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How to Develop a High-Quality Financial Model for an SME?

A financial model is an important tool for managing an SME. It is crucial when the company’s revenue comes from multiple sources, when there is a need to better understand the company’s profitability or when the future scenarios need to be communicated to financers. Without a financial model, it is impossible for SME management to make reliable, data-driven decisions while leading and developing the business.

What is a financial model? A financial model can mean different things in different contexts, but in the case of Aamu and SMEs, we mean a model designed for company management decision-making, covering the business operations, cash flows, financial history, and forecasts of the company.

What are the benefits of a financial model? The goal of financial modelling is to provide tools that support the achievement of the company’s growth and profitability. Through this, financial modelling helps companies achieve their goals and maintain sustainable business operations. Its primary objective is to ensure that the company can make informed decisions and anticipate various market conditions. Financial model:

  • is at the core of growth and profitability development.
  • enables additional financing on the best terms from the owners’ perspective.
  • conveys a professional and reliable image of the company to external stakeholders.
  • ensures cash optimization and sufficiency in connection with various business decisions and across different scenarios (e.g., demand decline due to market conditions and the resulting decision-making requirements, or reaching full capacity and the need for growth investments, and their financing and scheduling).

What does a good financial model include?

A good financial model is cohesive, including the company’s historical financial data, driver-based forecast models, and KPI tracking.

 

A good financial model features an up-to-date and reliable short-term (12 months) cash flow forecast, which allows for the optimization of operational activities. The financial model should also have the most reliable possible long-term forecast (13-60 months), facilitating strategic decision-making. To be useful in decision-making, the forecasts should account for different scenarios: “optimistic, neutral, and negative.” By anticipating various scenarios, the company can quickly and agile respond to changes in internal and external business environments.

 

Aamu’s forecast models are based on business drivers and the work with our expert team. Therefore, these forecast models are much more reliable than those based solely on historical financial data or automation.

 

A good financial model is driver-based and modifiable, with cross-linked information. This means that changes in different areas of the model, such as revenue and personnel costs in a personnel-driven business, or investments and capacity in a production-driven business, automatically reflect the entire model. For example, in a personnel-driven business, changes in revenue forecast directly affect personnel costs, while in a production-driven business, capacity growth requirements can be modelled based on revenue growth forecasts. Changes in operative forecasts update income statement and balance sheet forecasts, which update the cash flow forecast realistically and accurately.

 

The financial model includes customized financial and operational key performance indicators (KPIs) for the company. Financial KPIs may include, for example, equity ratio, working capital, inventory turnover, and strategic revenue or gross profit allocations. Operational KPIs might include, for example, the development of average sales price, productivity, and customer churn. These indicators help companies monitor and assess their performance from both financial and operational perspectives.

All good financial models include:

  • Historical financial data
  • Cash flow modeling
  • Long-term and short-term forecast models
  • KPI tracking
  • Relevant visualizations 

An exemplary structure of a good financial model:

  • User manual and instructions
  • KPI summary
  • Summary of graphs and visualizations
  • Annual modeling (income statement, balance sheet, cash flow)
  • Monthly modeling (income statement, balance sheet, cash flow)
  • Driver-based modeling of revenue and gross profit  
  • Modeling of personnel costs
  • Modeling of other operating costs
  • Modeling of financing 
  • Modeling of investments and depreciation
  • Change log

How to Create a Good Financial Model with Aamu?

Aamu’s core competence is enhancing the value of SMEs using the Clarity methodology. One of the key tools of the Clarity methodology is an effective financial model that supports decision-making. Aamu implements the Clarity methodology in client companies through a service partnership that includes expert team support, a systematic working approach, and customized software where the company’s financial model is updated monthly. If the financial model were not updated monthly, it would quickly become outdated and no longer useful for decision-making. At worst, an outdated financial model could be detrimental to decision-making.

 

When creating a financial model with Aamu, the process typically includes the following steps:

1. Crystallizing the primary use of the financial model – Determining the primary purpose of the financial model (e.g., model creation for short-term decision support to operational management differs from long-term modeling for communication with financiers).

2. Signing a Non-Disclosure Agreement (NDA) – delivering existing financial models and related materials (budgets, reports, accounting data…) to Aamu.

3. Background data review by Aamu – creating the framework for the financial model.

4. Workshop 1: Defining business logic – listing the drivers of business development to ensure the financial model accurately represents the company’s business operations.

5. Providing additional data to Aamu – ensuring the modeling is based on available operational data.

6. Creating the first version of the financial model – includes income statement forecast, balance sheet forecast, driver forecasts, and cross-linking various data sources.

7. Listing identified raw data quality improvement needs – relating to the business logic by Aamu.

8. Workshop 2: client’s evaluation of the model – listing necessary changes and implementing those changes.

9. Creating the second version of the financial model – incorporating scenarios.

10. Workshop 3: reviewing the scenarios.

11. Creating the final version of the financial model – includes KPIs, tracking, assumptions, and verbal justifications.

12. Workshop 4: reviewing the summary.

 

How to Maintain a Financial Model with Aamu?

Maintaining the financial model is an integral part of Aamu’s core product, the Clarity partnership. After creating the Excel model, typically for a few months, both the created Excel model and the Clarity software are maintained. Once the software is well integrated into the client’s management processes, the Excel-based financial modeling can be phased out.

 

If you are interested in systematically increasing the value of your SME or financial modeling, please contact Aamu using the form below.

 

Mannerheimintie 15
00260 Helsinki
Y-tunnus 2864997-9