Financial Modelings is a simple and effective tool that you can build in Excel to forecast and provide a clear picture of the financial performance of your business. The forecast is based on your business' historical performance and assumptions about the future. The process results in the construction of a mathematical model that helps at the moment of making decisions and financial statement analysis.
Creating a financial model requires preparing an income statement, cash flow statement, balance sheet, and supporting schedules.
Financial modeling refers to the art of converting a set of assumptions, based on the market behavior, into numerical predictions.
What is it used for, and why is it important?
The model's output should inform your decisions and provide critical information to perform financial analysis, whether inside or outside of the company. When used inside the company, the decisions to be made are concerning:
Raising capital
Growing the business organically.
Selling or divesting assets and business units.
Valuating a business.
Now for the why. At this point it may be evident, but let's dive in a bit deeper. Its importance is rooted in its capacity to enable better financial decisions for a business and is used for future planning. By creating this model, your business can simulate the impact of important variables and allows for the preparation of different scenarios. This way, you know what course of action to take in various situations that may arise.
Financial modeling can also play an important part when capital budgeting and it helps to determine the cost of capital.
Although this is a difficult skill to master, here are some tips to get you started.
There is no one right way to do it as each model is unique to each company. So, instead of trying to make your models "right," make sure that it makes sense for your company or business based on preferences, level of complexity, and your assumptions.
Do Your Research: When creating the model, be sure you do thorough research if your market, competitors etc. ensuring consistency between the model and expectations regarding the future performance of the company.
Make it simple. Even though the complexity of each model is determined by each company and the level of details and elaborated calculations involved, it is crucial to keep the model as simple as possible. You should know what your model is saying, and you should be able to explain it.
There are a few tricks to help to clarify models such as color coating, using different tabs instead of trying to jam all the information on one sheet, start very simple and then build out, basically anything that can help prevent misunderstandings will be beneficial. There are numerous templates available online, find one that is easy for you to use that you can later build on.
While creating a financial model can seem like a tedious task, it is essential to understanding how much money you need to start and to run your business and to explain to your investors when and how you plan to become profitable.
Although this can be a difficult skill to master, whatever you do, don't skip this step of planning your business.
Comments