General purposes & Core principles
What is a financial model?
A financial model is a tool that helps predict a company's financial situation in the future based on historical data and assumptions about the future. Financial models help businesses forecast their financial situation in the future, thereby making appropriate strategic decisions.
Why does every business need to build a financial model?
Every business needs to build a financial model for several reasons:
Risk Management: Financial modeling helps identify and mitigate risks by providing accurate revenue and expense projections, enabling better decision-making and smoother day-to-day management[3].
Capital Allocation: Financial forecasting informs capital-related decisions, such as allocating existing resources, prioritizing projects, and timing major purchases to maximize value and maintain positive cash flow[3].
Growth Strategy: Financial models help assess a company's current financial stability and performance, allowing leadership to analyze and adjust strategies accordingly[3].
Funding: Accurate financial modeling provides the necessary information for investors and stakeholders to determine whether to invest and what terms to require[3].
Business Value: Financial modeling aids in business valuation calculations for owners looking to sell their company and can strategically increase business value for those looking to hold onto the company[3].
Forecasting Revenue and Expenses: Financial models help founders make better decisions about spending, revenue streams, and other variables that keep their startups on track for success[4].
Planning and Budgeting: Financial models assist in planning and budgeting by monitoring trends in spending and revenue to ensure sufficient cash flow and stay within budget[4].
Fundraising and Financing: Financial models help plan ahead for fundraising and financing by visualizing the burn rate and securing financing at the optimal time[4].
Strategic Decision-Making: Financial models provide a framework for strategic decision-making, such as opening new facilities, expanding into new markets, or purchasing additional equipment[4].
Ongoing Management: Financial models serve as a trusted assistant, gathering and interpreting data to ensure the best decisions are made for the company[4].
In summary, building a financial model is crucial for businesses to manage risk, allocate capital, develop growth strategies, secure funding, and make informed decisions about their financial operations.
Citations: [1] https://jtbconsulting.co.za/blog/7-vital-reasons-why-you-need-financial-models/ [2] https://baremetrics.com/blog/how-to-build-a-financial-model [3] https://www.cfoselections.com/perspective/understanding-the-importance-of-financial-modeling-should-you-build-a-3-year-model [4] https://www.forecastr.co/blog/reasons-why-need-financial-model [5] https://sku.is/the-hows-and-whys-of-creating-a-financial-model-for-your-business/
Characteristics of a good financial model?
a. Accurate forecasting: The financial model needs to accurately predict the company's future financial situation.
b. Flexibility: Adjusting assumptions and input data should be easy with the model.
c. User-friendly: The model should be simple enough for anyone to use.
d. Transparency: It should be easy for everyone to understand how the model predicts the financial situation.
e. Scalability: The model should allow for easy addition of new elements.
f. Easy customization: Changing parameters in the model should be simple.
g. Quick updates: The model should allow for easy updating of new data.
h. Easy testing: Testing the accuracy of the model should be straightforward.
i. Easy analysis: The model should allow for easy data analysis.
j. Easy statistics: The model should allow for easy data statistics.
k. Easy reporting: The model should make reporting the company's financial situation easy.
l. Easy visualization: The model should allow for easy data visualization.
m. Convincing: The model should convince stakeholders of its accuracy.
n. Negotiation: Discussing the conditions and terms of the model with stakeholders should be straightforward.
Steps to build a financial model
a. Define the objective: Determine the purpose of the financial model. The financial model can be used for various purposes depending on the needs of the business.
Internal use: The financial model is used to predict the company's future financial situation.
External provision: The financial model is used to provide information about the company's financial situation to stakeholders such as shareholders, investors, banks, regulatory bodies, etc.
b. Identify the user: Determine the user of the financial model.
c. Identify data: Determine the necessary data for the financial model.
d. Identify assumptions: Determine the necessary assumptions for the financial model.
e. Build the model: Build the financial model based on the identified data and assumptions.
f. Test the model: Test the financial model to ensure accuracy.
g. Evaluate the model: Evaluate the financial model to ensure flexibility and user-friendliness.
h. Use the model: Use the financial model to predict the company's future financial situation.
Why is Microsoft Excel not the best tool for building a financial model?
a. When building a financial model, a lot of assumptions and factors are continuously added.
b. Users can easily intervene in the model, leading to its unreliability.
c. Each person can create a different formula, leading to inconsistency in the model.
I don't know where to start to build a financial model?
To simplify, imagine building a financial model is like assembling a bicycle. A bicycle needs basic components such as the frame, wheels, crankset, drivetrain, brakes, etc. A financial model also needs basic parts such as general assumptions, customer channels, revenue, costs, personnel, loans, equity, etc.
BeeKrowd tends to help you create a financial model with a predefined structure that has been programmed with calculation formulas and ensures accuracy and logic.
For example, regardless of how users enter values, the Balance Sheet still balances, meaning the total assets equal the total liabilities and shareholders' equity.
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