It’s vitally important for owner-managed businesses to keep a tight grip on their financial management and cash position. Creating a financial model allows you to react to change, understand your weaker points and plan effectively.
The impact of coronavirus and COVID-19 has permeated every industry and sector, to a greater or lesser degree, creating a host of financial challenges and cashflow worries. But with access to robust financial modelling, you can quickly start to enhance your forecasting, scenario planning and decision-making.
Gary Staunton explains the basics of financial modelling, the power of forecasting and why avoiding a future cash problem is always better than firefighting.
Coping with the current coronavirus situation
The coronavirus situation is hard work for many businesses, mainly due to the uncertainty around when lockdown will end, when income will appear and how long your money is going to need to last.
Although the Government is offering financial support, many businesses have been finding that the Coronavirus Business Interruption Loan (CBIL) is quite difficult to access. The big high-street banks have always made cash-strapped companies jump through plenty of hoops to get additional finance, but it’s even more difficult now.
If you weren’t viable for a loan before the crisis, it’s likely you won’t meet the criteria now. It’s a Catch 22 situation: the businesses that really need loans are the least likely to get them.
We don’t know how long different sectors will be affected. I have a travel client that can’t do anything at present. Holidays are not top of people’s agenda, they have no business income, lots of refunds and all the same overheads.
It’s in these kinds of scenarios that financial modelling comes into its own.
What is financial modelling?
Financial modelling aims to build an abstract representation of a real-world financial situation. In most scenarios, it is a way of creating a flexible model that’s based on the real-world drivers in your company’s business model.
Once you have a financial model, you can change the value of a certain driver – maybe your sales income, or your price point – and instantly see what the impact of this change will be in the future. Combined with detailed forecasting and scenario-planning, financial modelling helps you to ask all the important ‘what if..?’ questions and allows you to change your strategy accordingly.
For my travel industry client, we’ve built a variety of scenarios into their financial model. In one scenario, there may be no income for the rest of the year, whereas in another, income may recover after six months.
By running these scenarios, we can quickly see:
- What the impact is on the financial health of the business
- What the specific pinch points are in their finances
- Where and when any cash holes are likely to appear
- How much additional cash may be needed to get them through.
With this information at our fingertips, you can plan out the next few months of trading, understand how much money is needed to keep the lights on and at what point you’re most likely to need a loan or extra funding.
How do you create a financial model?
There are important factors to include in a financial model if you want it to become a valuable tool over the course of your planning and decision-making activity.
To kickstart your model:
Fire up Excel
In most cases, the starting point for any financial model is Excel. You can’t do these kinds of calculations on a piece of paper, so you absolutely need a customised spreadsheet to calculate these numbers and begin mapping out your model.
Decide how deep your model needs to go
The next step is to map out how sophisticated you want the model to be. Do you only need the high-level numbers, or do you want to get truly granular with your level of detail? Knowing which drivers and which key numbers to focus on will be vital.
Focus on cashflow
When you’re facing a potential recession (or even a full depression), you need cashflow in the model. Cash is far and away the most important number to focus on in the short term. Knowing how much cash you have to keep trading is absolutely critical.
Add in the P&L and balance sheet
There are three key elements to include in your initial model. Your profit and loss (P&L), the balance sheet and your cashflow statement. Having the historical numbers behind the business is vital. With monthly figures across all of these three areas, you can begin to understand the business.
Look at money coming in and going out
You’ll also need to look at costs, cash, income, sales and how quickly money is coming into (and flowing out of) the business. Ensure you factor in things like VAT or corporation tax bills, how much they are and when they will need to be paid.
Review your margins
Really getting to understand your profit margins can be a positive move. The more you can work on flexing and moving those margins, the more you can play around with costs, price points and the overall profitability of the business.
Analyse your debtor days
The time it takes to get paid has a huge impact on your overall cash position, so look at how long most customers take to settle your bills and how much aged debt is sat on your balance sheet. Shortening those payment times makes a big difference.
Customising and flexing your model
A template-driven financial model is a good starting point, but every business is different – so you’ll need to tailor and flex your template to factor in the specific drivers and financial elements that are important to YOUR business.
We have a basic model in a spreadsheet format, to start with. We then work with you to tailor this to the exact needs of your company. You need flexibility to mix things up and take into account different payment times, different sales patterns, unexpected variables etc.
Doomsday for any owner-managed business is having no income. If you can pay your overheads for a few months that’s good, but what happens after that? Can you defer your VAT payments? Could you ask for a rent holiday? What other revenue streams are open to you?
I have a client running a retail business. None of their shops are open, but online sales are booming. They needed scenarios that factor in more online sales and little to no retail.
So, ask yourself:
- Will people visit your physical locations once lockdown is eased?
- Will your target audience have the money to buy anything?
- Will customers be scared of going into shops or offices where social distancing is tricky?
- Do you need a loan to fund your re-opening strategy?
You can only make assumptions based on the facts and information you have available. So, it’s important that you can flex those assumptions based on real-time information. They drive all the future forecasts, planning and decision-making.
Using your financial model to help the business survive
At present, you won’t be using your financial model to forecast and plan growth; you’ll be using it to get through this dire situation – giving you the edge you need to survive.
For businesses that are starting to struggle, partnering with an accountant is a valuable way to cope with the challenges that COVID-19 is throwing up. Crunching the numbers, seeing what the key problems are and talking to your accountant are all vital elements.
If you’ve done the forecast in-house and everything looks fine, the chances are that you’ve done it wrong, if I’m honest. You need someone to challenge you on the numbers, ask you why you’ve made these assumptions and discuss how you think you’ll get through this.
Having a trusted adviser who will ask those difficult questions has huge value. It’s likely that more actions are needed and a deeper view of your model is required.
Learning to anticipate, rather than react
The biggest benefit of having a financial model is the opportunity to anticipate a financial problem before it becomes a reality.
Once you’re firefighting, it’s a downward spiral. But if you have contingency planning in place and access to finance, you have a much better chance of survival.
We can help you spot the pothole in the road that’s coming up, and swerve to avoid it, rather than blindly ploughing onwards and falling into that hole.