One benefit from writing this monthly column is the chance to share a variety of real-world situations. Hopefully, the reader sees there is not one solution that fits everyone’s business but that many people face similar predicaments.
The same goes for financial modeling. Good modeling varies by company. But done correctly, it can be applied to tackle vastly different needs.
Here are two examples that show how distinct needs can be, and how a good financial model can be a great tool to help answer those needs.
First is a small, profitable service company that wants to expand its reach in the market. Its owners know how much they can afford to spend next year on marketing and want to get the greatest return on those dollars.
This is a very defined problem – how to get the best bang from X dollars. The model began with defining what was absolutely necessary for their marketing efforts. After subtracting the need-to-have costs from the budget, we had the discretionary amounts. Working through a series of linked scenarios, we were able to maximize the impact of the budget.
The second example is of a much larger company that was trying to forecast cash need for several years as it brings a new technology to market. Cash is needed to continue product development and prototyping, including long-term beta testing.
We also had to determine fixed and variable production and operating costs. Additionally, there were the dollars needed for an effective sales effort. To say this type of model is complex is a gross understatement, but without it, the company had no idea of its capital needs, let alone the source of the capital.
The first model is very specific – there is so much money to spend; how do you get the best results by properly allocating it? The second model puts its needs first and then asks how much money is needed to accomplish the goals.
The approaches are almost complete opposites, yet both are questions that need to be asked and answered. Financial modeling is a great tool for either of these and many other tasks. Be sure to use it instead of going blindly ahead with either checkbook or hand held out.
Erwin Bruder ([email protected]) is president of The Gordian Organization. Reach him at (216) 292-2271.
