How Financial Spreadsheets Help Entrepreneurs
Financial spreadsheets are essential for helping entrepreneurs on various fronts. Although this may not be blatantly obvious to the business owner, a well-built financial spreadsheet is a useful tool for cost analysis, break-even analysis, budgeting, financial planning, cash flow projections, liquidity planning, decision making, raising financing, company valuations, investment evaluation and many more applications. In general using financial spreadsheets allow entrepreneurs and key executives to obtain an in-depth understanding of the economics of a company and enhance the quality of their decision making.
Financial spreadsheets are also useful when dealing with investors and banks, as those mostly rely on facts and figures. A spreadsheet captures this language and the calculations can better explain a business in the language of finance professional.
Of course thorough financial analysis can be time consuming. Therefore an entrepreneur either needs to employ some financial modelers on his own, outsource the task or simply use templates built to solve use cases as similar as he is faced with. By making use of standard templates, it is possible to save some time and benefit from financial modeling know-how.
In the following, we shortly like to review common use cases for financial spreadsheets.
Financial Spreadsheets for Cost Analysis
Entrepreneurs need to build profitable businesses in order to be successful. Therefore a careful analysis of the costs is required to identify saving potentials and maximize the company’s profits. In addition Entrepreneurs also want to compare their cost structure with their competitors and other benchmarks. Lastly, the separation into fixed and variable costs allows to run a. break-even analysis and figure out at which sales volume the company will be profitable. By running such analysis, the entrepreneur has a good chance to ask himself the right questions in order to identify savings potential or ways to be enhance the company’s economics.
The Importance of Cash Flow Projections
Cash is still king in any business as accounting profits can be easier manipulated while cash is cash. Deriving cash flow projections is important and is mostly used when preparing a business plan for investors and banks. Planning cash flows also leads to good questions, especially when having to plan investment projects (capital expenditures CAPEX) which can consume quite a bit of cash. So shifting the investment and their benefits from one start year into the other can give the business owner more freedom to find the most cash optimal path to his success. Planning cash flows is also very important for fast growing Startups or companies who need to obtain visibility on their funding needs, as raising financing normally takes quite some time.
Cash flow projections also form the basis for investment evaluations and company valuations.
Financial Spreadsheets for Raising Financing
When dealing with investors and banks, a spreadsheet can become an important communication tool.
Banks normally like to understand the risk of defaulting on the promised debt service and like to run scenario analysis on Debt/EBITDA and other financial ratios. Finance professionals therefore prepare for such discussions and calculate those numbers for the bank in order to anticipate their questions and have additional arguments ready to defend their case. Many entrepreneurs realize at some point that the bank is talking a different language than them and sometimes become quite frustrated. The solution to that problem can be very simple when the entrepreneur manages to puts himself in the shoes of the bank and views his business through the same financial ratios and number a bank does. A financial spreadsheet thus can be quite a handy tool to facilitate discussions with the bank.
Investors focus on other key metrics of importance to them. In many cases this will be the Internal Rate of Return (IRR) while in other cases investors want to discuss valuations. Therefore the entrepreneur will have a better chance to obtain financing if he can serve the arguments to the investor on a silver tablet by calculating these numbers FOR the investor and readies himself for such discussion. At the end investors want to make money, so the only thing which works is to give them what they want. Therefore an entrepreneur has to come up with a case summarized in a spreadsheet somewhere to convince them. This will already send a first signal to the investor that he deals with somebody who understands his needs and therefore he can trust him to protect the investors’ interests and money.
Company Valuations all rely on Financial Spreadsheets
Company valuations, especially when using the Discounted Cash Flow method or IRR analysis, all rely on financial spreadsheets. Those spreadsheets normally are complex to build but need to contain a certain level of detail in order that one can obtain the confidence that the analysis was conducted carefully. All assumptions put into those spreadsheets need to be backed up through research and need to be defended. In addition the spreadsheets also should provide transparency how a company valuation is derived and it will become easier to discuss eventual differences in the assumptions resulting in different views on the valuation.
Financial Spreadsheets for Scenario Analyses
There are different types of spreadsheets, from back of the envelope calculations to sophisticated dynamic financial models. Those can be very useful when running scenario analysis. But first of all, why do we need scenario analysis?
Scenario analysis is very useful when defining a downside case, a base case and an upside case. Any financial model is inaccurate by definition, as it is only a simulation of reality. Thus more important than the output is how the model reacts to a different set of assumptions and understanding what will happen if a company performs worse or better while then drawing the respective conclusions from it. A real estate investor e.g. wants to find out how big would be the cash flow gap if a building is vacated by its current tenant and it will stay empty for 1 to 2 years. Depending on the result he will then learn that it might be smarter to lower his rental price expectations earlier than when waiting for two years in order to avoid a financial disaster. A Startup requires scenario analysis to simulate the effect on the company’s valuation. By running those scenarios, the management can figure out different ways forward and will obtain an idea what kind of valuation implications these scenarios have. Therefore they might be better motivated to work hard to achieve success.
Let’s face it, running a profitable business is not as easy as a, b, c. It takes careful thought and keen decision making skills. Bad decisions will lead to poor financial results, therefore its important to focus the energy on value creating activities. By using financial spreadsheets, decision making becomes more rational as one can understand on which basis a decision can be justified or not. When looking at best practices of larger corporations, basically all of them rely on sound financial models to justify their decisions among colleagues, managers, board members and even shareholders.
Financial spreadsheets can become invaluable tools for entrepreneurs and help them to move their business forward. Viewing a business from a financial perspective is very useful as it helps entrepreneurs to focus their time and effort and value creating activities and makes it easier for them when talking to capital providers such as banks or investors.
View the inventory of efinancialmodels.com for a wide variety of applications for financial models.