CRASH COURSE Financial Modeling 101 - "BAU"
What does every business need to do if they want to make a large purchase?
If the purchase is large, a justification or business case will likely be needed to get approval from the senior leadership including the CFO or CEO. What is typically needed in this justification? Documentation of the current state and what the issues are, proposed solutions, what the potential benefits are of the proposed solutions, and why the purchase needs to be made now. A really important part of this justification is showing how the purchase compares financially to the existing – “current state” – financials. Is the purchase resulting in higher or lower costs? What is the impact on budgets, CAPEX, OPEX, or cash flow? Is the purchase expected to impact revenues or profitability? To effectively show this, the current state baseline financial information needs to be modeled, that any suggested solutions can be compared against.
What is this “BAU” thing?
BAU is an abbreviation for “Business-As-Usual” financial model and is the current state financial model. The BAU is a critically important part of the Current State in any Sales Proposal. If you and your customer don’t understand the BAU and how any proposed alternatives compare against it, there could be some serious roadblocks to the purchase getting approved. Ideally you and your customer can build and agree on the BAU before embarking on any potential alternative options.
** Note to all Sales Reps: if you aren’t involved in helping your customer create the BAU financial model you are missing out on an important way to significantly help them and increase the value you provide them as a Sales Rep!
How do I start building a BAU Financial Model?
Most business decisions are evaluated over a multi-year period, typically 3-5 years, so the BAU financial model should show a similar timeframe. The timeframe could be shorter than 3 years and may even be longer than 5 years – it all depends on your customer, so make sure you are in alignment with them on this.
So your BAU framework should begin something like this…
The next step is to include the key financial elements for the specific areas in scope. For example, suppose you have an existing software solution that costs $10 per user per month and there are currently 5,000 users…so $50,000/month. The software solution contract expires on 12/31/2023. Since it is July 2022, the remaining cost for the 5 months in 2022 would be $250,000. The cost for 2023 would be $600,000 and the BAU model will look like this….
Let’s assume that the number of users will increase in 2022 from 5,000 to 5,500…500 additional users is an additional $5,000/month. With 5 remaining months in 2022, the total is $25,000. And let’s also assume that in 2023 the number of users will increase further to 6,000…an additional 500 users and an additional $5,000/month. For 2023, the ‘growth users’ will total $10,000/month or $120,000 for the year. Now your BAU model should look like this…
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Let's keep going! If the existing solution isn’t replaced in 2023 let’s assume that it will continue to be used in years 2024, 2025, and 2026. And let’s also assume that the cost will remain at $10 per user, but the number of users will increase by 500 each year. Your BAU model will now look like this…
One of the things you may have noticed is that the total cost, by year or for multiple years, becomes larger and larger. This comprehensive financial view of all the relevant cost elements across multiple years is exactly what the CFO or CEO wants to see!
This isn’t rocket science, but…
This is a very simplistic example, but hopefully gives you a general idea of how to begin constructing a BAU financial model. The basic ideas are pretty simple, but there are many potential considerations and variations about what to include. One of the biggest, and most important, is projecting expected increases or decreases in both quantities and associated costs. One example of this in our model above is that it is very unlikely that the existing software solution cost will remain at $10/user for 5 years. Similarly, will the number of users really increase at an even 500 per year? You and your customer will have to make some assumptions and my recommendation is to be realistic, but conservative with any future growth or cost assumptions.
Another big consideration is making sure that all relevant cost elements are included in the model – these should be everything that the proposed alternative solutions may impact. In the example above, let’s assume that the current software solution requires the customer to have 2 full time administrators, each with a cost of $100K/year, but the proposed alternative solution only requires 1 full time administrator. The cost of the 2 administrators could be added to the BAU financial model (and only 1 administrator in the proposed solution financial model) to show this cost difference…
Whew - great job if you made it this far!
Final point which is super important…
Whether you build the BAU model directly with your customer or not, make sure your customer is in agreement with it. The cost elements, the timeframe, the growth estimates, and the assumptions. It is best for you and your customer to mutually agree on the BAU model before investing a lot of time discussing alternative, proposed solutions.
Nice job Karl