We must ask ourselves why Finance, which handles investment analyses of millions of euros with a great impact and responsibility on the market and community, still entrusts its Predictive Economic Financial Analysis to “do it yourself" models on Excel sheets, created by individuals analysts, who ignore the responsibilities that are too time-consuming. The average capacity of approximation and therefore level of reliability of Financial Economic Reality implied with Excel spreadsheets technology is at best, 15-20%.
It's like taking a photo with an old camera with outdated goals that can only produce blurred photos with confused images!
Today the world has changed and some cameras allow you to focus extraordinarily on reality! It's time to change. Think about it.
APPROXIMATION of PREDICTIVE E / F Models BASED ON EXCEL SHEET
As carried out thus far, the Economic and Financial Predictive Analysis of Investment and Corporate Models (Financial and Economic Plan, Business Plan), is completely inadequate.
If the result has an approximation of 20%, Reliability will be low and it will have a margin of error of 80%.This implies, for example, that a Cash Flow value of 1,000,000 can fluctuate from a value of 1,000,000 +/- 800,000, i.e. from € 200,000 to € 1,800,000.
This type of approximation highlights the problem of reliability, social and economic responsibility, your great impact as an Investor, Entrepreneur, Consultant, Stakeholder, Public Administration, and finally as a community, which you should take into consideration.
THE CAUSES OF APPROXIMATION
The Reliability of a Predictive Financial Economic Analysis is influenced by two causes:
- The approximation of input data;
- The approximation of the Mathematical Model which processes it;
THE APPROXIMATION OF THE INPUT DATA:
By being a Predictive Model, the Input value cannot be accurate so had to be performed in a probabilistic concept, having a range of values between the Best and the Worst therefore determining the Best, the Medium, and the Worst-case Scenarios.
A variable operates on a range of values.This range will expand by a variation (V%), which is influenced by the variable risk and the probability P% of this risk occurrence. Therefore, the definition of the interval ensures the reliability of the established data.
This formality also explains the pointlessness of looking for the value, used by those who work with Excel sheet technology. We are predicting, so it makes sense to define an interval as we cannot know exact values.
IMPORTANCE OF APPROXIMATION OF THE MATHEMATICAL MODEL:
The mathematical model processes the range of values (e.g. the range of revenues) (PEF, Business Plan) and other variables (e.g. payment/income days, VAT associated, method of return, etc.) and determines the reliability of the result.
If we insert a range of values in a mathematical model with an approximation of 15%, what reliability can the result have?
For example, we have compared two scenarios with the same economic conditions, same investments, the same revenues and operating costs but:
Scenario 1 was made by analysis on an annual basis. Self-financing, methods of payment and income were not considered, VAT was considered in an economic way only, meanwhile the other taxes were not considered.
Scenario 2 was made by a monthly analysis. Self-financing, real mode of payment, income for each item and taxes were considered.
Thus the results of Scenario 1 were: (Only some values are shown):
Always positive annual cash flows with apparently no criticality, Equity of 16,819,000, a Net Profit of 6,431,000, Shareholder profit after tax of 2,548,000, and a Shareholder IRR of 27.74% with the Equity cost of 10.00.
Meanwhile, the results of Scenario 2 were:
Negative cash flows for the first 8 months, and Equity of 6,842,000 for activation of self-financing, a Net profit of 2,338,000, Shareholder profit after taxes of 284,000, and a Shareholder IRR of 8,249 (82.49%) with Equity cost of 10.00.
These results show the importance of assumptions and the importance of the mathematical model that processes them.
THE LIMITS OF EXCEL SHEET TECHNOLOGY
The reasons that Excel sheet technology leads to unreliable representations of the Financial Economic Reality, regardless of the skill of the Financial Analysts who develop it, are essentially the following:
LACK OF A SYSTEMIC APPROACH:
Due to the Excel sheet technology’s inability to take into consideration all the variables in a given context, which require approximations as well (for example, the exact VAT associated with each variable in the model, the exact days of payment/income, the tax rates, risk variables, etc).
ANNUAL TIME SCALE PROBLEM:
Excel sheet technology can only be used on an annual basis or at best monthly for the first few years. This assumption implies, for example, that you can view cash on an annual basis that is always positive, when in reality it is negative for most months. It makes the project unsustainable, with profitability issues, unreliable bankability, and sources necessary for the inadequate debt coverage. Another example, which implies the need to have a cash flow monthly is the need to see the payment of taxes, dividends, etc.
It is difficult to break down the Project (an investment, a Business Model) into its fundamental economic components with Excel sheet technology (Business Unit and operating periods, investments, operating costs and revenues, seasonality, etc.). It doesn’t identify the important components that can impact the business and therefore engage the possibility of activating a Business Unit or postponing it;
PROBLEM OF LIMITED USE OF MATHEMATICAL FUNCTIONS:
In fact, with the technology of Excel sheets it is difficult or even impossible to use all the functions allowed in finance, such as recourses calculations, reimbursements, the calculation of commission fees, self-financing, the different methods of VAT compensation, the use of variational principles to optimize system variables;
PROBLEM OF LACK OF TRANSPARENCY:
Due to the extreme subjectivity of the Excel sheet, the only person who can understand and read the sheet is the person who created it. Summary statements can be different from each other.
PROBLEM OF LACK OF CERTIFICATION OF THE ALGORITHMS USED:
Without referring to sources, that affirm that the algorithm used is correct and authentication is not checked.
COMPLEXITY-RELATED ERROR PROBLEM:
This is the hypothesis of being able to represent all the above functionalities, the Excel sheet would become so complicated and complex that it would proportionally increase the probability of Excel error, making the simulations unreliable anyway.
THE FIRST RISK IS THE EXCEL SHEET: with an average 80-85%
THE CHANGE OF PARADIGM: " FOR A BETTER CAPITALISM "
The new Nobel Prize of ' Economics Joseph Stiglitz, the CEO of Black Rock, Unilever and other large American companies is now in agreement to abandon Friedman's theory, supporting the need to:
- Abandon short-to-medium-term business analyses in favour of medium-long term ones;
- Reject Approximate Analysis
In order to recognize the Social Responsibility that an Investor / Company has in realizing a new investment.
WHAT IS THE DEGREE OF APPROXIMATION OF YOUR BUSINESS MODEL?
In other words, what camera do you use to photograph reality?
Write on a piece of paper the degree of approximation and therefore the reliability that you believe your Excel spreadsheet will have for the 'analysis of investments and business models.
Then call us to have an objective evaluation of the approximation you have indicated.
Remember: Awareness of the Approximation that you carry out the analyses with provides you with the measure of Responsibility that you have towards the community and allows you to make an effective contribution to improve your own Society!