As a small business, it is important that you can predict how your business will perform in the future. There are many ways to do this, one of them being financial modelling. This practice will help you see where you need to invest to ensure your business’s future is not in jeopardy.
Financial modelling is when you create a summary of how your business expenses and earnings are doing to see the impact in the future. Financial modelling is usually done on an Excel spreadsheet.
The process may be tedious but it’s important especially if you want to increase your business’ longevity. If you decide to sell your business, financial modelling will help you value your business correctly.
In this article, we will explore what financial modelling is and how to use it effectively for your business.
Types of Financial Modelling
There is not just one set template for financial modelling. There are different forms which perform different functions. Some types of financial modelling include:
Discounted Cash Flow
This type of financial modelling is a prediction of your business’s free cash flow. This is done by predicting future cash flows and discounting them to get a current value. To calculate this, factors such as inflation, risk, capital costs and analysing the company’s future performance. Once the discounted cash flows are added, the total is your business’s equity value.
Three-statement Model
This method is used to predict your business’s income statement, balance sheet, and cash flow statement. Also, it’s used to project the forward financial performance of your business.
Capital Raising
This form of modelling analyses how raising debt or lowering equity can impact your business.
Leveraged Buyout Model
This helps you determine how much debt a buyer can use to purchase a company.
Sensitivity analysis
This helps you see how sensitive your company or investment is to certain changes that are based on several business and financial variables.
Growth Margin
This model helps you see how much of the money you charge customers is going to deliver the product or service and what is left.
Mergers Model
This helps you determine the impact of a merger or acquisition for both companies involved.
Budget Financial Model
This model helps predict your company’s expenses and revenues. It considers sales, operating expenses, and cash flow.
Forecasting Model
This will help you predict your company’s future performance. The prediction is based on past trends and current market trends.
Pro Forma Financial Model
This model projects future values to predict your business’s financial performance over some time. This model uses income statements, balance sheets, and cash flow statements. These documents provide data alongside assumptions about prospective financial performance.
Scenario Modelling
This helps evaluate different scenarios and the potential they have on your business.
Merger Model
This model will help you see the impact of a merger or acquisition on both your business and the person/company doing the acquisition. This model is very helpful for startups.
IPO Model – This model helps startups assess their business from the investor’s perspective. This will help you determine the right price to offer shares to the public.
Sum of the Parts Model
This model looks at the value of your business’s separate divisions and how they compare to each other. This helps you see which areas are performing well and which ones need restructuring.
These are just some examples of financial modelling concepts. There are many others that apply to your business.
Now that you know the types of financial modelling, let’s look at some of the ways to use it to better your business.
How to Use Financial Modelling
There are few instances in which you will use financial modelling.
Risk Management
Financial modelling helps you see any future adverse occurrences in your market. By using financial modelling to assess your risks, you improve your business decision-making and can navigate any drastic market changes correctly.
Merger and Acquisitions
As a small business owner, you never know when someone else might take an interest in your company. A merger is when two companies become one. An acquisition is when one company offers to pay another business for its shares or cash.
Using the merger and acquisition model, you can estimate how the acquisition will affect the buyer’s profits per share. The merger and acquisition models also let you know if the merger or acquisition should go on using financial insights from the model.
Valuation of Your Company
As mentioned before, financial models help you determine how much your business is worth. Using financial modelling, you determine your company’s value by looking at the financial accounts.
It can also be used to determine how much money you require through venture capital, loans and other financing options. Financial modelling can also help you determine the value of your assets. This includes stock, building, and equipment.
Evaluation of assets is usually done before you buy, sell or insure your assets.
Capital Distribution
Capital distribution is when you determine where in your business you should invest more money. By using financial modelling, you can determine where to correctly allocate funds within your business.
Raising Funds
When running a small business, there will be times when you will need extra capital. You can apply for a loan or grant to help with this problem. Financial modelling can help you determine what kind of funding you need. Whether it is a loan, grant, debt or equity funding or working capital.
Budgeting
Budgeting is important when running a business. It helps you save up for future goals and helps you see where you can afford to spend and how much you can spend.
Using financial modelling you can see any future monetary demands you might have and can begin plans to address them. This will also help you ensure that you have enough money to cover future expenses.
This will also help you forecast your future financial results.
These are just a few examples of how to use the different types of financial modelling. You must be able to determine what you want to forecast in terms of your financial future and apply the appropriate financial modelling template.
Financial modelling does not need an expensive app or platform, it can be done on Microsoft Excel. And if you cannot do it, you can hire a financial consultant to help you with your financial modelling.
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