further. That step is bottom up analysis. By focusing in on critical business factors, you will quickly determine what are the driving forces of your business plan strategy. This is where you determine, how, which and to what extent variables, factors and determinants prove your business concept makes financial sense. For Example: Effectiveness of Sales & Marketing or Elasticity of your Pricing. For Example: What drives sales? Is it online ads? If so what are the CTR for ad placements? If you are selling a product or service : Where does Competition prices their product? How will that impact your sales? By pricing my Widget at Y how will that action reduces my net margin?

9. Variables vs. Assumptions Assumption Online Ads will drive my business revenues to 10M by year 5 Variable �Click-Through-Rates� for online ads are .05%, therefore my site, which receives 100,000 page visits, can convert roughly 50 potential sales leads per ad campaign. Investors in businesses get spooked easily. One thing I learned early on from Springboard was never to present assumptions to investors. All it does is bring on a series of probing questions. Therefore to prevent any red flags � use defendable data points. Don�t make easily avoidable generalizations. Investors in businesses get spooked easily. One thing I learned early on from Springboard was never to present assumptions to investors. All it does is bring on a series of probing questions. Therefore to prevent any red flags � use defendable data points. Don�t make easily avoidable generalizations.

10. Outline list the key driving variable of your business -- group into categories Because there most likely will be many variables driving your business. To begin to compile the story -- I find it easiest to draft an outline with category specific variables. This way when I begin to write my models I know exactly what needs to be fit into the overall picture. Because there most likely will be many variables driving your business. To begin to compile the story -- I find it easiest to draft an outline with category specific variables. This way when I begin to write my models I know exactly what needs to be fit into the overall picture.

11. list how each variable fits together begin to develop links between key factors Outline It will also help you begin to formulate links between variables � this tends to be the most difficult step in the process. It will also help you begin to formulate links between variables � this tends to be the most difficult step in the process.

12. Control I find it very helpful to design models using a control page � with lots and lots of input fields. This will give you the tools to use the model for many different tasks; including month manipulation. Most of my financial models have more than a 20 individual sheets within an excel workbook (which could be 1000s of lines of formulas). I pity the person who has to bounce between slides to see the effect of a single change to one sheet. To make it easier on yourself please adopt the use of summaries on each page of your model so that if and when you change an input you immediately can see how it affects the rest of the model. I typically include Revenues / Sales / Net Margin / Cash Flows � all annualized. This will save you a huge amount of time and reduce calculation errors. Remember a good model is cross connected � just like a real live business. I find it very helpful to design models using a control page � with lots and lots of input fields. This will give you the tools to use the model for many different tasks; including month manipulation. Most of my financial models have more than a 20 individual sheets within an excel workbook (which could be 1000s of lines of formulas). I pity the person who has to bounce between slides to see the effect of a single change to one sheet. To make it easier on yourself please adopt the use of summaries on each page of your model so that if and when you change an input you immediately can see how it affects the rest of the model. I typically include Revenues / Sales / Net Margin / Cash Flows � all annualized. This will save you a huge amount of time and reduce calculation errors. Remember a good model is cross connected � just like a real live business.

13. Key Components of a Financial Model The Core Five Revenues: the channels from which your business generates revenue and how much from each stream Sales & Marketing Plan Cost of Goods (COGS): the cost of selling your product or service Operational Expenditures (OPEX): how much your business spends in order to properly operate Income Statement: how much net profits or losses your business will incur during a period of time Cash Flow: how much cash your business generates and uses during a given time period I call them the CORE five. Because each component has its own chapter found in the business plan. And because a good financial model is simply translation of your business strategy these are the components you want to spend the bulk of your time perfecting. Revenues are where your business makes money. In order to do so you will have some sort of S&M strategy. COGS is the cost of selling your service OPEX is the cost of running your business IS is the bottom line. Cashfows is a great tool for managing and planning fund usageI call them the CORE five. Because each component has its own chapter found in the business plan. And because a good financial model is simply translation of your business strategy these are the components you want to spend the bulk of your time perfecting. Revenues are where your business makes money. In order to do so you will have some sort of S&M strategy. COGS is the cost of selling your service OPEX is the cost of running your business IS is the bottom line. Cashfows is a great tool for managing and planning fund usage

14. Other Components of a Financial Model In a Later Phase Capital Expenditures (CAPEX): money spent acquiring or upgrading physical assets i.e. Property Balance Sheet: summary of a company�s assets, liabilities and share holders equity at a given time period Working Capital: how well a company manages its current assets vs. current liabilities

15. Case Study PalmerRogovHarris Laboratories Concept vs. Company I would like to talk about the importance a financial models played for one my business, PRH. Our financial model proved PRH to be a great concept but not a viable business. On a national scale the model worked. With all of the planned resources, economies of scale, marketing, PRH would have made a huge splash in the marketplace. However we had limited IP protection. And no reasonable investor was going to spend 10-15M to build a national sale and marketing strategy without IP protection. Too much risk. They were interested in making a play on a smaller scale. So I set forth in revamping our strategy and model. Using what we learned from our deductive and inductive research we switched our approach to a pilot market. I took to a lean and mean approach in modeling our projections unfortunately the outcome this time was, we made very little money. This taught me invaluable lessons. Without all of our deductive and inductive research we would never had as accurate tools to model on a small scale. In summary we saved significant amount of time and capital walking away and using that time focusing on something new. In summary � what I thought was a very real business turned out to be nothing more than a very real good idea and nothing more. I would like to talk about the importance a financial models played for one my business, PRH. Our financial model proved PRH to be a great concept but not a viable business. On a national scale the model worked. With all of the planned resources, economies of scale, marketing, PRH would have made a huge splash in the marketplace. However we had limited IP protection. And no reasonable investor was going to spend 10-15M to build a national sale and marketing strategy without IP protection. Too much risk. They were interested in making a play on a smaller scale. So I set forth in revamping our strategy and model. Using what we learned from our deductive and inductive research we switched our approach to a pilot market. I took to a lean and mean approach in modeling our projections unfortunately the outcome this time was, we made very little money. This taught me invaluable lessons. Without all of our deductive and inductive research we would never had as accurate tools to model on a small scale. In summary we saved significant amount of time and capital walking away and using that time focusing on something new. In summary � what I thought was a very real business turned out to be nothing more than a very real good idea and nothing more.

16. Adam B. Harris | Principal Calacles Consulting Group | www.calacles.com E: aharris@calacles.com P: 510.821.4499 Adam Harris, a native of San Diego, California, has a well-diversified finance and analytical background that includes his own entrepreneurial business ventures, consulting with emerging businesses, and managing traditional to alternative investment strategies including venture capital, private equity, hedge funds and international securities for leading investment banking firms. After receiving a degree in Economics and International Business from the University of California at Berkeley, Mr. Harris quickly moved into investment banking and capital markets. Mr. Harris served as the lead business analyst for the executive management team at ThinkPanmure (formerly ThinkEquity Partners), a research-centric institutional investment banking firm in San Francisco where he was charged with business development, investment due diligence and analytics, and monitoring the many capital markets verticals for alternative corporate investment strategies. While a registered financial advisor handling part of a $15 billion portfolio at A.G. Edwards & Sons, San Francisco office, Mr. Harris oversaw the direct management and advising of a $500 million high net worth, pension and corporate client portfolio. In addition to his roles at these large investment firms, Mr. Harris has co-founded multiple emerging businesses, including an investment holding company focused on next generation companies, such as a wholly-owned dermatologic surgical device start-up and portfolio company, OtoSonic Diagnostics Inc (formerly PalmerRogov Labs), a consumer medical device manufacturer. Most recently, Mr. Harris has spent time consulting for The Keating Hotel Group, directing the procurement and governance of debt and equity funds for the domestic and International Keating Hotel Brand expansion. Mr. Harris holds board titles with the IAM Brands Inc., Albany Berkeley Soccer Club, La Jolla Scientific L.L.C., OtoSonic Diagnostic Inc.(formerly PalmerRogov Laboratories Inc.), Kellys Running Warehouse Inc. and Peak Running Publishers, Inc. Mr. Harris holds his Series 7 & 66 Securities Licenses and is an Accredited Asset Management Specialist (AAMS).Adam Harris, a native of San Diego, California, has a well-diversified finance and analytical background that includes his own entrepreneurial business ventures, consulting with emerging businesses, and managing traditional to alternative investment strategies including venture capital, private equity, hedge funds and international securities for leading investment banking firms. After receiving a degree in Economics and International Business from the University of California at Berkeley, Mr. Harris quickly moved into investment banking and capital markets. Mr. Harris served as the lead business analyst for the executive management team at ThinkPanmure (formerly ThinkEquity Partners), a research-centric institutional investment banking firm in San Francisco where he was charged with business development, investment due diligence and analytics, and monitoring the many capital markets verticals for alternative corporate investment strategies. While a registered financial advisor handling part of a $15 billion portfolio at A.G. Edwards & Sons, San Francisco office, Mr. Harris oversaw the direct management and advising of a $500 million high net worth, pension and corporate client portfolio. In addition to his roles at these large investment firms, Mr. Harris has co-founded multiple emerging businesses, including an investment holding company focused on next generation companies, such as a wholly-owned dermatologic surgical device start-up and portfolio company, OtoSonic Diagnostics Inc (formerly PalmerRogov Labs), a consumer medical device manufacturer. Most recently, Mr. Harris has spent time consulting for The Keating Hotel Group, directing the procurement and governance of debt and equity funds for the domestic and International Keating Hotel Brand expansion. Mr. Harris holds board titles with the IAM Brands Inc., Albany Berkeley Soccer Club, La Jolla Scientific L.L.C., OtoSonic Diagnostic Inc.(formerly PalmerRogov Laboratories Inc.), Kellys Running Warehouse Inc. and Peak Running Publishers, Inc. Mr. Harris holds his Series 7 & 66 Securities Licenses and is an Accredited Asset Management Specialist (AAMS).