A continuation of our ‘Start your Own Business‘ series, In an extract from his book in Sunday Business Post 25/4/2010, Starting a Business in Ireland, Brian O’Kane continues on with advice on Business Models & Projected Figures.
A financial model of the business is effectively a set of accounts, represented on computer spreadsheets or in a dedicated modelling package for ease of manipulation – for example, Business Plan Pro from Palo Alto Software.
While a financial model is useful for businesses of all sizes, it is essential for a business of any complexity. Your model should enable you to change certain variables – such as the number of units of product sold, the price at which you sell them or the cost of supplies – and discover what the effect will be on the business.
Your financial model should consist of:
- Profit and loss account
- Cash-flow statement
- Balance sheet
You can also create some management accounts that look in more detail at production and overhead costs and allow you to manipulate certain of those variables. It is crucial that the figures you use in your model are as close to reality as can be.
Your model must show what your break-even point is likely to be in different circumstances and allow you to estimate how long it will take to reach it. This calculation is very important when it comes to raising finance.
If you will be able to repay borrowings in three to six months, you maybe willing to risk a bigger initial loan than if your earliest estimated repayment date is a year away.
The rule is to be cautious and prudent, but realistic. If your figures are too optimistic, you could find that you cannot meet your repayment schedule, and the additional cost of borrowing over a longer time damages your business growth prospects, if not its viability – and your credibility with your bank manager.
Equally, if you are unnecessarily pessimistic about the length of time it will take to repay the loan, your calculations may indicate that the entire project should be dropped – which is exactly what your bank manager will do.
Some of the main reasons for using a financial model are to estimate:
- A break-even point under different market conditions
- How long it will take to reach a desired level of operation
- The consequences of price changes
the consequences of undertaking expansion, R &D and other special projects.
If you have no experience of financial modelling, seek help from your bank, County City Enterprise Board, accountant or one of the other organisations in the ‘business plans’ section of the directory of the book.
Again, the details of the assumptions on which the model is based should go into an appendix to the business plan, as should any detailed statistical analysis. Quote the important final figures in the body of the plan.