Financial modelling is essential for providing you with the information you need to get the big decisions right. It can help you develop a resilient organisation ready for tomorrow’s challenges and, when done right, it can minimise the risk of error.
So how do you start building an effective financial model?
While no two models are the same, there are often common themes you’ll need to think about during your build process.
There are many situations when you may need financial modelling, such as:
- To evaluate an M&A transaction or investment
- To evaluate your strategic decisions better.
- To price a bid for a contract.
- To keep track of your assets and forecast your future cash position.
This list is by no means exhaustive. In short, a model can predict your business’s future financial performance in a range of possible scenarios.
With that in mind, we’ve outlined some of the key foundations that you’ll need to consider when building your financial model.
Nail down outputs
The key to developing a successful model is understanding what you want it to achieve and what its specific outputs should be. For example, do you need covenant compliance checks, variance reporting of budgets or return on investment forecasts?
Once you know your destination, you can structure your model. This is often referred to as its architecture and should accommodate all the dimensions of your business that will influence the model’s outputs.
One dimension of your architecture will be a timeline. Others could include your legal entities, your markets, and the currencies and regions you operate in. Many of these will interlink, so the architectural design of your model is critical to ease of use and future-proofing.
Delve into the detail
Knowing how much detail to include in each dimension is a bit of a balancing act. You’ll want enough to make sure your outputs are accurate – but not so much your model becomes overly complicated and more costly to produce.
The skill lies in deciphering which details have a material impact on your forecasts and which can be aggregated or averaged.
A real-life example of this was a model we built for Paybreak. Their existing model averaged loan lives; consequently, cash forecasting was not accurate enough. Modelling different loan lives separately led to greater accuracy and increased confidence from their own lenders.
Set your priorities
Before you commission a model, be clear about your priorities and what you expect your provider to deliver. Is speed, cost or functionality most important to you?
The right partner will balance sophistication with your time and budget constraints, to build a model that meets your specific needs.
If you are working towards a corporate transaction, speed is essential. But if you need a model to monitor loan repayments due in six months’ time, your deadlines can be more relaxed. This, alongside the complexity of the model, is likely to have a knock-on effect on the cost too.
Where should you start when building your financial model?
In this time of economic uncertainty, an effective financial model is key to success. Your reasons for considering a new model will entirely depend on your circumstances as a business but building strong foundations will help set you on the right path.
A great place to start with building a model that works for you, is to find the right partner.
If you’re looking for a flexible partner who’ll work closely with you to design and build a model that delivers on all fronts, please get in touch.