Sophocles a Greek poet once said “quick decisions are unsafe decisions.” Very often in businesses the same behaviour is replicated. Quick decisions trump decisions based on data and analysis. An Excel financial model is an ideal tool to help business owners ground their decisions on data. If this tool is used properly it can help improve a company’s sales, decrease costs and ultimately improve its profits. The following are seven reasons every business should have an Excel financial model.
Case # 1 Forecast
The primary purpose of a financial model is to develop a picture of how the bottom line of an organization will look in the future. A thorough financial model includes forecasts of an organization’s revenue, expenses and net profit for at least three years in the future. An Excel financial model bases future performance on data and educated assumptions. In addition, many models include other financial statements such as cash flow and balance sheet. I also like to include a return on investment analysis for certain projects. That feature takes into account other statements and determines if the current course of action is worthwhile.
Case # 2 Validate Business Assumptions
No matter how new or old the organization is, deep seeded assumptions about the business are prevalent. Very often those thoughts are not based on reality but erroneous assumptions or historical truths. The process of developing a financial model helps to challenge old assumptions and validates the current business decisions.
Case # 3 Stress Test Business
“Stress testing” is the process of determining how would hold up against straining changes. For example, applying a 10 percent reduction in sales would be a stress test applied to a business. A financial model is the perfect tool to test such stresses upon a business.
Once a financial model is developed, various pictures of the future can be developed for a business. As a rule of thumb, I typically develop 3 possible scenarios for clients. The three scenarios are best, likely, and worst case. In each of these situations, it is important to brainstorm steps which would need to take place for each scenario to become a reality. The steps determined to lead to the best case scenario should become a part of the company overall strategy. The steps thought to lead to the worst case scenario should become part of a risk management plan so that it can be avoided. It is also important to note that steps related to the worst case should also be used to see at what point the business would be insolvent and unable to pay bills. The steps leading to a likely scenario should be used as a benchmark. It is at this stage a business owner identifies the elements that are driving current business growth.
Case # 4 Deepen understanding of organization
One of the pleasant by–products of developing a financial model is the increased understanding of an organization by all participants. All experts involved in the process inevitably come across new found information about the organization. Perhaps the “gem” was locked in the mind of one of the company experts or data analysis revealed relationships that can be leveraged to attain new clients.
For example, while creating a financial model for a client the levels at which the business would be unprofitable, were realized. That newly found knowledge became a sober reminder that the new business venture was not a “sure thing” but needed to be managed well.
Case # 5 Balance “gut” feelings with facts
At the end of the day, many people trust there intuition or “gut” feelings more than data. These types of off-the-cuff decisions can mean disaster if not tempered with data. Both data and intuition have a place at the decision making table.
Case # 6 Run your organization better, leaner than competitors
One of the reasons Dell Computers built its dominance was due to its superior ability to quickly configure customized PC’s and deliver to customers. This ability turned out to be a competitive advantage. The introduction of a financial model into a business can potentially turn into a sustainable competitive advantage for a business owner. If an organization is able to make better, quicker, data based decisions, which would lead to more profits and a competitive advantage.
Case # 7 Locate previously unknown opportunities and markets
Recently, while creating a financial model for a new business owner, many decisions and opportunities were exposed. The process of creating an Excel financial model brought to the forefront Strengths, Weaknesses, Opportunities and Threats (SWOT) which would not have arisen otherwise. Discussions about different types of cost and hiring plans ensued as a result of creating a financial model. This process saved the business owner the stress of figuring out things after the company had officially opened.
Microsoft Excel is an adaptable tool which can be used in myriad of ways. One of the applications of that tool is to assist business owners with the continuous planning needed to run a growing organization. An Excel based financial model can help businesses owners become profitable in a continuously changing business atmosphere.