In a rapidly changing environment, organisations that have thoroughly planned for the years ahead have a significant advantage over their competitors. These organisations are able to consider changing circumstances, how they will react to cost pressures or tightening revenue and the ultimate impact on the organisation’s cash flows.
Your starting point is a detailed profit and loss budget and an understanding of the relationships that exist between various cost and revenue drivers. Variations in these drivers are captured so that their impacts on the organisation can be easily assessed. This provides a basic level of understanding that every owner and executive should have.
Next, add in a cash flow forecast that will guide you as to the levels of free cash flow or debt you may require to operate your business. Finally, add a balance sheet that will give you a projected statement of assets and liabilities. These are the basic tools that all organisations require.
When the elements above are put together into an integrated model it is called a 3-way financial model.
Such a model is an extremely powerful tool. It allows you to explore the various scenarios and assess your organisation’s sensitivities and subsequent impacts on cash flow, bank covenants, and any other key performance measures.
This allows you to identify areas to improve your business and to also consider the impact of various growth opportunities. Your 3-way model should be extended over at least a 3 year period so you can appreciate the impact of your decisions in the medium term.
Both Public and Private organisations need a financial model that will meet their particular business and reporting requirements, to support executive decision making, and provide the right information for stakeholders.