Alexei Garan, Head of Business Funding at Shaw & Co, shares six essentials for business owners to consider when preparing a financial model.
Not only does a good financial model provide a business owner with a clear overview of their company’s financial health, it also provides a potential lender or equity investor with the reassurance that a SME is paying strict attention to the bottom line – money.
"Getting a financial model wrong can have perilous consequences."
Although it may seem like a given, getting a financial model wrong – or filling it with the wrong information – can have perilous consequences, especially when trying to secure funding for business growth. Recently we came across a profitable family-owned business that had gone into liquidation simply because it had a hugely inexperienced financial director (a family member) who had not kept the management team updated on the company’s financial situation. The company was taking on numerous – and very expensive - individual loans when it should have consolidated all borrowing and extended the overall repayment profile. This created an unworkable cash servicing requirement which was, ultimately, unaffordable.
So, with this in mind, here are six things to consider when building your financial model:
At the very least, your financial model should clearly show your Profit & Loss (P&L), balance sheet and details of your cashflow. It should also be integrated so the impact of any change in working capital, or deviation in P&L terms, can be immediately and clearly highlighted in the resultant cashflows, thereby identifying potential ‘pinch’ points in cash reserves.
Your financial model should be a working document which clearly shows month-by-month performance, as well as the projected growth over, say, a three or five year period.
Funders will draw confidence from models that reflect how incoming capital will work in the business, tracking factors such as return on investment and cash burn (equity); or leverage, covenant performance and cash available for debt service (debt).
Insufficient granularity in the model can let a business down; for example where multiple product lines are averaged instead of presenting the performance of each product. It is also important to highlight other potential issues such as a vast majority of sales being harvested by a handful of star executives, or coming from too few key customers. Income seasonality can also be ‘hidden’ in quarterly rather than monthly projections.
Businesses regularly try to capture every detail in their model. This is as bad as insufficient detail as the model soon becomes unworkable and falls out of date. Understanding the right balance is an art as much as science and one that can only be developed with experience.
Great models integrate a clear and concise monthly reporting pack for a company’s management team, enabling them to make key strategic decisions based on the very latest financial information ‘from the coalface’.
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