Why Optimising your Financial Model is Crucial
It all begins with an idea.
If the business is a journey, its financial model is the compass that successfully navigates you to the destination.
It is no secret that a properly developed financial model not only represents the intricacies of your business in a mathematical manner but also depicts the vision, objectives, and potential of the business in its current form. Every single row of the model contains the opportunity to optimize revenues, market share, efficiency, or profitability of the business. And this is why it is imperative to formulate an optimal financial model.
An optimal financial model must encapsulate the following characteristics –
Accurate analysis of revenues and costs – Revenues and costs have their own natures. Ensuring that all sources of revenues and cost centers are included is not enough. An accurate financial model always takes into account the nature of the same. How scalable are some of the revenue sources? Are the costs direct or indirect? Which expenses are variable, and which expenses are fixed?
Such an analysis ensures that the model considers all foreseeable surprises that your business can reveal in the future.Consideration of capacities and bottlenecks – Depending on the industry to which the business belongs, its nature, your core team, and the strength of the supply chain, your business may be limited to a certain level of activity. Including these factors in the model would ensure that growth is adequately budgeted for!
Consideration of ratios – Certain ratios, based on both financial and non-financial data, are crucial when extrapolating past performance to future expectations. An evaluation of these ratios can ensure that both internal and industry-wide benchmarks are met. Selecting the ratios depends on the size of your business, growth ambitions, industry characteristics, and past performance, among other factors.
A financial model that includes these characteristics and is optimized to reflect the prevailing external factors in the segment/industry can be a blessing for the business. In particular, it could help you with the following –
Considering multiple scenarios – With ever-increasing uncertainties plaguing the business, the financial model, with its adaptability and computation of causal relationships, could help quickly evaluate multiple scenarios. What would happen if you were to go aggressive with stock orders? Could you afford a tantalizing but expensive marketing opportunity? Could you offer an improved product? All these questions could find accurate answers in a matter of minutes.
Optimizing operations – Sun Tzu’s quote, “Know the enemy and know yourself; in a hundred battles, you will never be in peril” applies to business as well. Knowing the competitor’s metrics can help you emulate them over a period. A well-built model would challenge you with increments to operations and ultimately help you reach benchmarks. This could include minimizing production costs, improving logistics, reducing transaction costs, maximizing CAC, etc.
Sustaining the business – A growing business’s biggest fear is getting stuck in the growth paradox. Even worse, what if growth ambitions fail and the business finds itself reeling in a cash crunch? A strong financial model leads the business through such uncertainty and ensures that the business can sustain itself.
Noticing the red flags – Finally, a strong financial model could help you see weaknesses from miles away, ensuring that red flags are visible and dealt with before they can deal a significant blow. For instance, a weakening ROAS would give a red alert about issues with the marketing team – either it is unable to combat changes in the external environment, or it is losing its efficiency.
Ultimately, the success of your business will be largely measured by its financial success, whether it is revenue growth, profitability, return on investment, or market penetration. A continuous, meticulous, and proactive optimization of the financial model pushes the business toward the direction of your vision and goals.
At Prudence Finance, we have helped dozens of businesses with the improvement of financial models and maximization of growth and profitability. We adapt our services to the objectives of the promoters to ensure that they have a suitable barometer. We have helped businesses engaged in SaaS, E-Commerce, Construction, Real Estate, Manufacturing, Service businesses, and EdTech get the most out of their resources in this way.