Financial modelling is an essential tool for small business owners and decision-makers across Australia. It empowers you to forecast, plan and make informed decisions that can drive your business growth. In this guide, we will explore what financial modelling is, why it matters and how you can build an effective model tailored to your business needs.
What is Financial Modelling?
Financial modelling involves creating a structured representation of your business’s financial performance. Typically built in spreadsheets or specialized software, these models simulate various scenarios based on historical data, market trends and business assumptions. The primary goal is to project future revenues, expenses and cash flows, providing a clear picture of potential outcomes.
Why Effective Financial Modelling is Crucial for Better Business Decisions
For Australian companies, particularly small businesses, effective financial modelling can be the difference between thriving and merely surviving. Here are some of the key benefits:
a) Informed Decision-Making: By forecasting potential financial outcomes, you can assess the impact of different strategies before implementation rather than flying blind.
b) Risk Management: Models help identify potential risks and allow you to plan contingencies.
c) Budgeting and Planning: Accurate projections ensure that you allocate resources efficiently and plan for growth. It also can serve as a post investment tool to evaluate the performance of past decisions.
d) Investor Confidence: A robust financial model builds trust with potential and existing investors by clearly outlining your business’s financial potential. It also shows that you have a clear line of sight for future performance as well.
e) Scenario Analysis: Test out various ‘what-if’ scenarios to determine how changes in the market or operations can affect your bottom line. This allows you to play out the different scenarios, allowing you to stress test the assumptions and also how different scenarios can impact your existing operations.
Below are the steps to build an effective financial model:
1. Gather Accurate Data
Start with collecting historical financial data, including revenue, expenses, assets and liabilities. Reliable data is the backbone of any effective financial model. Below are some of the data sets that could be used as data for the modelling:
a) Historical Financial Statements: This includes your income statement, balance sheet and cash flow statement. It can be easily generated if you have an accounting system or maintained good manual records.
b) Market Research: Incorporate industry trends and economic forecasts relevant to the Australian market. This can include forecasted cost escalations, inflation rates etc.
c) Business Assumptions: Document assumptions about company specific growth rates, cost fluctuations, pricing and sales amounts etc. This will be unique for each business.
2. Define the Purpose and Scope
It is important to determine what you want your model to achieve. Whether it is for budgeting, securing financing or planning a new project, having a clear purpose will guide the structure and details of your model. To define the purpose, you should:
a) Set Clear Objectives: Define the key questions your model should answer. This can be estimating a budget for next year, or to determine whether it is a good price to buy a new piece of equipment..
b) Identify Key Metrics: Based on the objective of the model, the focus of model varies. It could include revenue growth, profitability, cash flow and return on investment (ROI).
3. Build the Model Step-by-Step
Creating your model involves structuring it in a logical and flexible manner. (You will need some basic Excel skills) Here is a step-by-step approach:
a) Structure Your Spreadsheet: Set up separate excel tabs for inputs, calculations and outputs. Clearly identify which cells are manual inputs and calculated cells.
b) Input Assumptions: Clearly label and separate your assumptions from calculations. It is also important to document the basis of your assumptions as it goes so that it is easy to review down the path.
c) Create Formulas: Use dynamic formulas that automatically update the output as input data changes. Try to keep the formulae as simple as you can so that it can be easily traced and understood by others.
d) Forecasting: Extend historical data into the future, applying growth rates and adjustments. Adjustments will include any once-off events that are not anticipated to persist in the future.
e) Sensitivity Analysis: Given that the modelling involves assumptions and estimates, it is important to test how changes in key assumptions impact outcomes. This will ensure you will be well prepared for different scenarios.
4. Utilize the Right Tools and Software
While Microsoft Excel remains a popular tool for financial modelling, there are now modern alternatives that offer enhanced features that you may want to consider:
a) Microsoft Excel: This is still widely used for its flexibility and familiarity. However, you would need some basic excel skills to do the modelling.
b) Cloud-Based Solutions: Platforms like Google Sheets or specialized financial modelling software can offer collaboration and real-time updates. However, it may cost more than the normal Microsoft excel license.
c) Automation Tools: Software that can automate repetitive tasks and reduce errors.
5. Review and Refine Regularly
An effective financial model is not built once, but rather, it evolves as your business grows. Regular reviews help ensure your model remains accurate and relevant to the objective you intend to achieve. Below are some tips to ensure the accuracy of your model:
a) Periodic Updates: Incorporate new data and adjust assumptions as needed. This includes changes to your business, external economic conditions etc.
b) Feedback Loop: Collaborate with stakeholders to refine your model. This could include your potential banker or financial adviser who may be able to advise what they are looking for in your model.
c) Have the courage to redo the model: If there are fundamental changes to either the requirements/outputs or inputs format, that may require a wholesale change of the model. If so, bite the bullet and do it rather than making do with the current model. It will save you time down the path.
Conclusion
Effective financial modelling is a powerful tool that can equip Australian companies with the insights needed to make better and informed business decisions. By gathering accurate data, defining clear objectives, building a dynamic model, leveraging the right tools and continuously refining your approach, you can navigate uncertainties and unlock your business’s full potential.
Take control of your financial future today. Whether you are planning for growth, managing risk or seeking investment, a robust financial model is your roadmap to success. For tailored guidance and expert support, contact Oopensteps and let our team help you build a brighter financial future.