When a new business model is being considered, proponents must first undertake a qualitative review – i.e. determine whether the story underpinning the model makes sense. There needs to be a logic behind the adoption of the model and a compelling case that it will be supported by its intended target audience.
Upon completion of the qualitative review, it is essential that a comprehensive quantitative review is then undertaken. Our experience is that far too many business owners and managers ignore this vital stage of business model assessment. Unfortunately, many believe the hard work is done once they have established a credible story about how they will make money from their proposed business or project.
For each possible business model, there is a unique set of variables – both technical and financial – which will impact upon the performance of the business. It is not enough to test movements in one key variable at a time. When testing new business models, it is imperative that any combination of key variables can be tested simultaneously and rapidly in order to assess the likely impact upon financial performance. This can only be achieved through the use of a customised, integrated model which has been designed for this purpose.
Financial projection models
A crucial first step in designing an appropriate financial model for this purpose is the identification of all key drivers underpinning, and variables likely to impact upon, the financial performance of the proposed new business, business unit or project. This process is also crucial when an expansion, a merger or an acquisition is being contemplated. Comprehensive, sophisticated and customised financial projection models should then be designed and constructed to incorporate these drivers and variables in order to project likely financial performance across a selected period, usually five years, and to assess financial feasibility.
If done properly, these financial feasibility assessment models can become valuable management tools which can be run repeatedly in order to project financial performance by month and year in all anticipated operating circumstances. Of particular importance, cashflow patterns can be mapped and analysed to identify likely maximum cash requirements under all scenarios contemplated, thereby allowing debt and/or equity financing requirements to be planned on a timely basis.
All businesses differ in the scope and range of variables likely to impact upon financial performance. Comprehensive, well-designed and well-constructed financial models should be able to easily and repeatedly test for the effects of changes in all variables likely to impact upon the financial performance of the business, project or investee entity. Importantly, they should also be able to test all relevant permutations and combinations of relevant variable sets, and to estimate the effects of both upside and downside departures from the anticipated scenario. (F1F9 Academy)