Thread by @rebootdude

1/ Shortfall analysis

In #risk a powerful concept named #shortfall analysis works very well as for building financial models for #founders and #startups.

It's a bit of a mind bender the first time you read it but has interesting applications once you understand it.

2/ Imagine an important business metric.

Let's say customers order. Link that to an equally important performance measure. Profit & Loss (PnL).

The two are clearly linked.

How would you stress test or sensitivity test them? For an internal planning meeting? For a money pitch?

3/ There are 3 models you can pick for a stress test.

a) What could be our worst case loss if PnL turns negative?

b) What is the probability of a negative PnL?

c) How much do customers orders need to drop for us to hit the red zone?

4/ If you bind (b) and (c) above you end up with shortfall analysis.

How much do customer orders need to fall for our PnL to turn negative? What is the probability of that event?

5/ The concept maybe a bit awkward to grab but the underlying math is high school statistics.

As is the case with simple models, the model is very crude and comes with a long list of challenges.

But its a very powerful thinking tool.

6/ Imagine the applications. It's not just limited to customer orders and PnL.

If you have a measurable metric with a historical trend and a quantifiable relationship you can apply shortfall analysis to it.

Simple questions, simple answers.

7/ Within the banking, insurance and financial services world, we use shortfall analysis for capital modeling and planning and communicating risk thresholds to boards.

There is no reason why the same principle can't work for your #startup as long as you have data.

8/ An excerpt from the revised edition of Founder Puzzles, out later this month in October. Watch this space for the pre-order form.

#startups #founders #shortfall #analysis #financial #finance #modeling.