Financial Modeling and Strategic Planning: Part 2
Previously, we defined financial modeling and how it helps you prepare for the eventual sale of your business. That was only the first step. Today’s blog focuses on taking your business’ financial model and using it to develop and enhance strategic planning initiatives as you prepare for the sale of your business.
A financial model addresses five components: determining if your business’ value is where you want it to be, reviewing projected vs. actual results, finding opportunities for improved performance, developing action plans to achieve results, and setting the current organizational structure to reflect your business goals.
Will my business provide me with the financial reward I desire?
As mentioned in part one, a financial model typically projects three to five years of financial performance for a business based on assumptions of growth in revenue, gross profit, R&D, SG&A, effective tax rate, and other factors.
Using these projections, an owner or advisor can calculate the business’ adjusted EBITDA, then attach appropriate comparable transaction multiples to a given year’s adjusted EBITDA to approximate its enterprise value.
This exercise is usually quite revealing for owners; they’re typically shocked at how little their business is worth or pleasantly surprised by their future nest egg. Regardless of the outcome, this provides the owner with a guide on how much growth they must achieve in order to reach their financial goals.
What if I exceed or fall short of the financial model’s budgeted results?
It would be really convenient if the financial model projected everything down to the nearest cent, but that isn’t realistic. The goal is to not deviate too much from the budgeted results without a good reason – i.e., signed one new client that alone increases revenue by more than 10% – because significant deviation suggests that the model doesn’t accurately depict your business.
As for how much deviation is acceptable, that’s up for debate. An established company with a long-term growth rate of 3% shouldn’t all of a sudden show double-digit growth – barring the launch of a new business line that should have been captured in the model. Conversely, a younger company showing more significant levels of growth and greater budget deviation is expected, but the model shouldn’t predict 20% growth and all of a sudden show 150% growth; that would be a bit excessive.
How do I respond to deviations from the financial model’s budget?
Now that we’ve established that deviation within reason is acceptable, let’s talk about what to do when you see variances. This is where analyzing the minutiae of your income statement (or P&L) line items comes into play since these are opportunities for improving your business and the financial model.
Some of the common variances that you can expect to see in any income statement include the costs of goods sold (COGS) and SG&A since these categories account for so many different expenses. For example, a client services-based business tends to see labor account for the majority of all operating expenses, which can very easily get out of control if someone is not closely monitoring these costs.
Once you’ve identified the source of the deviation, the next step is to take action to correct the issue. As the owner, you will have to decide if the financial model needs to be reformatted to better represent the business, or the variance represents an opportunity to eliminate excess expenses.
Assuming the variance represents an opportunity to eliminate excess expenses, how do I take action?
This is where you need to work with you management team to develop an action plan for correcting the issue. Fortunately, there are numerous action planning models out there for you to use, but we tend to recommend the SMART model; specific, measurable, attainable, realistic, and timely.
SMART models require that you define each component and develop a formal plan for not only taking action, but tracking progress and measuring success. The most important component of these action plans is taking the time to complete the write-up and participate in the follow-up to ensure accountability.
Do I have the right team and organizational structure in place to help my business succeed?
At some point in this process, you will have to ask yourself if your business is built to support your growth/value objectives, and whether or not your team is capable enough to make it happen. Questions like this are hard to ask, but essential to the long-term success of an operation. It can be even more difficult when leaders are micromanagers, and lack the necessary skills or vision for running a larger business.
If you are honest in your assessment of the team you’ve assembled, as well as your own limitations, you will be in a better position to take the necessary strategic planning steps to grow your business and maximize value.
If you have any questions about financial modeling or strategic planning, please contact us at email@example.com for a confidential discussion.