Effective financial models provide these 7 insights. How does yours stack up?

Jason Hershman is a seasoned finance leader with over 12 years of experience driving the financial success of hyper-growth companies, from being the initial finance hire to navigating through exits. His multifaceted expertise includes raising and renegotiating millions, leading company sales, and implementing robust financial systems. Jason has a knack for combining deep accounting knowledge with strategic financial planning, enabling companies to optimize initiatives, boost revenue, and enhance valuations. His passion for transforming financial planning into business success led to his own FP&A as a service business, Point FP&A, dedicated to empowering leadership teams to achieve remarkable financial results.

A well-crafted financial model enables leaders to make informed decisions, allocate resources effectively, and communicate better with stakeholders. Obviously, all this is incredibly important.

One thing I’ve found, though, is that the process of constructing a financial model is just as significant as the final output. Here’s why: Building a good financial model requires an in-depth understanding of your business’s operations, KPIs, and the market dynamics at play. To get it right, you have to do a sweeping analysis of your business from multiple angles. The process should uncover the strengths you can leverage and the weaknesses you need to address.

If you get it right, you’ll be able to uncover these seven insights. 

1. How everything everyone is doing comes together

At its core, a financial model consolidates all the moving parts within a business. The process of building a financial model is taking all the ideas people have and consolidating them into one place to tell a coherent story. It represents the collective efforts of different teams, from sales and marketing to operations and R&D. 

When you start putting everything on paper, you can see costs, tools, vendors, people needs, and timing. When you go through the process of putting the model together and speak to the different stakeholders, it all gets brought together, offering clarity into budgets, timing, holes in strategy, potential pitfalls, and more. It allows you to observe how one team's efforts may affect another, ultimately contributing to the company's bottom line.

2. Data to back up the story you are telling about the company.

A robust financial model supports the narrative you’re telling about your company, whatever that might be. It provides real data to support your assertions about the business's potential and viability. The model reflects the unique story of your business—its trajectory, growth drivers, and risk factors.

Or, it might make you pump the brakes a little. It gives actual numbers for key KPIs, and things might turn out differently than you thought. You might reassess the targets you’re comfortable with. Since it brings everything together, you might identify how seasonality will impact various targets. All of this will help you make the case for realistic goal setting that still backs up the aspirational narrative your CEO is telling. 

3. Goals for your team to hit to keep everyone accountable.

The process of building the model gives everyone an opportunity to react to different teams’ inputs. The output is a cohesive strategy that relies on everyone delivering what they said they would deliver. It provides accountability and encourages collaboration. 

When everyone gets to give inputs and understand the bigger picture, you’re more likely to have cross-functional teams aligned around a singular goal. And you’ll have an objective measure to track teams’ performance over time. 

4. The timing of everything, including product releases, market launches, and more.

Everything a company does has a financial impact—hiring, selling goods, buying materials, contracting with vendors, everything. A good financial model takes into account the timing of key business activities. 

It also helps you understand the impact of those activities. For example, if you see ten sign-ups every time you publish a blog post, and marketing will publish 20 posts in a month, you can assume that you’ll have 200 signups that month. These insights allow for a more accurate projection of revenue and costs and a better understanding of potential cash flow needs or financial constraints during crucial periods.

5. What to communicate to investors and how this business makes sense.

A good financial model will help you show a detailed view of what’s happening with the company. For example, if your revenue is up but you’re losing money, which is common in the early stages of business, you have to communicate why that makes sense. A good model will help you tell that story and present a compelling case for where your business is going. 

6. The results of decisions made and how they change based on future decisions.

Good, adaptable models enable you to evaluate the results of past decisions and predict how future choices might affect your business. The iterative decision-making process, monitoring outcomes, and adjusting the strategy over time will be reflected in the numbers, allowing you to make inferences about what’s working and not working overall, ultimately making future forecasts more accurate.

As new data streams in, it’s important to understand how it impacts the plan. Make sure your spreadsheet or FP&A software brings in the correct information from your ERP, CRM, and other business system integrations to monitor actual performance and track progress against the plan. This enables you to understand where adjustments are needed and how these changes impact your forecasts.

7. The resources needed to accomplish everything, how much they cost, and their benefits.

A good model will tell you what resources you need to achieve your revenue goals. It identifies your needs, from personnel and capital expenditure to marketing and R&D budgets. This clarity allows for an assessment of each resource's cost against its potential benefit, helping you allocate resources effectively to maximize value.

The final word on effective financial models

A robust financial model is a cornerstone for any business aiming for substantial growth and stability. If your financial model falls short, it's a call to action. It indicates a need for a more thorough analysis and refinement. 

Begin by revisiting the foundational elements—operations, KPIs, and market dynamics. Identify and address the gaps, focusing on enhancing clarity and comprehensiveness. A refined and robust model becomes an essential tool for strategic decision-making, and harnessing these insights is critical for businesses aiming to navigate the path ahead with precision and agility.

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