Why Financial Modeling Needed by Every Business

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Why Financial Modeling Needed by Every Business

It is absolutely impossible to predict the future, but financial modeling can help estimate the future. It is an analytical activity that breaks financial activity down into a series of variables, allowing you to test the impact of variation for each variable. Studying the impact caused by the variation of these variables allows you to better make decisions for the growth of your business.

The financial model is a vital financial tool for every business regardless of size. And with the recent pandemic, it has become of the utmost importance for all businesses to decide exactly where to go, and none other than financial modeling can serve you better.

Is financial modeling a lifeline for businesses? For what? In this article, we will discover the answers to these questions.

What is Financial Modeling?

Financial Model, as its name, defines itself, modeling your finances. It is a process of creating digital models that define your business and then predict how your business will behave in the future. These predictions depend on scenarios, which are called assumptions in financial modeling.

Regardless of the size of the company or business, financial models are often made using Microsoft Excel spreadsheet software. In addition, some companies use other financial software to customize the Financial Model that can meet their requirements. These financial models relate the financial data of the company to the formulas made by variables. Using these variable formulas, the financial model predicts future performance over a certain period.

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These variables, called assumptions in financial modeling, help you see what impact your business performance would have under changing circumstances. Except for size, every company and business needs these financial models to anticipate their growth.

Small businesses that don’t have much profit margin must rely on financial modeling to interpret the future appearance of their business. While large companies cannot risk big changes unless they can be sure of a positive impact on their performance, this cannot be done without a well-designed financial model.

What is the use of financial modeling?

Financial models are used by executives and decision makers, and they make vital decisions for business growth and profitability using the results of financial models.

Some of the common uses of the Financial Model are given below:

  • Fund raising
  • Acquisition of assets
  • Organic business growth
  • Commercial evaluation
  • Analysis of financial measures
  • Budgeting
  • HR resource management
  • Anticipating future growth

Why is financial modeling important for companies?

Financial modeling is essential to assess the future growth of businesses and identify any potential risk that may affect the performance and profitability of the business in the future. There are certain areas where financial modeling becomes of utmost importance to your business.

Financial modeling is a great starting point. If you’re looking for a better way to evaluate investment strategies and compare a company’s future performance, this is for you. Theoretically, the financial model is an abstract mathematical representation of real-world financial situations and future business conditions.

Additionally, entrepreneurs use financial modeling to analyze a company’s revenue growth, cash flow, and expenses. In practice, we display the financial modeling on a Microsoft Excel spreadsheet. It is also used to project the financial performance of a company based on a set of historical data and analytical measures. Generally, it is important to analyze how a company will react to various economic situations before committing funds.

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Foresee us deeply to understand the importance of financial modeling for your company or business.

  1. Increase your business

With successful financial modeling, you gain insight into various factors affecting your business growth. You can improve your business by addressing these areas. Sometimes elimination leads to growth, and other times adding certain factors makes you successful. And it is financial modeling that guides you to do certain actions to address the factors that are hindering your performance.

For example, suppose you find through financial modeling results that you are not spending an adequate amount on a specific advertisement. In this case, the assumptions show that spending more on these channels could improve your profitability by bringing in more leads and customers. You can prioritize expenses that lead to the growth of your business or business.
An example of the predicted impact of marketing spend by a Financial Model is given below:

Why Financial Modeling Needed by Every Business
  1. Churn reduction
If for some reason your business is losing customers, all your efforts to target new customers are wasted. Instead, a thorough analysis of your business can uncover potential churn risks affecting your business growth. Most businesses focus on finding new customers, although that’s not wrong. But identifying the reasons why your business is losing customers can help you take the necessary steps to reduce churn and retain customers.
Churn is extremely fundamental in measuring the growth of any business. If the churn rate is higher than the growth rate, it indicates that the business is losing customers, which leads to lower profitability in the future. On the other hand, a lower churn rate than the growth rate reflects the growth of the business, increasing profitability in the future.
For example, if the business added 500 customers in a shift but lost 100 customers, the net loss would be 100 customers. There was no growth this quarter; Rather the company lost. That would be a negative growth rate during a positive churn rate. An effective financial model will keep you well informed of your company’s churn rate, monthly, quarterly, yearly or even five years.
An example of a churn calculator by a well-designed financial model is listed below:
Why Financial Modeling Needed by Every Business
  1. Business valuation
It is quite difficult to assess the value of a company; Either way, you are a buyer or a seller. Financial modeling is the essential tool for valuing your business. It helps in estimating your business valuation or comparing business to industry peers.
With financial modeling, you can better estimate the amount of revenue your business generates, the essential expenses to generate that revenue, and your business value in future years. It is also equally important if you plan to buy business. Without a Financial Model, you cannot make a correct decision to buy any kind of business, and it gets worse if you have no knowledge of that business.
The valuation of companies predicted for five years by a financial model is displayed below:

Why Financial Modeling Needed by Every Business
  1. Risk minimization
Financial modeling is an effective tool that helps understand the impact of risk before it affects your business. Risks are associated with business, and these are not inherently bad if mismanaged, misunderstood, or simply “missed.”
The risk factor varies from business to business, but it generally includes:
  • Product reserve
  • Prices
  • Production
  • Product life cycle
  • Exchange rate
  • Economic policies
  • Change in government regulations
  • Cost of raw materials
  • Changes in capital expenditure
Financial models are designed to manage business risk, and there are many methods for identifying and quantifying risk factors. By using any of the following methods, you can identify the risk associated with your business that could create an obstacle in the future performance of your business.
  1. Sensitivity analysis
  2. Scenario analysis
  3. Monte Carlo simulator
All of these sensitivity, scenario and Monte Carlo analyzes are powerful tools and are of the utmost importance in identifying any type of risk factors in your business. Without these tools, you cannot predict risk and may have to deal with an unseen situation that is sometimes difficult to manage.
For example, using one of the tools above, a Financial Model can help you identify the cost of your marketing campaigns, the cost of entering a new market, the impact of changing internal policies of your business or the impact of changing economic conditions. Without any intimation of these elements, you cannot decide in time to minimize the impact of these risks.
The importance of financial modeling to your business can be easily displayed with the following chart created with a well-designed financial model.
Why Financial Modeling Needed by Every Business
  1. Benchmark & ​​KPIs
Benchmarks provide you with the benchmarks to compare your company or business with other businesses in the same industry. Without effective financial modeling, you cannot create such benchmarks that can help you measure your comparison against others.
Likewise, KPIs provide you with the facts of how your business is performing against your strategic goals. And financial modeling provides you the facility to evaluate your business performance with specified time intervals which can be monthly, quarterly or yearly.
So without benchmarks and KPIs, you can’t understand your position in the industry, you can’t assess your progress against your goals. Also, you cannot satisfy your funders on your performance against the promises you made when funding from them.
Below is a graph produced by a Financial Model showing monthly KPI forecasts.
Why Financial Modeling Needed by Every Business

However, the primary role of financial modeling is to develop a picture of how a business will look in the future. It takes from the bottom line to the top line. Once a financial model is ready, different scenarios of the future can be developed for a business. It will help organizations become profitable in an ever-changing business market.

Suppose you are eager to prepare assumptions around the future of your business, or want to learn more about financial modeling. In this case, you can visit FinModelslab , where you can find more than 500 types of financial models.

FinModelslab has designed a variety of financial models to meet the needs of every business. Below are some of the top categories containing dozens of financial templates to meet business requirements.

  • Agriculture
  • Beauty and sports
  • Care and education
  • Cleaning, repair and services
  • E-commerce
  • Entertainment and leisure
  • Finance and professional services
  • food and drinks
  • Health care
  • Hospitality
  • Manufacturing
  • Marketing and consulting agency
  • Market
  • Real estate
  • Retail
  • Software as a service
  • subscription box

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