Financial Modeling and Strategic Planning: Part I
For many business owners, the sale of your business is synonymous with funding your retirement. Given how much planning goes into retiring, why wouldn’t you spend just as much time planning for the sale of your business?
Owners should anticipate facing buyer questions about the current financial and organizational structure of their business, regulations concerning their industry, and even more personal questions, like, “Where do you see yourself five years from now?”
At this point, you might start to wonder if this is a sale or a job interview. A lot of owners have an idea of where they will be and what they will be doing following a sale, but very few can answer that question when it is directed at their business. Even fewer can provide an actual strategy for achieving past and future growth.
All buyers want to quantify the business’ value by understanding how much top and bottom line growth it will generate in the years following a transaction, and they won’t just take your word when it comes to these projections. In fact, buyers tend to assume that everything you say is overly optimistic, and they won’t believe you until they see evidence suggesting otherwise.
Failing to provide defensible answers to these questions usually results in a lower valuation with more burdensome earn out provisions. This is where financial modeling and strategic planning for your business comes into play.
What is financial modeling?
Financial modeling is the act of building a conceptual framework that depicts where a business’ financial situation will be at some period in the future – usually three to five years – using a combination of historical financial performance, guidance from those within the operation, and industry trends. These models are usually built through a tool like Microsoft Excel to facilitate edits and revisions as more information is gained.
How is a financial model different from an owner’s guess?
When done correctly, a financial model considers all areas of a business’ financial performance and generates a three-statement model – income, balance, and cash flow – using clear, logical, and defensible assumptions in order to account for changes in business activity. An owner’s guess, though sometimes accurate, is just a guess without any hard values or defensible logic to back it up. Furthermore, these guesses fail to provide a buyer with the organizational knowledge needed to operate the business without the owner staying on for an extended period of time.
Why are some financial models better than others?
Financial modeling can be as basic or complex as the builder and business owner want it to be. Usually, a more complex model – at least to a degree – is better since it accounts for more elements by addressing things like different growth rates for multiple revenue generating segments, future investments in technology and infrastructure, or the expansion of the executive team. More importantly, the best financial models are flexible and have the ability to account for multiple growth scenarios (i.e., optimistic, realistic, and pessimistic).
Who should I use to prepare a financial model?
A financial model is a tool for your business that will be used to facilitate strategic planning and the eventual sale of your business, so preparing the model is not something you should trust to just anybody with access to Microsoft Excel. The person preparing your financial model needs to have a strong understanding of accounting fundamentals and financial statement analysis, and ideally has knowledge of your industry. If someone doesn’t check all these boxes, he or she probably shouldn’t be trusted to help you with strategic planning and the sale of your business.
I have a really great financial model… now what?
While financial modeling can help a buyer feel more comfortable with your growth projections, it is only the first step in this process. You will want to use your financial model to determine the current and projected value of your business to see if it meets your goals. Next, you should identify areas for improvement or investment in your business, and develop a strategic plan for making this all happen. Make sure to keep records of everything that goes into this process because buyers want to know how close you came to achieving past projections, what actions you took when you missed or exceeded projections, which members of the leadership team were essential to this process, and how they can take your business to the next level.
Keep in mind; financial modeling is only part of the process. The next blog in this series will address the use of financial modeling to develop and enhance strategic planning initiatives as you prepare for an eventual sale. If you have any questions about financial modeling or strategic planning, please contact us at firstname.lastname@example.org for a confidential discussion.