Why it is Important to Build a Financial Model for Your Business

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Getting your finances in order is important for a financially sound future. One of the ways you can keep your finances in check is by using a financial model. A financial model is a tool you can create in excel and use to predict your business’ financial performance into the future.

The prediction is dependent on past performance and requires that you prepare the following documents:

  • An income statement
  • A balance sheet
  • A cash flow statement
  • A three statement model

Forthwith, you can come up with more models like a discounted cash flow model, a leveraged buyout, mergers and acquisitions, and a sensitivity analysis.

What do you use the model for?

A financial model gives you a clear picture of the financial situation of your business.  You can then analyze and make decisions based on what you find. Financial modeling works hand in hand with financial planning.

It helps you make decisions regarding:

  • Whether there is need to raise capital and in which way.
  • Expansion and growth; either trying out new markets or opening new
  • Selling some of the business assets or units.
  • Planning for the coming years.
  • Allocation of capital.
  • Laying off workers or adding to the workforce.

The Builders of Professional Models

  • Investment banking
  • Equity research
  • Accounting

All these are involved in giving advice to business people on financial matters that affect their business. They give you tips on how to grow and expand, or get out of some financial crunch. It therefore makes sense that they would need such a system that can help predict growth or the lack thereof, so they can give relevant advice.

Can a business owner learn financial modelling?

Business owners can and should learn business modelling. The best way to learn is through practice. A good business model is not built in a day.

In addition, you can read equity research reports which can give you something to draw inspiration from. Also, get a financial model from an established company and look through their financial history. This will give you an idea of how to build your own model and how to work with the share prices or target prices to better your predictions.

The best practices of financial modelling include:

  • Following the best practices in Excel when building the financial model.
  • Clearly differentiating between inputs and outputs when formatting, by for instance using different colours for inputs and outputs.
  • Easy to follow layout and design.

There is nothing as important as having a clear path for where your business is headed. Without that, you might find yourself floundering and making avoidable errors. Part of financial planning is having the ability to read your business’ financial state. Only then will you be able to put in place ideas that will help you achieve the success you dream of.

So, get started on building a financial model for your business to help you navigate the business waters. Moreover, you need to do financial planning so that you always know how much money is coming in and how much is going out.

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