August 4, 2020

What Is Financial Modeling?

As an executive, you know how many crucial decisions you make each day. Sound financial modeling can help relieve some of that decision fatigue by helping you play out those “what if” scenarios using real data.

When approached correctly, financial modeling can help you maximize your profits and run a more efficient business. Get started with an introduction to financial modeling below.

Your Financial Modeling Crash Course

What Is A Model?

In a nutshell, a model uses a set of equations to mimic something that is going to happen in the real world. A financial model can serve to help you understand the financial implications of your business decisions.

When creating a model, you will use Google Sheets of Microsoft Excel to input key business data and play out “what if” scenarios.

For example, you could use a financial model to calculate the cost of a new product, or the outcome of setting a certain budget.

How Do Models Help Decision Making?

The goal of using modeling is to make decisions based on numbers. This gives you as a leader a reliable, data-based method for making decisions. 

You can run any number of financial issues through your models, and even use them to help you prepare for worst-case-scenarios. For example, many businesses are using financial models to help themselves determine how they will weather the next few months of the COVID-19 outbreak.

You may use a financial model to ask questions such as:

  • How many employees do I need for my current revenue levels?
  • If my sales increase by 20%, how many more employees do I need?
  • If my sales decrease by 20%, how will that affect my staff? How long can I afford to pay for unutilized people?
  • What would my return on investment be if I hire a new salesperson?
  • How much cash do I need to keep in my account? 
  • Should I get a line of credit?
  • Which of my profit centers are least profitable?
  • What’s an appropriate level of bonus for my operations staff?
  • Should I buy or lease my building?
  • What is my forecasted cash flow?

In short, a financial model helps put you in control, rather than leaving your company’s financial future up to fate.

Tips To Get Started

Define Your Problem

As demonstrated above, a financial model can be used to answer any number of questions for your business. To get the most out of your models, start by clearly defining the problem you’re looking to address. Cash flow? Staffing?

Know What Improvement Looks Like

Just as it’s important to know the problem, it’s also important to know what you’re solving for and what specific outcome you’re seeking. Set a clear goal for yourself. Are you looking for a certain dollar number, or improved team capacity? 

Know Your Limits

A financial model serves to illuminate specific parts of your business. However, you can’t use one model as a crystal ball. You can’t model everything, so it’s important to limit yourself to asking questions tied to data that’s simple to input, yet predictive.

A financial model can help you better anticipate what’s to come for your business and prepare yourself to better achieve your goals. A simple financial model can help you make the sound decisions that will help your business grow. Junction Peak is offering an online guide to financial modeling to help you get started. Sign up here.

About us

Junction Peak is your finance and leadership consulting team. We use accurate financial forecasts and proven tools to help you grow. 

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