You might not be able to predict the future with confidence, but financial modeling can help you prepare for the future by showing you the likely results of the decisions you make.
What Is Financial Modeling?
Modeling uses spreadsheets to plug in numbers such as expenses and earnings. After a model is developed, you can change the numbers to different values to show the impact of changes you may be thinking of making in your business.
Some Popular Models
1. The Three Statement Model
This model combines three different types of financial statements: cash flow statements, balance sheets and income statements.
2. The Budget Model
The budget model is used to create a budget for the business. Different amounts can be plugged in to see the outcomes of different budget decisions.
3. The Discounted Cash Flow Model
The discounted cash flow model is used to value a company. It expands on the three-statement model to come up with a valuation.
4. The Forecasting Model
This model can help a business forecast trends, predict changes in demand and determine the impact of business changes.
5. The Options Pricing Model
The option pricing model can help you determine whether it is a good idea to purchase an option. It forecasts whether the option will bring you a profit or not.
What You Can Do With Modeling
It is best to start out by using real-world numbers in your models. This will show you the state of your business today. Later, you can try out different scenarios. One use for the model is to input best-case and worst-case numbers to see the results in those cases. At least, then you know the parameters within which your results will fall.
You can use market research to make some predictions with your models. You can use models to figure out whether you should open a new business location, purchase new equipment, hire more employees or pay down debt. A model can help you to decide how many customer service people you need, for example.
As time goes on, you can revisit your models and plug in new numbers as conditions change. Once you have developed some good working models for your business, decisions will start to become easier since you can model the probable results more easily.
It is a good idea to start experimenting with financial modeling since it can help your business make decisions more easily. If you are having trouble getting started, you can hire a consultant to help you initially. Pretty soon, you will become experienced in how to use models in your business.