Why Small Businesses Should Use Financial Modelling?
Small businesses and enterprises that are planning to take their company to the next level must capitalise on the major benefits offered by financial modelling. The issue is that most entrepreneurs take ‘financial modelling’ as a financial analysis of their company, especially as the financial analysis of their five-year business plan.
Although it may not be entirely wrong, financial modelling includes more extensive practices too. Moreover, if it is done correctly, financial modelling is much more extensive and allows you to take your company to the next level.
Why Utilise Financial Modelling?
Over 80 per cent of small businesses across the UK fail due to poor management of business finances. So as a business owner, do you think it is necessary to adopt a full financial model or rather base your business decisions on the financial statement attached to your business plan?
Well, the answer to this question may be different for different businesses, but it usually falls under one of the following categories:
- Cash flow management
- Financial risk and strategy
- Quality of earnings
Keeping this in mind, we further elaborate some benefits of financial modelling for a small business.
With a strong financial model in place, your company gets an advantage over other small companies that solely rely on their projections. Moreover, this will improve your brand reputation in the industry, especially because not every small business uses financial modelling.
Your company will appear much more professional in case you are seeking investors or commercial finance loans. This will force your competitors to either back out or step up their game, giving your brand a significant competitive edge. Another benefit of a solid financial model is that it will provide your company with a sustainable plan for future growth.
We agree that a company can survive by breaking even every month. But with this type of a plan in place, that company would be forced to become dependent on debt financing for expansion or adapting to the changes in the marketplace. Having a financial model will help you understand how exactly you can grow your business. It provides you with opportunities that aren’t available to your business otherwise. All this will ultimately result in the evolution of a financially stable company.
Small businesses and enterprises should be well-prepared for any economic instability. Poor management of business finances is one of the top reasons why most businesses fail during periods of economic instability. Hence, it is important for you to have a proper business finance management system in place that will help you attain financial stability.
If you have a solid financial model, your business can have access to investors (which is a huge benefit to your small company). Investors are much more open towards investing their money in businesses that show them a business plan with a solid financial model in it. This again gives you a significant advantage over your competition.
Think like an investor here – would you choose a business that tells you their financial plans or a business that shows you their financial plans?
For instance, let us take a look at venture capital and private equity firms. The main question anyone would ask here is:
What is the Return on Investment?
Investors that offer venture capital usually expect businesses to go through a rigorous budgeting process, which also involves financial modelling. While reviewing business plans for investing, they want to see where exactly the company needs money (whether it is marketing or product development).
Our point here is, if a small business approaches investors or finance firms with their financial model, the entire process of securing funds goes much more smoothly. Moreover, it also proves the importance of financial modelling in business finances.
The Bottom Line
It is important that your financial models are flexible and are updated on a regular basis. Forecasting should be a part of your basic operations here. Your team should be able to fetch real-time data so as to monitor the rapid changes that occur in the market.
Models use the analysis of the actual results against the forecasts to forecast business cash flow. Ultimately, financial modelling is used to determine the future profitability of a company, its position and the potential financial risks.