The Importance of Financial Modelling
In this post, we share some advice on the importance of Financial Modelling and highlight 4 key points that you should be aware of.
Know what a financial model is
A financial model is a representation of a company’s operations expressed in numbers and typically comprises the past, present and forecasted future performance of the company.
Financial models are essential decision-making tools that company’s use in a variety of scenarios to help advise business strategy. Financial models assist strategic planning when evaluating projects such as growing a business organically, making acquisitions, raising capital, capital allocation, setting/assessing bank covenants.
Analysts and advisors use financial models to anticipate and consider the impact of certain events on a company’s performance. Both internal and external factors are considered when evaluating these models which in turn advises investment decisions and company valuation parameters. Financial models can be structured in a variety of ways to address scenario planning, investment appraisals and deal specific considerations.
Know your business financials & growth drivers
It is critical to have a strong understanding of your company’s financials, past trends, and underlying growth drivers.
Credibility is a key component of a strong financial model. Whilst a financial model is unlikely to be 100% accurate, it is important to demonstrate credibility by ensuring that assumptions are well thought out and take a considered view of both internal and external factors which influence the business.
Developing a ‘sensible’ set of assumptions around the expected growth drivers associated with the business is important. Ideally a company wants to outperform a set of forecasts as this will add credibility to an opportunity when it is being evaluated externally.
Structuring your financial model
Structuring a model effectively from the outset is important to ensure outputs are consistent, accurate and well considered. A typical financial model will produce a profit and loss, balance sheet and cashflow.
Examples of best practice to follow:
- Create a plan from the outset
- Keep the model’s inputs, calculations & outputs separate
- Ensure data validation and error checks are incorporated
- Avoid links to external sources
- Include explanations where necessary
- Ensure the model can be rolled forward on a monthly basis for trading updates
Look at it from a buyer/investor perspective
It is important to consider what buyers/investors are evaluating when preparing and presenting a financial model. Some key aspects to contemplate include:
- Assumptions: how they have been derived and how credible they are
- Growth profile: how this compares against historic performance and wider macro trends
- Sensitivity analysis: “a what if” analysis assessing the impact that various scenarios have on the financial model and expected outcomes
- Cash generation: that there is sufficient cash generation to support all of the cashflow requirements of the business along with delivering investor expectations
- Financial statement analysis / ratio analysis: use financial and accounting ratio analysis to evaluate the financial performance of the business, comparing this with historical ratios and similar businesses in the industry
Further information
Whether you are looking to understand your overall exposure to risk, investment funding requirement, or future-planning, Velocity can provide you with the financial modelling support you need. Take advantage of our years of experience and speak to one of our expert modellers now.
Click here to watch a recording of our recent webinar on The Importance of Financial Modelling