Use your numbers to make decisions
Whenever you’re thinking about what’s next for your business, see what the numbers tell you – both your current financial figures and what these might be in the future.
You might want to look at your numbers when you’re deciding whether to:
- launch a new product or change an existing one
- move into a new market
- buy or lease equipment or work premises
- invest money in the bank, in shares or back into your business
- seek investors.
Even small changes might affect your costs or earnings.
Start with forecasting, then do your modelling
Financial forecasting
A forecast is an educated guess at your business’s costs and income over a period of time.
The most common type of forecasting is cash flow forecasting. Many small businesses use this. You can present a forecast in a spreadsheet or accounting software, and you can work with an accountant to make sure you get it right.
To forecast future financial figures, use information such as:
- your current operating costs, sales and other figures found in your financial statements
- how your costs might change
- expected ups and downs in your sales
- insights on sales trends from staff and suppliers.
Financial modelling
Start financial modelling when you can read your financial statements and cash flow forecast confidently.
Financial modelling shows you:
- how much free cash flow you have to spend during a project
- if a project makes good financial sense.
A model uses similar line items as your financial statements. It’s usually a spreadsheet and includes equations that use your financial figures to calculate the expected performance of the project over time.
Watch: Introduction to finance modelling
Transcript
Whenever you think about what's next for your business, where you are going to go in the future, it's always a good idea to see what the numbers are telling you.
Both in terms of where you currently stand, as well as making forecasts for what's going to happen afterwards.
The financial modelling section at business.govt.nz has a very user-friendly, step-by-step guide for setting up your own financial forecasts.
There is also a workbook, which does all the calculations for you and gives you all the answers. So that nothing is too scary.
Financial modelling is all about making forecasts of your cash flows in order to make informed decisions about your business. So, as long as you can understand your financial statements and what the cash flow forecasts mean, you are ready to create your own financial model.
If you are not sure that you understand how to read financial statements, please check out the relevant section of our website first.
Financial modelling takes your financial forecast to the next level. Financial modelling will help you, or your accountant or your business advisor, to identify the profitability of your business.
So, for example, you'll be able to see what the risks are to your cash flow and whether you will need more money, whether it's from lenders or investors.
If your finances stack up and your business is profitable, the next step is to work out how to fund your business.
Head to our website and explore our modelling workbook, at business.govt.nz
Steps to focus on financial modelling
- Step01
Take time out
Take time away from distractions to get into the right headspace. After you’ve talked to an accountant or checked your financial statements, set some time aside to think about your costs and income, profit and loss, rather than heading straight back into your day-to-day tasks.
- Step02
Forecast key figures
Start with the costs involved, the price you’ll charge, and who you plan to sell to. Be realistic when forecasting numbers. If your business is new, use market research and benchmark figures for your industry. If you have an established business, use past figures to help predict future costs and income.
Include ranges from low to high, after thinking about:
- how your costs might go up or down
- what customers might be prepared to pay.
- Step03
Think about the big picture
This is particularly important if you’re aiming for high growth or a major project, but consider this even if you’re a small business.
Keep an eye on New Zealand’s trade deals. A new deal, or changes to an existing deal, could open a new market, change the market you’re already in or affect suppliers or creditors you work with.
Do a PEST analysis, which stands for political, economic, social and technological.
Here are examples of factors to think about:
- Political: When is the next election in your main market? Will a law change affect your industry?
- Economic: Are exchange rates, or interest rates, stable? What’s the disposable income of your key customers? What’s happening with the price of your ingredients/raw materials?
- Social: Are your key customers in a population group that’s growing or shrinking? How might changing lifestyles affect your business, staff or customers? Are trends emerging that might grow new competitors?
- Technological: Do you or your customers rely on technology that’s changing? Is your industry adopting automation or other new technology? Are competitors investing in new technology?
- Step04
Move on to modelling
Enter your forecast figures into a modelling spreadsheet or other tool. The results are not 100% accurate, but a best guess of how much a project might cost, how much revenue it will generate, and what the interest rate might be.
Talk to a business advisor about how to get reasonable forecast numbers. The tool’s formulae then calculate how the value of your initial costs and projected income change over time. These results help you analyse the profitability of the project.
- Step05
Stress test your numbers
Stress testing helps you:
- understand potential risks and rewards in detail
- set targets and limits for that new product or other project, including at what point to quit.
You can stress test with your forecast or your model.
It’s important to see what happens to your finances in a range of scenarios, good and bad.
Make several versions in which you change the predicted numbers to reflect highs and lows in your:
- sales or other income
- costs
- interest rates.
- Step06
Show and tell
Show your planned project and the numbers you’ve modelled to someone you trust. Explain the range of scenarios you’ve modelled, and why you have chosen them.
Encourage them to ask questions, for example:
- What problem will you solve for potential customers?
- Are people willing to pay for your solution?
- How much does it cost to make or do?
- How did you set your selling price?
The aim is to find out if your forecast figures are realistic.
- Step07
Decide how to fund your project
You might have enough free cash flow to fund it yourself. But if you plan to raise funds from another source, use your forecasts and models to show potential lenders or investors how you expect the project to go.
- Step08
Regularly check you're on track
Check your financial statements every month. Compare your actual figures – also called key performance indicators (KPIs) – with those you predicted. If the numbers you’re tracking are different from what you had predicted, you may have to make some changes.
Using our modelling workbook
Download our modelling workbook (an Excel spreadsheet) and enter your numbers in it to help you start making decisions.
The first two sheets are for forecasting – these show sample forecast figures for revenues, costs, tax rate and capital expenditure (capex) for our fictional tech company.
The sheets labelled Step 2 and Step 3 are for modelling – these use our tech company’s sample forecast figures to calculate modelling results like net present value and internal rate of return.
To see how the results change when these financial figures rise or fall, you can either:
- change our numbers
- type in your own figures.
Reading the results
If you type in your own costs and income, the spreadsheet will work these figures out for you:
- EBIT – earnings before interest and tax.
- EBT – earnings before tax.
- Net income – how much money your project makes after taxes, expenses and other bills.
To decide if you should go ahead with a project or not, look at these results:
- Net present value – a positive number indicates the project is likely to make good financial sense.
- Present value of cash flows – positive numbers are preferred, but it is OK if some dip below zero if the net present value is positive.
- Free cash flow – positive numbers show you have money to spend during the project. A negative number means you will need money from a lender or investor to cover that period.
- Internal rate of return – shows if your expected profits will be high enough for you and your investor or lender to get a cut.
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