No matter the size of your business, a financial model of some sort should be a key focus if you want access to flexible, clear guidance that can help you make informed financial decisions to guide the future and growth of your business.
Unfortunately, it’s impossible to know what exactly the future holds for your business, your market, your customers and your finances. Still, a clear financial model can help you mitigate risk and give you information on what you need to do to hit your growth targets.
In this article, we’ll take a look at some of the benefits of financial modelling and explain why it can be beneficial for your business to invest in it.
What is financial modelling?
Financial modelling is the process of building a model to forecast and predict how a business may perform in the future. In small and large companies, financial models are often made using Microsoft excel/spreadsheet software or other financial modelling software to link a company’s financial statements with formulas. These predict the business’s financial performance over a certain period based on certain assumptions.
The assumptions used in a financial model can be changed to see what effect different circumstances would have on future growth. While all companies can benefit from financial modelling, small businesses that don’t have huge profit margins rely on financial modelling to get solid interpretations of how their business currently looks and how it may look in the future.
From a commercial perspective, financial models are also beneficial for financial analysts who use these models to predict how a company’s stock performance might be affected by executive/business decisions such as investment and future events.
Why you should invest in financial modelling for your business
Monitoring bank balances and receipts aren’t enough to get a clear understanding of how your business is functioning, particularly if you’re trying to monitor how much profit your business is making.
If your business is profitable and seeing success, it can be easy to take your eye off the ball and lose the incentive to monitor your financial position. This is why, even if your business is profitable, it’s advisable to have a clear financial model in place that can guide your decision making.
Financial modelling can give you a better understanding of your business
The process of developing a financial model will help you gain a deep, intricate understanding of your business and how it functions. The method of creating a model forces you to think about what your expenses are, the various factors impacting your business, your growth projections and areas of your business that need attention.
Financial modelling can help give you answers to key questions that could affect your business, such as:
- How would a product price increase impact your profitability?
- How would increasing staff wages affect company profitability and employee productivity?
- Would switching suppliers for a particular piece of software decrease our supplier costs?
Understanding the key questions that could affect the profitability of your business helps you make better decisions that can benefit your business in the short and long term. If your a small business or start-up, you can use financial modelling to work out:
- Any investment projections or start-up capital you may need
- Your financial burn rate
- The cost of losing customers to your business
- Compare different pricing structures and models
- Model future business expenses
- Identify key drivers that are affecting your business
Financial modelling can help you mitigate risk
Unexpected challenges, circumstances or disruptions can hit even the most robust business. For example, you might lose a major customer; your main supplier might face a manufacturing problem. Using financial modelling can help you analyse any adverse event’s impact on your business and help you prepare accordingly.
Financial modelling is also helpful if you’re looking to find out the value of your business. With the correct modelling, you can see how much cash flow you have available and how you’ll need to hit specific targets.
If your company has investors, a model can also help you see how much money an investor may be owed if your company hits a specific valuation, whether you’ll need to seek funding in the future or what a certain investment will be worth based on future expected projections.
Financial modelling gives you consistent results
Suppose the financial model you’re using is set up to provide monthly insights into your business’s performance. In that case, you should be able to get a complete picture of exactly how your business is performing each month, and you won’t need to rely solely on budgets or financial plans to assess how your business is performing.
These monthly results allow you to make better decisions, plan for the future with a degree of consistency and quickly gain insights into every area of your business.
A clear financial model that gives you consistent results will also help in your conversations with investors if you’re seeking their capital. Documented results of how your business will be essential if you’re looking to attract investment into your company.
The main takeaway you should get from this article is that financial modelling can help you understand how your business is performing. Furthermore, the findings you can get from a clear and consistent financial model should give you invaluable takeaways that you can implement to improve the performance of your business and ensure its long-term prosperity.
When many businesses are just beginning to recover, it’s never been more critical to understand how every part of your business is functioning.
If you run a business and creating a financial model seems intimidating, consider investing in a course to learn how to create a financial model yourself or invest in professional financial modelling services to gain clarity into your business’s performance and to plan for the future.