Stock and Flow: Build Better Models

Understanding stocks and flows will improve your ability to model revenue, costs, users, inventory and more.

What is a Stock vs Flow?

• Stock: A snapshot of something at a specific point in time. For example, the value of the equipment on hand is a stock.
• Flow: The rate of change of a stock over time, representing what adds to or subtracts from the stock. For example, capital expenditure increases the value of equipment (inflow), while depreciation reduces it (outflow).

In simple terms, stock is what you have at a given time and flow is what changes the stock, either increasing or decreasing it.

Detailed Examples

1. Capital Stock: Value of property, plant and equipment (PP&E)
2. Annual Recurring Revenue (ARR): Revenue from recurring subscriptions
3. Staff Costs: Employee operating expenses
4. Monthly Active Users (MAU): Users interacting with your product monthly

How to Model Stock and Flow Using the BASE Method

The BASE method helps structure and forecast stock and flow effectively:

1. Begin Stock: Start with the opening value of the stock. Example: $10M of equipment on the balance sheet at the beginning of the year.
2. Add Inflows: Increase the stock value over the period. Example: $3M in capital expenditure adds to equipment value.
3. Subtract Outflows: Reduce the stock value over the period. Example: $1M in annual depreciation reduces equipment value.
4. End Stock: Calculate the closing value of the stock after accounting for inflows and outflows. Example: Equipment value at year-end = $10M (Begin) + $3M (Add) - $1M (Subtract) = $12M

Detailed Examples

1. Capital Stock

Model the value of Property Plant and Equipment (PP&E) over a year. Key Values:

• Capital Start: Opening stock value of PP&E from the balance sheet
• Capex: Capital expenditure inflows (spending on new PP&E). Model as a % of revenue.
• Depreciation: Depreciation expense (outflows). Model based on useful life of equipment (e.g. 10 years).
• Capital End: Closing stock value of PP&E.

2. Annual Recurring Revenue

Model ARR over a year. ARR is calculated as the Monthly Recurring Revenue (MRR) at a given month multiplied by 12.

Key Values:

• ARR Start: Starting ARR at the beginning of year.
• New Logos: Revenue from new customers. Model as a % of sales team’s quota attainment.
• Expansion: Revenue growth from existing customers. Model as a % of starting ARR.
• Churn: Lost revenue from customers who left. Model as a % of starting ARR.
• Downsell: Reduced revenue from discounts or downsells. Model as a % of starting ARR.
• ARR End: Closing ARR at end of the year.

3. Staff Costs

Model annualised employee operating expenses over a year.

Key Values:

• Staff Cost Start: Annualised staff costs based on current run-rate (use the most recent quarter’s expenses, multiplied by 4).
• New Hires: Costs for new hires, including replacements for attrition.
• Salary Increase: Wage inflation and promotions. Model as a % of starting staff costs.
• Redundancy Cost: One-time costs for redundancy. Model as a % of redundancy savings.
• Attrition Savings: Savings from staff attrition. Model as a % of starting FTE and average salary.
• Redundancy Savings: Savings from staff redundancies.
• Staff Cost End: Closing annualised staff costs, representing the expected run rate for the next year.

4. Monthly Active Users (MAU)

Model monthly changes in Monthly Active Users. Key Values:

• MAU Start: Closing MAU figure from the previous month.
• New Users: Users who signed up and activated during the current month.
• Resurrected Users: Existing users who logged in this month but did not the previous month.
• Dormant Users: Existing users who logged in last month but not this month.
• MAU End: Closing MAU figure for the current month.

By understanding and modelling stocks and flows, you can better forecast critical business metrics like revenue, costs and user engagement. The BASE method provides a structured approach to identify stocks and flows and the key drivers and assumptions used to model them.