When it comes to predicting future cash flow, many business owners rely on annual budgets derived from the profit and loss statement. As much as this provides a good picture of expected revenue and expenses, it does not in any way reflect the pace of cash flow in your business.
You can only manage your business efficiently if you prepare a financial model that fully traces the flow of cash. This will in turn help you make decisions related to capital expenditure and debt repayment.
What is a Financial Model?
Generally, a financial model is a tool used by business owners to predict and assess the financial position of a company based on set assumptions. It operates through a company's historical data, which is used to predict future financial results.
What is the Role of a Financial Model?
Financial modeling and forecasting is critical in the contemporary business environment. Such modeling tools provide invaluable information that aids in solid decision making. Generally, a company's financial model serves the following purposes:
It helps to determine a realistic market potential.
It helps quantify the amount of investment needed to get a business off the ground or through the next chapter.
It facilitates proper valuation of a business in a transaction.
It provides a timeline to positive cash flow and profitability.
Importance of Financial Modeling
1. Helps you create a feasible plan of how your business will make money to grow. For instance:
How many products do you need to sell out for your business to pay rent and salaries among other expenses?
Is the number of products feasible considering the constraints of money, time, space and potential customers?
2. It provides your business with a score card that can help you compare your anticipated financial performance against actual numbers at the time. For example,
Fast-forward your business to one year after being opened. Do you think you're making more or less money as projected in your financial model?
3. It uses a vital sign chat that assesses the health of your business and further prescribes solutions that lead to success.
Again fast-forward your business to 12 months after opening. Has it done better compared to initial projections? What caused the success and how can you do more?
If the business hasn't been successful, what caused the poor performance and how can you improve?
Business owners should not shy away from creating financial models as it is one of the common tools that can drive your business to success. If you're a bit gray in the area of financial projection, you can seek the help of financial modeling freelancers to streamline your business.