Puzzling during working hours

“Depending on the complexity of the grant application, the required financial elements range from a summary financial report to a complete financial model and business plan. Financial reports, no matter the complexity, include several tabs for financial statement: one for profit & loss, one for the balance sheet and one for the cash flow. Depending on the complexity of the grant, additional tabs may be included, with information such as market analysis tables or depreciation schedules. Nevertheless, a representation of the three financial statements is always required.

Now, we all know these three financial statements, and we understand that they are interconnected. However, when filling out a financial file for the first time, it’s not always intuitive to know where to start or how to connect them. In our team, we normally start with a process of data gathering and source verification, in close collaboration with the client. ”

Gathering information as we go along

“As conversations with clients unfold over several weeks, it can sometimes feel like we’re staring at a puzzle that we can’t yet begin to solve. Already in the kick-off meeting we start gathering key information useful to our financial segment, when the project will start, how long it will last, how much funding is planned to be requested, and, if we’re lucky, the estimated costs of certain activities. As more meetings take place and the project gets discussed we start gathering additional data that we know will be important for our financial statements. How many new jobs will be created, what will be the main expenses and what is the approximate time line for each activity.

While these pieces of information will come together harmoniously later on, for now, we just need to keep them in the back of our head, in an external file or temporary document until the time comes to translate them into the financial statements. It’s much like setting aside a puzzle piece that doesn’t fit at the moment but will be crucial later on. During consequent meetings we check if the amounts we had heard previously are still the same.

Often, this is not the case, but since we have followed the client’s project manager close enough, we are able to understand the changes, and adjust accordingly.

The next step goes beyond listening and gathering financial information, the work also includes rigorously validating the data, verify the sources and challenge the client as if we were already the evaluators.”

Validating the information

“When applying for a grant a client wants to show how important the innovation is to society, how disruptive it is and by consequence how much of the market it will reach. Normally, the client will provide us with a study or market research, assuming the market share of their innovation. However, if the technology is new or disrupting, a well-rounded research study may not be available. This serves us with an obstacle, because without proper research we cannot vouch for a hypothetical market participation. ”

Questioning the client

“Hence, we have to challenge the client with a different approach. What is the scope of their production capacity? How many units will they intend to sell? Is there a market demand? Are there clients for the innovation? And if it is an alternative technology we need to prove that these clients are ready to pay for the higher cost that comes from the innovation. And how can we demonstrate this? All of this preferably accompanied by the discreet but mighty letters of intent, which serve to assure that the so far hypothetical assumptions are based on clear intentions. They provide security to the viability of the project and more important it allows us to validate our numbers.”

Gaining insight

“After having understood the viability and funding strategy of the project, we have to make sure it is clearly presented in our financial file. For instance, in any project, there are three ways to raise money: cash financing, coming from net earnings, equity financing, coming from ownership stakes of the company or debt financing, coming from loans and credits. Most innovative projects do not manage to acquire loans as the development of a new technology is a risky investment, but in some cases, the company already has a line of credit that they manage to exploit, and it needs to be addressed. This part can be complex when displaying it in the financial file, and unless you are a tuned analyst it requires an additional debt table that is usually not presented. This enables us to understand how the interest expense gets added to the income statement yearly, that the balance sheet changes yearly with a new closing balance, and through the cashflow the accomplished repayments.”

Full shebang of emotions

“Sometimes the problem arises that the client’s cash flow does not match the controlled debt table that we developed. In this case, as with other verifications, first comes the anticipation: Maybe we have not accounted for all the debt? Or maybe we are using a different interest rate?

Here, as a junior analyst, my next step is to share this new challenge with a senior consultant in the team: “Hi, do you know why my closing balance remains bigger than opening balance?” More often than ever, they have already lived this situation and can help me navigate the problem. However, if we find together that the problem comes from wrong data from the client to start with, the best way to fix the problem is to talk to them one more time and walk with them through our financial questions.

Controls like this are necessary to validate all the data we have previously gathered. Once we have confirmed that the amounts are correct we can start establishing our financial file. But where do we start?”

Choosing a starting point

“Typically, we start with the income statement, as the project’s revenues and costs determine our net income. This approach might seem counterintuitive since, when applying for a grant, we’re often developing a new technology, and during the initial years of production, there may not be any revenues. However, usually the financial file we are required to complete covers medium to long-term periods, typically ranging from three to seven years, and we need to demonstrate the company’s progress even after the project has been completed.”

Figuring out a price

“Assuming we know the number of units to be sold the only thing missing is to figure out the price of each unit. This is always challenging as we have to account for new costs and new services when addressing innovation. If the company already has a pricing strategy, they will be able to provide the revenue of the project during the different years. Nevertheless, as consultants it is our job to challenge the company in its market share and pricing policy to make the project as interesting as possible for the evaluators, for instance with questions such as did they account for inflation, price regularization and volume pricing?

With pricing and number of units we arrive to revenues in the first line of our income statement. We can then reduce the cost of goods sold and consequently the expenses related to the project which will lead us to our net earnings. The net earnings will be added to the retained earnings presented in the balance sheet from previous years, and the total of it would be seen in the cash flow statement. If a forecast of the balance sheet has been provided we need to check the coherence, otherwise we need to account for this accounting rule. This is where everything starts to get intertwined, and the beauty of interconnecting the financial statements takes place.”

Five tips to prepare your financial report

At the very start of a project, write down all the numbers and dates you hear – they will be useful for forecasting and data validation.
If possible, validate information on the spot – early corrections are easier to make than later ones.
Don’t be afraid to get technical – ask about the state of the art; this will help align the financial file with a market analysis.
Do not accept vague estimates – is either 15 or 20 new employees, but “somewhere in between” is just a guess in disguise.
Always go for the 4-eyes-principle – it’s easy to get lost in your own numbers, do not hesitate to ask a colleague for a review.

Bringing everything together

“Every project is a different story, as my co-worker always says. As I see it, every project presents us with a different challenge. Sometimes the financial file has already been created and we can’t alter the income statement because that has already been reported to cover 30% of the cost of the project. In other situations the cash flow cannot be touched because the Work Packages have already been created, and we have reached the maximum amount of grant we can ask for. Although it may seem that everything has been accounted for, we always need to verify the coherence of the three statements. This is more like undoing a puzzle. We are walking backwards through the financial file making sure that everything adds up.”

Moment of truth

“Almost reaching the finale, we consolidate the three different cash flows and wait for the moment of truth: do the three cash flows match the balance sheet amounts, and does the change in retained earnings match the net income? Usually (and fortunately) this is the case, and we can rejoice for having a well-fitting file, but even then we continue to feel skepticism: isn’t it all too good to be true?

So, at this point we start double checking every line for a possible mistake. And while we are reviewing our formulas we receive a message from our team lead: – “Is the financial file ready yet? I want to add some financial data to part A, B or C of the proposal!” “Yes, almost done” we reply, imbued with the fact that our team is counting on us and our numbers – making us wanting to check the total amounts even more! Hence, we read those letters of intent we keenly asked for one more time and review the same lines over and over again…”

Completed puzzle or…?

“Once we feel confident with our work, and we see that everything reconciles, we can finally send the much-anticipated message: the financial file is ready! Just as completing a puzzle, we feel relieved and proud since we have helped our team. And still, those intrusive thoughts come to mind. Wait, did we check the amortization? Were those inventory changes coherent? Did we account for overhead costs? Very well knowing that we have already checked all these items a million times, we check the numbers one more time to be sure the quality is good.”