Posted 18 Oct 16
Significant business decisions are usually based on financial models with forecasts. Approximately 90% of financial models contain errors and may exclude key value drivers, which can result in misleading results. Over time most financial models evolve without well-structured design or integrity checks and often without documentation. Making relatively minor changes can often take a long time and have unexpected consequences.
If your business is considering:
- Significant expansion through organic growth or acquisition
- Debt or equity funding to finance growth in your business
- Seeking external investment to commercialise your ideas
- Entering a sale process, or
- Planning an IPO
Then it is imperative that robust financial models with reliable financial forecasts are prepared. The financial forecasts for your business will also usually be required along with historical financial information by any potential investors or financier.
Robust financial models and forecasts should include:
1. Integrated three-way statements:
The financial model should comprise of integrated profit and loss statements, balance sheets and cash flow statements. This is typically done through a financial model created using Microsoft Excel. The cash flow statement is often overlooked in the preparation of financial models and forecasts despite this being the critical factor in the investment or financing decisions of investors and banks.
2. Detailed assumptions:
The preparation of a detailed assumptions worksheet or booklet is essential to enable third parties to adequately understand the forecasts. Supporting information such as customer or supplier contracts should be made available where appropriate. Key assumptions in the financial model should be able to be “flexed” or “sensitised” to assess the impact of changes in the assumptions on the forecast.
A client of ours is in the process of expanding their early childhood education business into China and came to us seeking help with a business plan and negotiating with investors. It became clear that a robust financial model with forecasts was the foundation for their business plan and to have a basis of what the business is worth for investors. After providing the framework for their business plan and presenting them with the financial model, they had a clear picture of:
- How feasible the opportunity is through various scenarios
- The initial funds required to fund capital expenditure and working capital
- The impact that investors will have on the ownership structure
Our client will also gain further benefits from the financial model as their business progresses, which includes:
- Rolling forecasts: Year to Date (or monthly) results can be updated in the forecast to provide a more accurate view of the forecast financial position and performance of the company.
- A stronger view of business cash flows: The use of an integrated forecast model will assist management to identify any potential cash shortfalls and ensure appropriate action can be taken.
- Ensuring that the business will have sufficient cash to secure appropriate facilities such as overdrafts or debtor finance facilities to fund the operations of the business. This is particularly important in times of high growth or expansion where the necessary investment in working capital places pressure on the business’ cash flow.
- Identifying the funding requirements for expansion plans, acquisitions or new projects.
- Completing ongoing valuations of the business using discounted cash flow techniques as a starting point for negotiations with investors.
- Assessing what debt amortisation profile the business would be able to sustain.
These financial models and forecasts will be used by external parties (investors/financiers) to:
- Assess the reasonableness of forecasts.
- Complete analysis with respect to valuation/financing capability of the Project.
- Develop an offer for the investment/acquisition of the business or the finance approval.
- Form a view on the capability of management.
Financial models with insufficient forecasts with unreasonable assumptions can severely impact an investors’ view with respect to the capability of management.
To overcome the key challenges of preparing financial models and forecasts PKF Corporate Finance:
- Works together with you to analyse uncertainties of key business and market drivers and underlying assumptions.
- Undertake proper planning in the design and build of the model for longevity, consistency, practicality, and with a focus on the required outputs
- Incorporate version controls and backups, rigorously test the model, build in checks, and protect parts of the model that are not supposed to be changed by users.
- A robust forecast model will be available when called upon, which provides a positive impression of management and the business for investors and financiers.
Click here to contact one of our financial modelling experts.