A financial model is a tool that is used to determine the best decisions for any business to create a healthy financial future. It has several steps and factors, but it creates a full and detailed picture of the current financial status of the business as well as predicting the future income, expenses, and profits by using modeling and market trends to estimate what is likely to happen next and plan for the future.
Making a Financial Model
Most often a financial model will be created on a spreadsheet for ease of use and readability. It will track the current situation as well as predict future finances and use past and current trends to determine what is most likely to happen. It addresses not only the current financial picture but tries to create a picture of what the business will look like in a year, in two years, or five years. In order to create a financial model, it is key to have accessed or prepared all of the other financial paperwork including the income statement, the balance sheet, the cash flow statement, and the current financial situation of the industry.
All of the information that has been gathered is used to create additional financial statements and projections, and each of the points and documents is included within the spreadsheet to paint a full picture of the business as it is now and as they predict it to be in the future.
Purpose of a Financial Model
A financial model can be used for many circumstances including creating an updated business plan, securing further investment, deciding on next steps and growth factors, guiding decisions on expansions or downsizing, determining what projects to move forward with and which to cancel, and many other decisions. It can be shared amongst all those who are involved in decision-making and used to show outside influences the stability and projections as well as the information they are based upon.
Who Makes Them?
Almost any business can use a financial model, and most will have one in some way even if it isn’t labeled as such. It can be created by the finance department and is often a collaboration of finances, human resources, management, and those who are responsible directly for the buildings, products, and other assets. It can be created in-house, or it may be created by someone who is providing fractional CFO services who will access all of the information and create the model for you, allowing a business to see its progress and where they are heading next.
