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A Beginner’s Guide to Small Business Financial Modeling

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Today’s small businesses are in a volatile and unpredictable environment like never before. Government guidelines are limiting business operations. Customer demand is in flux due to public health concerns. No one knows when we might have a COVID-19 vaccine.

In other words, it’s now more important than ever before to make the best possible decisions regarding your business’ finances.

Enter financial modeling. Modeling is a way to understand and project future financial performance. Companies use financial models to estimate future profits, understand how many workers to hire, and much more.

For many small business owners, financial modeling might sound like something best left to accountants and analysts at Fortune 500 companies. But it’s much more accessible these days.

In fact, every small business owner can leverage financial modeling to make better decisions for their company. 

Let’s review what every small business owner needs to know about financial modeling and how they can get started.

Take a breath: the basics of financial modeling

Business owners like yourself have likely already done some sort of financial modeling. Have you entered your business’s financials into a spreadsheet to understand profits? What about playing around with those numbers to understand your best and worst-case sales scenarios?

These are all basic forms of financial modeling. Financial models help you understand and prepare for the ebbs and flows in your business. To see how, let’s break out financial models into their core components:

  • Historical Data: Previous financial data that is used as a basis for financial calculations. Small businesses with established history can use previous sales history to project future months’ performance. For seasonal businesses, this is especially important.
  • Algorithms: The calculations of different financial data points to see a future outcome. Examples include break-even analysis, cost of goods sold, and debt-to-income ratios.
  • Variables: The factors that are manipulated to see different outcomes. These include assumptions, utility values, time values, probability ratios, etc. This is easily the hardest part of financial modeling to get right.

Let’s say the owner of a small outdoor equipment store wants to understand how their revenue will be impacted by a change in product prices.

  • Historical data would be previous sales history and pricing. The business owner would have to isolate the products they’re interested in changing the price of and look at the week-by-week sales data.
  • The simplest algorithm for this analysis would be to multiply the number of products sold by their price on a specific date and add it all up to get a total revenue value.
  • The variables of interest would be the products on the shortlist for a price hike or discount and the numbers of items sold historically or projected to be sold in the future.

Yes, financial modeling can be this easy. It’s also vital for long-term planning for your business. 

Considering investing in new equipment or opening up a new location? Without financial modeling, moving forward with these decisions would be risky because you wouldn’t fully understand their financial impacts. 

financial forecasting plate

What financial modeling tools are available?

For those new to financial modeling, spreadsheets are often the first tools that come to mind. Yet they also come with major drawbacks.

Many business owners don’t have an accountant or financial analyst on payroll. This means that every aspect of financial modeling—like building spreadsheets, researching formulas, and projecting sales—is up to the business owner (or a once-per-quarter accountant they hired).

This isn’t ideal. Aside from the huge risk of human error and incorrect assumptions messing up any and all models, most business owners have a lot on their plate. Setting aside countless hours to diagnose spreadsheet errors means losing valuable time to grow your business.

Unfortunately, the best (and only) financial modeling tool available to most small business owners are Excel and similar, spreadsheet-based solutions. These solutions (which have been around for nearly 50 years now) are powerful—only if you’ve been trained as a financial analyst and know how to use them.

But they’re also unwieldy, cumbersome, temperamental, and—this cannot be overstated —incredibly prone to human error. Any mistake, from incorrectly shared file versions to typos in manually entered formulas, can compromise the integrity of a financial model.

Thankfully, business owners can streamline their financial modeling activities by using financial modeling software that does most of the legwork for you. Synario, for example, leverages pre-built templates that can be used for financial modeling right away (more on this later).

What are the most common types of financial models?

Business owners can leverage a variety of financial models to answer specific questions about their finances, performance, and prospects. Below we’ve outlined the essential models business owners may eventually need to use.

Three-statement model

The model that links the three basic financial statements (balance sheet, cash flow statement, and income statement) to offer a complete picture of your business’s financial health. The advantage of this model lies in the modified income statement. By experimenting with different scenarios, your income statement will reflect these changes.

Sensitivity model

Sensitivity models are used to test out different scenarios to understand how they’ll impact revenue and other top-line financials. For example, how would revenue look if sales increased by 5 percent over last year? What about 10 percent? Understanding revenue across different outcomes allows you to better prepare for what’s to come and inform your business decisions.

Scenario model

While sensitivity looks at how one variable impacts your business, scenario financial models take into account several variables based on a hypothetical event. For example, what happens if a business has to adjust their hours of operation due to new restrictions? Sales, overhead, and more would be affected. Scenario models will take all of these factors

Forecasting model

Forecasting models use past performance data and industry benchmarks to forecast future business performance. Though often used for budgeting, forecasting is also used for projecting sales, revenue, and more. Keep in mind—it’s important to never treat forecasts as absolute truths. Instead, they’re useful for getting a general idea of where performance may be headed.

Budgeting model

Every small business needs to plan out their spending. Budgeting models break down your spending into great detail, so you know exactly where your expenses are coming from. With this information, you’re better able to set appropriate limits on supplies and other costs. Budget models can also be used in tandem with cash flow forecasts to understand cash-on-hand when various expenses are due.

Discounted cash flow model

This model focuses on the cash flow statement and is typically used to understand cash flows after large-scale capital projects. The result is an understanding of your capital costs and the present value of your business.

Financial models can also be used to project the impacts of important decisions as your business grows. Merger & acquisition (M&A) models, for example, are used to show stakeholders the growth in value of your business following the acquisition of another business. 

If you decide to move into another line of business, Consolidation models can show the top-line financial projections that include all your business units.

Tips for creating financial models

Consider best-case, worst-case, & everything in between

Your best and worst-case scenarios should be, by definition, the outcomes least likely to happen. But what about everything in between? One or two financial models are never enough. 

Small business owners need to understand a range of scenarios to understand how to best navigate their industry landscape.

Let’s consider a small outdoor gear that’s looking to open another location. The year-over-year increase in sales by 10 percent over the last five years is the main factor in making the decision. Yet what if sales only increase by 5 percent this year, or even drop?

Business decisions should never be a zero-sum game. Likely, this small business wouldn’t scrap the expansion even if sales didn’t grow by exactly 5 percent. By using a sensitivity financial model, the business could understand their thresholds for the expansion.

Always have a long-term perspective

Stakeholders should periodically take the time to reflect on the long-term direction of their business. A great advantage of financial modeling is its flexibility. You can adjust your financial models to look at these longer time-spans to understand the viability of your vision.

Can your current business growth support your goal of multiple locations, for example? And if it can’t, what can you do to get there? What can you do with your current numbers?

Uncovering reasons why you’re not on track to meet your goals is critical for growth. Sales projections may not be pulling in enough revenue. Maybe too much overhead is eating into your profits. With a long-term picture of your finances, it’s much easier to spot and adjust operations.

Make small business financial modeling work for you

In a world where new changes come by the day, financial modeling should be an essential tool for all business owners:

  • You can better understand the impact of long-term decisions.
  • You can find novel yet viable ways of keeping your business running.
  • Better yet, you can avoid practices that will hurt your business in the long-run.

All of this is to say that the greatest advantage of financial modeling is the ability to adapt much more quickly (and prudently) to change. We don't know what the future will look like years or even months from now. But that doesn’t mean we can’t be prepared.

Thankfully, business owners can streamline their financial modeling activities by using financial modeling software that does most of the legwork for you. Synario, for example, leverages pre-built templates that can be used for financial modeling right away.

You can easily conduct various types of scenario analyses and build elegant financial models just by adjusting relevant sliders and levers rather than having to recreate Excel spreadsheets from scratch for each new question you want to answer.

Synario features also allow for the seamless integration of models into ready-to-present slideshows for stakeholders.

Running a business and managing your budget shouldn’t feel like groping around in the dark with a blindfold on. With proper financial modeling, you can see all the possibilities, maintain control of your business no matter what happens, and step confidently into the future.