The future is unpredictable, and no one can know with certainty the result of a decision made today, particularly in the volatile realm of business.
That’s why every business needs a detailed strategy, direction, and purpose to succeed in an increasingly competitive and globalized market. Whether you are selling to other companies or directly to the consumer, it is essential to make strategic decisions based on data, accurate assumptions, and processes that best simulate real-world outcomes.
Financial modeling is one of the most useful tools to quantitatively predict the financial future resulting from one or more strategic decisions.
Typically, financial models will provide a calculated forecast for a range of financial metrics, such as cash flow, profit, balance sheet composition, and entity valuations based on a set of assumptions. Financial models are adjustable, respond to changing variables, and deliver a span of potential outcomes that enables management to make decisions to the best of their ability.
While all types of businesses can make use of financial models, they are particularly useful for largely project-based industries, such as the power and utility sector. Power and utilities financial modeling allow these companies to assess the feasibility of new technology and plant investments, the value of customer contracts, monitor ongoing operations, work effectively alongside regulators and evaluate potential acquisitions (M&A).
Whether you own or contribute to decision making in the telecommunications, oil and gas, power provider, or renewable energy industry, power and utilities financial modeling is an essential tool to get the most out of what you do.
What is financial modeling?
Analysts in the finance department often conduct financial modeling to provide senior executives with the financial tools and information needed to make informed decisions. Financial modeling can vary from a simple, high-level profit and loss (P&L) budget to an incredibly complex, multivariate M&A valuation.
Traditionally, Microsoft Excel has been used to create almost all types of financial models. However, this is changing. Powerful, dedicated, intelligent financial modeling software provides a range of advanced functionalities to make the process that much more straightforward and effective, no matter your goal.
The most common goals of an organization using financial modeling are to simulate the following financial scenarios:
M&A - whether you are looking to acquire a new business line, expand vertically, or merge with an equal, you need a solid financial rationale to ensure the deal makes sense for the bottom line.
Raising debt or equity - pricing a capital raising is an essential task for any business. Financial modeling provides visibility around the cost of issuing debt or selling equity to external investors.
Making internal investments - if your organization is looking to grow, such as opening a new power plant or offering an adjacent utility, it needs to provide a clear financial benefit.
Forecasting and budgeting - P&L statements, cash flow, gross margins, and balance sheets. Every business needs visibility on crucial financial and accounting metrics to make decisions. Risk management is a vital part of management in general. Financial models allow you to forecast financial risks (such as the impact of an increasing interest rate) before they arise, allowing you to take preemptive action and respond effectively.
No matter how elaborate your financial model (or the primary scenario it’s simulating) is, it should effectively follow the same four steps:
Modeling. The model build itself should follow the best financial practices. Educated finance professionals are usually tasked with building the base model as they have the skills and experience to effectively manipulate inputs to deliver the required outcome. There is a famous saying that states, “garbage in equals garbage out.” Even if the technical aspects of the model are correct, the accuracy of the data and assumptions fed into the model drive the output’s appropriateness.
Analysis. The goal of financial modeling is to answer one or more questions and provide a deeper explanation of the forecasted scenario. Flexible models are able to present multiple scenarios from a single model, as well as assess the impact of changing individual financial variables - known as a sensitivity analysis.
Presentation. Every model should have a clear output that is presentable to relevant stakeholders. Whether internal or external, the outputs and analysis should make sense to those that need to use it, regardless of their financial aptitude.
Decision. A financial model provides clarity and support for the decision that’s made by the organization. It should have clear metrics and be retrospectively testable. Were the assumptions right or wrong? Tweak and improve the model for next time. Have confidence you are creating a brighter financial future for your organization.
How power and utility financial modeling drives results
The power and utilities industries are experiencing the most significant structural change since the start of the Oil Age and the Industrial Revolution. According to Deloitte’s 2020 Power and Utilities Industry Outlook, growth will continue to be driven by shifting and increasing investment towards the transition to clean energy.
And due to climate change concerns and global sustainability efforts, IRENA (International Renewable Energy Agency) expects over $10 trillion in fossil fuel investment to be redirected towards clean energy transformation by the end of the decade.
Utilities continue to see the transportation industry as a key driver of future revenue, as electric cars, buses, trucks, and other vehicles continue to grow rapidly. Not only do they need to supply sustainable electricity, but they must invest in the charging infrastructure to deliver it.
In addition, digital transformation and connectedness have led to the development and proliferation of smart cities. Smart cities are defined by the use of IoT sensors and rapid electronic communication that delivers instant infrastructure data insights.
Power and utility companies will become increasingly involved with smart cities, whether that’s optimizing the flow of electricity, managing the water supply, or providing the 5G telecommunication networks to support the proliferation of near real-time data.
No matter how your organization is involved in these structural changes, the competition to allocate capital efficiently will be fierce. There is massive value at stake, and the companies that make wise investment decisions will not only reap the rewards but also drive lasting change in our next phase of development.
Power and utilities financial modeling is a critical undertaking to drive the insights that will guide effective decision making. Whether that lies in setting charge rates, predicting the outcome of expanding supply, the profitability of a new renewable energy project, or the projected value of a significant customer contract, the ability to make accurate decisions cannot be understated.
Financial modeling also plays a role in managing external stakeholders, such as governments, regulators, and investors. Power and utility regulators use financial modeling to simulate the impact of policies on organizations and society. Governments and regulators will try to enact rules that influence the behavior of relevant organizations, without crushing returns beyond the cost of capital.
Similarly, power and utilities financial modeling is used to identify and assess the requirements and optimal mix of debt and equity from external investors. Without financial modeling, the industry would be blind when making important decisions, collectively worth trillions of dollars over the next decade alone.
What a great power and utilities financial model looks like
The power and utilities industry is rapidly changing. Financial models need to reflect and test the variance in potential scenarios to deliver a clear forecast of the future.
The most useful model is often not the most complex or intricate to build. It is the model that produces meaningful results for the organization. This means that it delivers purposeful insights that can be presented in a way that leads to an informed decision by relevant stakeholders.
Put another way, simplicity and flexibility are two critical aspects of a financial model that are often underlooked. A great financial model should be both high performing and scalable if needed, without taking a lengthy amount of time to do so.
Decisions often require fast reflexes, and investment opportunities do not wait for archaic and inefficient manual financial models. Modern financial modeling software is cloud-based and integrates with your organization’s financial statements, making the flow of data as seamless as your data allows.
Some power and utilities modeling scenarios are incredibly complex. The challenge lies in how to best replicate the cause-and-effect relationship between the given variables and the desired output. Ideally, your company can question the results and easily explore a range of scenarios within a single model. It should only be truly limited by your imagination.
Underpinning all of this is the confidence that the output is as accurate as it can be. Old software and modeling techniques are often rife with errors, seriously questioning the integrity of the results.
Financial models should solve problems with clarity, not create more headaches. If you operate in the power and utilities industries and stand to benefit from advanced financial modeling software that meets all these criteria, Synario is for you.