Growing a successful corporation is something you should be proud of. Those who have successfully grown their business to become a multi-national corporation deserve a pat on the back and for those still striving to grow their business, taking a card from their expertise is essential. Part of growing your business involves corporate finance and a little help from a few tools of the trade. Among the most used tool in your growth tool box is a financial model.
What is a Financial Model?
For many, many years, expansions of corporations, SMBs, and virtually all types of businesses have used financial models to help them make the right moves and know where to put essential investments. A Financial Model is a document used to show the overall performance of a business over a period of time. Information contained within a Financial Model can include aspects such as a cash flow statement, schedules, labor costs and other aspects of the business.
Through this information, the corporation can determine when and where to invest to further expand the company. A Financial Model is among the best ways to help your corporation grow and have a keen outlook on the future of expansion. If you are truly ready to grow, you must first know how to build a financial model.
How to Build a Financial Model
Every Financial Model is not exactly the same. The type and direction of your Financial Model will change based on your business genre and goals for company growth. However, the following is a standard way you can build your own Financial Model that you can adjust and build to your business’s specifications.
History Repeats Itself (almost always)
Among the best ways to begin building your Financial Model is understanding the history of finances within your company. Although certain economic downturns can result in altered results, generally, you can tell your financial pattern from the last 3 years of financials. Include fixed costs, variable costs, inventory days, labor costs, equipment costs, and anything else, financially, that pertains to your business within the past 3 years. From this information you will be able to begin to see a pattern of spending and where all finances were placed during that time period. You will also notice that in each quarter, there are specific ups and downs in finances that you can use to determine perspective growth. This step is basically known as Forecasting Assumptions. All information should be cataloged into a spreadsheet such as Excel.
Income Statement and Balance Sheet
The next step in the process involves calculating gross profit, COGS, operating expenses, and revenue. Taxes, interest, amortization, and any depreciation will be included at a later date. Next, fill in the balance sheet for inventory and accounts receivable. Include AR days and AP days as well in this step.
A schedule for your capital assets such as any property, equipment, debt, and interest are your supporting schedules. These entities are taken from your historical financials and include capital expenditures and subtract from depreciation along with adding any increase in debt contracted during that period. Interest is primarily based on the company’s average debt balance. At this point, you can add these figures into your income statement and balance sheet to fill in those tax blanks left in the previous step.
Cash Flow Statement
Begin building your cash flow statement by starting with your net income and deduct back depreciation. Adjust changes for non-cash working capital and you will have your cash from operations. Capital expenditures such as cash used for investments are a part of this step as well.
In this step, you will calculate overall cash flow and perform your business valuation. Often, you will require the help of an experienced financial advisor for this step, especially if your valuation has increased substantially during the three year history period analyzed in the first step.
Add in A Sensitivity Analysis and Scenarios
It would be great if profitability remained steady throughout every financial crisis, but in our world today, you must prepare for everyone. Part of the process of building your Financial Model is accounting for any potential drops in sales. Ensure you know when and where you will have to raise money should sales decline for any reason. This will help show how sensitive your company is to decreases in sales and prepare you should money have to be raised in the event of an economic downturn.
Charts and Graphs
One of the most successful ways to portray a Financial Model to others is through charts and graphs. Although you have all the information in a complete spreadsheet, charts and graphs will enable you to help others visualize what you already know. They put it into a visual perspective for those who are visual learners and this will help substantially when you approach investors with your Financial Model. Numbers can often run together in those meetings. It is nice to see something apart from facts and figures.
The final step in the process of building your Financial Model is testing out different scenarios based on the information you already have. When you put the model to the test, the scenarios may change, but the model should remain consistent. Ensure all spreadsheet formulas are working properly before testing your scenarios.
Your financial model will be a key ingredient in knowing where smart investments lie based on your company’s needs, history, and current financials. Going into a potential investment blindly can be a hit or miss, but when you employ a calculated Financial Model that has been tested multiple times and found to be sound, your risk of failure drastically diminishes. A business owner that knows all aspects of their business intimately through this type of analysis can make the most profitable decisions for growth and know where to put the right people to make it all happen. Take your time when building your Financial Model and test each scenario multiple times.
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