Tuesday, January 1, 2008

A Financial Model that Drives Your Success

INTRODUCTION 
"Creating a solid financial model and using it to run your business is one of the fundamental actions required to build a successful business." Assembling the dynamic and fixed parts of the financial structure of a business creates a powerful tool - a financial model. However, failing to use it to run and improve your business renders it powerless. We hope to briefly discuss some of the benefits that may come if you discipline yourself to participate in and regularly revisit this exercise.

WHY CREATE THE MODEL
Here are the words of a budding entrepreneur: "I had a mentor who sat me down and built a financial model for me. He asked me, 'How many days does it take to do this? How many people does it take to do that?' Building on the answers to those and many other questions, he was able to predict the company's future several years down the line, a big plus in meeting with venture capitalists" ("Speaking From Experience," Entrepreneur.com, 11 Jan 2008). Your model can help you see years into the future and help you appropriately capitalize your business.

FORECASTING THE FUTURE
I know a lot of business owners who see no value in trying to understand the future because, as they might say, "I don't know what's going to happen in the future." While their statement is probably true, it fails to consider that forecasting the future empowers them to make the best decisions as the future becomes the present.

For example, I serve as the part-time CFOof a company that saw a decrease in its sales in 2007 of 21%. The firm's financial model helped the owners maneuver through its unforeseen internal and external challenges, tweak part of their revenue and cost structure, and still have a very profitable year. More importantly, the firm will, as a result of its corrections in 2007, increase sales in 2008 by at least 44% and reach an entirely new level of profitability. Without their financial model as a guide, they would have lost money in 2007 and would be struggling to return to a break-even status in 2008.

VIABILITY AND CREDIBILITY 
You will struggle to receive debt and/or equity financing if you do not have a firm grasp of your financial model. Lenders, angel investors, venture capitalists, and often friends and family want to see the financial model and understand how it works. They will ask questions about your assumptions and may want to look at your historical performance to validate your claims. Your model will also clarify the amount of external money required, your intended use of the funds, and the repayment period or return on investment your financier can expect.

CONCLUSION 
There should always be one thing constant in every deal - a sound financial model built on realistic assumptions. Regardless of if you need to raise money to take your firm to where you want it to go, having a financial model will help you run and improve your business. If you use it correctly, your model will be a driving force in your success.