Advantages of Financial Modeling

Corporations use financial models almost every day. These models help while making several key strategic decisions. If a company plans to enter a new country or even take it over the company, it will create a financial modeling first.  This model will help to generate the information that will be ideal for any due diligence.  However, financial modeling is not always perfect.  It is not the answer of all the problems being faced by the financial department of the any company.  Thus, before using financial modeling, it is imperative that everyone should be aware of its pros and cons.

Advantages of the financial modeling

Some of the major advantages of using financial models to setup a company as follows:

Better Understanding of the Business:

To develop a financial model, we must have the good understanding of the business. The process of mode; creation forces the business to think and list down the important components of the business.  The process also forces the business to think about the various changes that may happen internally as well in the external environment. Hence, it would be fair to say that companies that create financial models are somehow forced to do more due diligence as compared to their counterparts. This creates a better understanding of the business. Creation of financial models, therefore, has a spillover effect which leads to a better understanding of the underlying business.

Helps Decide on a Funding Strategy:

When any companies develop financial models, they are able to clearly understand what will be their cash flow situation.  The cash flow requirements that any company would be faced as well as the ability to borrow and make interest payments can be easily ascertained. This helps the company to choose an appropriate funding strategy. With the using financial modeling, they can decide on the amount of money that they need to have on hand in order to ensure that they survive until the revenues start flowing in. Therefore, start companies are able to ascertain the amount of equity stake they should sell to reach the next milestone. An accounting for startups is also mandatory for this purpose.

Helps Reach the Correct Valuation:

Financial modeling allows companies to understand their values.  In the absence of modeling, the discounted cash flow models decide the worth of the company. Some of these models assume linear relationships between revenues and expenses, which are just not true. This helps companies to know their exact worth when they are selling out their stakes to third party investors such as investment bankers and private equity funds.