Why Financial Models Matter
Many entrepreneurs do not see the need for a financial model. They simply want to start marketing and selling, without a full understanding of their enterprise and costs. I believe this is a reason why many start-ups fail, as they lack the understanding of both cash flow modelling and financial forecasting.
My Expenses are WHAT?!
A key input into financial models is expenses. Entrepreneurs sometimes have very little understanding of what all of their expenses are, from petrol to website hosting. Being an entrepreneur means you run your own company. You have marketing expenses, communication expenses, travel expenses and administrative expenses. Many entrepreneurs just fork out cash for these without understanding what they are all adding up to. A financial model allows an entrepreneur to understand what their expenses are and what they amount to. And ensure they make enough revenue to cover their expenses!
I thought my profit would be much higher!
What is your profit margin? What is your true cost of goods sold? Do you have operating expenses? A good understanding of your profit margin is key. A financial model is the easiest way to see profit margins.
I have a massive profit but no cash!
It is for this reason that I advocate cash flow modelling. A small business with profit materialising in the business in three months’ time is worth very little today when you need to pay bills. Sure, you can obtain finance and even factor your invoices, but surely you would rather be able to manage your cash flow more effectively? A cash flow based financial model will allow you to do this, and effectively forecast what different payment terms mean for your business and your working capital requirements.
As an entrepreneur, I need to build my own model?
Building your own financial model for your business is the best way to fully understand what drives your business. That said, there are lots of templates available for use and even advisors who will build models for you. Having a financial model is key for any entrepreneur to understand their business in detail. Because being an entrepreneur means that you are not only your business’s CEO, but CFO as well.
For more information on financial modelling, check out my online course here.
Good luck and happy financial modelling!