Financial modeling is the process of creating mathematical models for representing the financial performance of business entities. Financial models are usually used for cash management and budgeting but there are many more valuable benefits. They also provide important insights about the company which help in decision making. Such models help in analyzing how much profit is required for achieving target which, in turn, helps in formulating effective strategies. A good financial model should be detailed yet simple. No matter whether you are a startup or an enterprise, financial models help in predicting and estimating opportunities, investments, risks, outcomes and other important scenarios.
Financial Modeling for Decision Making
Financial modeling helps in forecasting the future financial performance of businesses by analyzing the past data and performances. This leads to tactical decision making which helps in establishing the direction of the organizational progress, maximizing profitability and developing industry sustainability. However, financial modeling isn’t only for forecasting financial performances. It is also crucial for understand the business model. It gives true insight about how much money is needed to attain stability, how to make more money, how much is required to grow your business and where your business stands in the industry as compared to other companies. Financial models lead to a variety of business decision and, thus, it is critical to develop such models with accuracy and certainty. In order to grow your business through various means like opening new stores, entering new markets, raising capital, valuing business and prioritizing projects, you need important insights to decide in which direction your company must put efforts. And, financial models provide such important insights, helping your company succeed.
Scenario Analysis through Financial Modeling
Financial modeling also helps in scenario analysis which is used for evaluating future events though the analysis of various potential alternative outcomes like including any possible risks or estimating the value of a portfolio. It also includes determining shifts in the value of a portfolio based on events that occur in varied scenarios. Organizations must gain information and foresight to stay prepared for future occurrences which could positively or negatively impact the organizations’ progress. Another important use of scenario analysis is determining how effective a company strategy is for achieving prime objectives. This can be achieved by analyzing income, revenue, new customer growth etc. Such insights shed light on the KPIs (Key Performance Indicators) of the business and help in understanding which areas are successful and which areas need more attention.
Flexibility of Financial Models
An important characteristic of financial models is flexibility. An experienced professional can make extensive changes in the financial models, as per the requirements, within a few hours. Moreover, preparation of financial models doesn’t require any additional investments or programing skills. They can be easily prepared on Excel sheets which are by default installed in all the computers of an organization.
Financial modeling is used in various stages of business operations and combines various components like business metrics, accounting and finance. It is one of the most valuable tools that a business can adopt to gain numerous benefits.