Don’t confuse financial modeling with budget preparation

Filed under: Contributed Columns |

This season, Treasury Secretary Hank Paulson, can be seen in a dark-grey pinstripe suit, generally sporting a solid blue tie. And check out those wing-tips! Federal Reserve Chairman Ben Bernanke, on the other hand, is donning the more traditional solid navy suit this winter.
Wait a minute … that’s not the financial modeling you were looking for?
OK, so what are we talking about? What is “financial modeling?” Isn’t that just accountant-speak for preparing a budget?
I know, if you have to listen to another accountant tell you the importance of preparing a budget …. So, I’ll stop you there. No, financial modeling is not the same thing as a budget.
If a budget is like the blueprint of an aircraft, then a financial model is like a flight simulator. A budget is generally a fixed document that sets expectations and perhaps helps you control spending as a business owner.
But a financial model is a management tool that lets business owners play the “what-if” scenarios with the financial performance of their company.
What will my financial situation look like if the market goes up, or worse, down in the next six months? What would the numbers say if I hire another employee?
The central aim of financial modeling is to test various assumptions and see the expected results that would occur.
A financial model will typically include traditional financial reports such as profit and loss and balance sheets, but it should also include a cash flow projection and other key performance indicator reports specific to the business.
More complex financial modeling can include additional reports such as a variance analysis, so that you can compare your past modeling with actual results.
With a good financial model, you will have the ability to input new facts and assumptions on a monthly or even daily basis so that your projections are never out of date and are always based on current knowledge.
What’s the value in a financial model?
Financial modeling effectively eliminates the financial surprises that business owners encounter on a regular basis by projecting future performance based on the most current facts.
It also gives the business owner an ability to update the model on a regular basis.
The owner can constantly run different variables of situations and get a sense of how the company will perform over the projected period. The owner can test the impact of a specific decision on profitability or cash flow.
Most importantly, it allows you to plan for growth, investment and profitability using real-time market forces and data, so you have the best possible information to make decisions.
If you or your management team is constantly juggling cash flow, or your company is being unexpectedly impacted by the economic conditions, or you feel that your financial information isn’t useful for making real decisions, then financial modeling could help you better manage these issues and put a plan of action in place to mitigate future surprises.
Chris Blees is CEO of BiggsKofford P.C. He can be reached at blees@biggskofford.com or 579-9090.