- What is a budget?
- A budget is an estimate of income and expenditure for a set period of time. Generally, 1 year
- It is a reasonable expectation given what we know.
- It assumes operations at peak efficiency and are generally associated with concepts such as stretch targets.
- It is effectively a hard set of numbers to which a business reports back against until they are reviewed the next year.
- It is generally focused on cash
- What is a financial model?
- In the creation of the financial model, it is the process of understanding the variables which is the key in undertaking subsequent financial analysis.
- It is more complex than the budget and tends to look at prior years and up to 3 years forward. The past and forward periods tend to be in months with annual summaries. This allows for trends / seasonality to be seen.
- It is a mix of cash and accruals and represents the financial position of the business based on accounting concepts.
- It normally has assumptions tab which allows the user of a model to vary assumptions like:
- interest rates
- tax rates
- salary indexing
- increase in sales
- payment terms
- profit distribution.
- Why is it important for a company or project to have not just a budget but a financial model?
- Most companies are looking for additional equity and/or debt and when seeking finance is generally a prerequisite that you are able to provide a financial model which allows the investor or lender to stress-test your assumptions.
- A financial model allows the user to look at other companies in the industry and substitute what they consider comparative data into the model.
- Financial model allows board members and management to evaluate the impact of decisions such as borrowing, acquisitions, hiring, repricing, changing the service mix, changing the payment cycle and importantly making changes quickly to see the impact if something does go wrong.
- Most importantly, financial models allow the user to value the business and simulate the impact of a new investment or loan.
- In the current environment, all businesses need to show that they are managing their money in a professional way and a financial model is a clear sign of this.
- When do you need a financial model?
- Government applications
- Equity raising
- Loan Applications
- Leasing of premises and equipment (other credit situations)
