In my career working with different teams, I sometimes come across members of the team that tend to do a back of the envelope analysis which is a quick and dirty calculation for the purpose of getting the investment memo out on time or any other reason.

People usually justify using back–of–the–envelope analysis by saying that at early stages of the appraisal, there’s no need to do a proper analysis. I understand this perspective, but by not doing a proper analysis you will be at risk of either rejecting a good project or moving forward with a bad one. Therefore from the early stages of the project, it is worth investing in a proper financial model. However, it is not enough to just have the financial model: you need a financial modeler who can benchmark the assumptions and devise sensitivity scenarios, especially in the early stages when nothing is yet set in stone.

In short, the dangers of back–of–the–envelope analysis are:

• Faulty decision making that might lead to rejecting a good project and proceeding with a bad one.
• Either underestimation or overestimation of project metrics that might have irrevocable consequences. Once you communicate a figure, especially if it is an underestimation of a cost, then it’s very difficult to adjust it later.
• Used mainly for reverse engineering to get the results that the analyst needs or want to achieve.
• If a back–of–the–envelope calculation is done in a “quick and dirty“ way then it increases the margin for error.

To me the crime is even worse when there is already a proper financial model, but somehow someone in the team decides to build a separate spreadsheet for getting information that is already included in the existing model. To me this is an unforgettable crime and the person responsible should be sentenced to stare at an empty Excel spreadsheet for eight hours without blinking!