In this blog I highlight 4 reasons why every business needs a great financial model. I’ll answer the following questions… What is a financial model, Who needs one, and how to get one.
Find out why they are the cornerstone of every successful business…
Firstly, lets clarify the difference between a business model and a financial model.
A business model outlines how a company plans to make money. At its heart, a business model explains the following key points:
Whereas a Financial model is a tool which a company uses to forecast its financial performance into the future. This tool can be a spreadsheet (e.g. Excel or Google Sheets) or specific financial modelling software.
The financial model basically takes the business model and projects the financial outcomes of implementing the business model.
The model will usually be based on the company’s historical performance and assumptions about it’s future performance. Various inputs and assumptions have to be entered into the financial model. Then calculations are performed within the model so as to generate the 3 financial statements (Income Statement, Balance Sheet, Cash Flow Statement). This is often known as a 3 statement model. Other summaries and metrics also form part of the outputs of the model.
The projections of revenues, cost of goods sold, operating expenses, personnel, capital expenditures and financing (etc) are calcluated based on the inputs and assumptions for volumes, product mix, sales pricing, cost development, market growth, inflation rates, interest rates, etc.
The blog title makes reference to needing a “great financial model”. Not all models are created equally.
A deficient model can have disasterous consequences.
For example, if potential investors find errors in the model, they will lose all confidence in the projected figures. As a result, the discussions may come to a halt. If they do continue they will be focussed on whether the figures are correct, rather than about the great business opportunity. What a pity!
So, what makes a great model?
Above all, it must support your business objectives. It must be as simple as possible, without sacrificing the necessary complexity and flexibility to meet the current and future needs. In addition, it must be clear and easy to follow. Most importantly, it must be free from errors and mistakes.
As you can see a financial model can be extremely complicated, so you might be asking… do I really need one?
The simple answer is YES, every company needs a financial model. Let me explain why…
A startup especially needs a financial model for two key reasons:
1. In order to validate the business model. The financial model enables you to discover whether the business model will lead to a sustainable and profitable company.
2. Furthermore, it enables you to identify the funding needs of the business and forms one of the key pillars for securing that funding. Whether the funding is being sought from an angel investor, venture capitalist or a bank, they will require you to provide a financial model which projects the company’s financial performance.
The better your model, the smoother those discussions will go!
But it’s not only startups that need a financial model.
Established businesses also need a financial model to be better prepared for the future.
Scenario planning and what-if analysis can be performed within a financial model, thus highlighting areas of operational risk or where greater resilience is needed.
Another reason is to set meaningful performance targets for the company to aim for.
Strategic plans, long-range forecasts, annual budgets, and forecasts all require a financial model.
Established businesses might also be making investment/divestment decisions for which a model is needed…see, it’s not only for startups.
Here are some of the main uses for a Financial Model:
Raising capital (debt and/or equity)
Making acquisitions (businesses and/or assets)
Growing the business organically (e.g., opening new stores, expanding into new markets, etc.)
Selling or divesting assets and business units
Planning, Budgeting and forecasting
Business Valuations
Financial statement analysis/ratio analysis
Management accounting
In simple terms, there are 4 ways to get a financial model
· If you have deep pockets you can engage with one of the top global consulting firms who will gladly work with you for a hefty fee.
· For those looking for a bargain-basement solution, an internet search for ‘Financial Model Templates’ will provide you with thousands of options.
However, using an off-the-peg solution is unlikely to be a perfect match for your business model and you will be left without support as you try to understand it and customize it yourself.
· Another option is to build the financial model in-house. This is a great solution if your finance team has the necessary expertise and the time required on top of their day-to-day work. It also requires that your finance team really are business partners who understand and engage with the business.
Please don’t ask John from accounting to knock up a model in between posting journals!
If these three solutions don’t quite seem right, then option 4 is the one for you.
⌂ Engage with a small consulting firm, rather than engaging with a top global consulting firm. Chose a firm that specializes in FP&A (Financial Planning & Analysis), Valuations, Corporate Development, Investment Banking, etc
This solution gives you access to the expertise you need, without the huge daily fees of a bigger firm. A further advantage is the personal service and customization afforded by a small consulting firm or sole consultant.
How can you find your ideal solution provider? Ask your professional network for word-of-mouth recommendations or search on LinkedIn
All businesses need a financial model for one or more of the following key reasons:
1. To validate the business model. The financial model enables you to discover whether the business model will lead to a sustainable and profitable company.
2. To identify the funding needs of the business. Whether the funding is being sought from an angel investor, venture capitalist or a bank, they will require you to provide a financial model which projects the company’s financial performance.
3. Be better prepared for the future. Scenario planning and what-if analysis can be performed to highlighting areas of operational risk or where greater resilience is needed.
4. Set meaningful performance targets for the company to aim for. For instance, strategic plans, long-range forecasts, annual budgets and forecasts all require a financial model.
There are several ways to get a financial model ranging from super-expensive to free, with each option having its pros and cons.
In my opinion, the goldilocks solution is engaging with a small consulting firm like YorkForte.
In conclusion, my models compare favorably to those of the big consulting firms and my day rates are considerably lower. When a recent model for a startup was presented to a global investment bank, they were impressed!
Complete the contact form and I will get in touch with you to discuss your financial modelling requirements.
Working with Richard was an absolute pleasure.
His expertise in financial modelling was immediately evident during the first day of a two-week sprint, and he continued to impress all throughout the project.
I can’t recommend working with him enough, not just for his modelling skills but his calm approach, clear communication style and “nothing is impossible” attitude.
