When we build financial models 📈, there are three key properties that we should try to achieve.

The first two, 𝗙𝗹𝗲𝘅𝗶𝗯𝗶𝗹𝗶𝘁𝘆 and 𝗔𝗱𝗮𝗽𝘁𝗮𝗯𝗶𝗹𝗶𝘁𝘆 are often what modellers put the most effort into:

• 🤸 𝗙𝗹𝗲𝘅𝗶𝗯𝗶𝗹𝗶𝘁𝘆 - allowing the user to see best and worst possible outcomes through assumptions that can be easily manipulated to create different scenarios and sensitivities
• ✂️ 𝗔𝗱𝗮𝗽𝘁𝗮𝗯𝗶𝗹𝗶𝘁𝘆 - preparing the model in such a way that it can be updated or modified in future, to track outcomes or incorporate new revenue/cost items

But these two should never come at the cost of the most important trait: 𝗨𝗻𝗱𝗲𝗿𝘀𝘁𝗮𝗻𝗱𝗮𝗯𝗶𝗹𝗶𝘁𝘆 💡. In fact, by making your model 𝘂𝗻𝗱𝗲𝗿𝘀𝘁𝗮𝗻𝗱𝗮𝗯𝗹𝗲, you will probably go a long way to achieving the first two properties!

But what does understandability mean in the context of a model, and why is it so important? The first thing to realise is that a financial model is all about 𝗰𝗼𝗺𝗺𝘂𝗻𝗶𝗰𝗮𝘁𝗶𝗼𝗻. Ultimately when we build any model, we are trying to 𝘀𝘂𝗽𝗽𝗼𝗿𝘁 𝗮𝗻 𝗶𝗻𝗳𝗼𝗿𝗺𝗲𝗱 𝗯𝘂𝘀𝗶𝗻𝗲𝘀𝘀 𝗱𝗲𝗰𝗶𝘀𝗶𝗼𝗻, whether that's investigating the size of a market, assessing the return of a new initiative, or preparing a quote in a bid process. In most cases, the people ultimately making that business decision aren’t the same people building the model. So our model must communicate clearly the answer, yes, but also 𝗵𝗼𝘄 that answer was arrived at.

And we’re not just communicating with the 𝗱𝗲𝗰𝗶𝘀𝗶𝗼𝗻-𝗺𝗮𝗸𝗲𝗿. We’re also communicating with:

• Our 𝗺𝗮𝗻𝗮𝗴𝗲𝗿, if we have one, who needs to know what we’ve done, and how (and how well!) we’ve done it.
• A 𝗳𝘂𝘁𝘂𝗿𝗲 𝗰𝗼𝗹𝗹𝗲𝗮𝗴𝘂𝗲 or 𝗰𝗹𝗶𝗲𝗻𝘁 of ours who needs to edit and maintain the model
• 𝗢𝘂𝗿𝘀𝗲𝗹𝘃𝗲𝘀 - how often have you come back to a model that you haven’t looked at for a while and completely forgotten how part of it works?!

Creating an 𝘂𝗻𝗱𝗲𝗿𝘀𝘁𝗮𝗻𝗱𝗮𝗯𝗹𝗲 𝗺𝗼𝗱𝗲𝗹 makes that communication so much easier, with all parties. It’s not easy though, even for experienced modellers, so having a set of guidelines (𝘰𝘳 𝘦𝘷𝘦𝘯, 𝘦𝘳, "𝘳𝘶𝘭𝘦𝘴") to work with is super-important. More on those in future posts!