Financial modeling, typically used to forecast cash flow, is an important part of business operations. The more information a business has about predictable patterns of consumer spending, the better it is able to respond to changes in consumer behavior. Historical data is not always predictive of the future, and changes in economic conditions affect businesses at their bottom lines. Knowing the financial health and market placement of a business is an important part of planning for the future. Businesses must know where they stand, before starting a marketing push, reorganization or introducing a new product.
Analysts collect data about company finances and put them together to create a financial model of overall operations. Financial modeling typically includes a cash flow report, budget document and valuation statements. This information is organized in an easy to read and evaluate fashion. When information is scattered and not given context it provides little in the way of guidance for decision making processes. By pulling all of the financial data into one place and providing comparison numbers from historical performance, modeling gives management an opportunity to plan for success in future endeavors.
Small businesses often operate on a very tight margin, with cash flow tied directly into sales generated. There is little to no credit extended to customers or from vendors, making the financial picture easy to read and access. Large corporations already have implemented processes to track all financial transactions and audit fiscal decisions. In fact, many large corporations have entire departments devoted to in–house financial analysis.
Mid–sized businesses fall somewhere in between. They may have some financial tracking in place, but it is rarely sufficient to show the entire picture. Transitioning from small to medium sized often happens as an out–growth of normal business operations, not allowing companies to adjust organizationally to a larger size. Since these changes happen rapidly, many mid-sized businesses fail to grow infrastructure to support a growing employee and customer base.
Financial modeling helps these businesses identify areas of weakness and areas of strength. It also helps businesses make determinations about the actual health of the business. Running in the black does not always indicate overall financial health. Sometimes, outstanding debts paint a bleak picture for the future, even though they do not negatively impact performance in the now.
The first and most important step in any financial analysis plan is data tracking. The more information is available to the analyst, the more accurate the results. Businesses should track every financial transaction and provide detailed reports about income and expenses. Income must be tracked on a cash basis, but it must also be tracked as a estimated number. With solid records, businesses should be able to easily make realistic estimates about future income expectations. Expenses must be likewise tracked. Not only should every dollar be accounted for, but the whether or not the expense is reoccurring or one-time should be noted as well. Only with detailed financial tracking can financial modeling create the most complete picture of current health and predicted future gains.
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