Author: Anna Steinfest
Financial models can be valuable tools for small businesses to improve their planning and decision-making processes. Here are six simplified steps to help small businesses utilize financial models effectively:
1. Create Realistic Financial Projections:
Develop updated and realistic financial projections for your business. These projections should include estimates of future sales, expenses, and financial commitments. Use spreadsheets to create simple projections that allow you to adjust variables for different scenarios. Focus on essential financial statements such as the income statement, balance sheet, and working capital for the next 12 months. Having accurate projections is crucial, especially if your business experiences uneven cash flow due to seasonal fluctuations or rapid growth.
2. Build Simple Models:
Use your financial projections as a foundation to create straightforward financial models. These models enable you to assess the impact of different business decisions. For example, you can evaluate the effects of potential expansions, new product launches, or changes in operational processes. It’s a good practice to link the data across your projections in a connected spreadsheet. You can also separate your assumptions onto a separate worksheet to easily view and adjust them. Visualize results using simple tables and charts.
3. Allocate Funds Wisely:
Utilize financial models to understand how different decisions will affect your working capital, revenue, financing needs, profitability, and valuation. Additionally, compare potential investments by examining their returns and payback periods. Financial models provide insights that can help you make informed choices and avoid unexpected challenges. They can also assist in managing scarce resources during uncertain or financially stressful times. For instance, you can create a cash budget to strategically plan payroll and supplier payments.
4. Consider Different Scenarios:
Recognize that future assumptions are uncertain. Conduct sensitivity analysis by considering various scenarios and outcomes. Keep it simple by including optimistic, pessimistic, and most likely scenarios for your projects. Adjust key inputs such as revenues, expenses, marketing efforts, inventory, employee count, and payment terms to assess the potential outcomes under different conditions. This will help you identify potential risks and better prepare for them.
5. Seek Professional Assistance:
In certain cases, it may be beneficial to seek help from professionals with expertise in financial modeling. As a small business owner, you may not have the necessary knowledge or resources to create complex models. Consider consulting with experts who can simplify the process and assist you in building effective financial models.
6. Update Regularly:
Financial modeling should not be a one-time task. Regularly update your models as conditions change and input actual figures to track their impact on projections. It’s important to keep your models current and accurate. Additionally, whenever you’re considering new decisions or projects, utilize financial modeling to assess their potential outcomes. By staying proactive and continuously modeling the future, you can make better-informed decisions for your small business.
By following these simplified steps, small business owners can leverage financial models effectively, improve their planning capabilities, and reduce risks associated with uncertainty and growth.