Muddling can be defined as coping in a more or less satisfactory way despite a lack of understanding, expertise, planning, or equipment. Hence the expression “ I don’t really understand the problem or the solution, so guess I will have to muddle through it”.
Hardly inspiring and hardly a good course of action if the objective is to comprehend or understand something of significance.
Of course, when you are running a business or responsible for the financial well-being of a business, muddling is DEFINITELY NOT a good idea.
And yet it is quite amazing how many businesses – sometimes mature businesses – muddle through when it comes to financial planning! So often monthly reporting is mechanised and the real essence of the resultant financial statements is often not understood – particularly relating to cash flows.
Understanding the elements of cash flow is an essential for effective financial planning and in the case of start-ups, it is critical.
Statistically 85% of start-ups fail due to inadequate financial planning.
In truth the only way to build an effective predictive financial model is with the full participation of the client.
Whether this relates to an existing business or a start-up or a new project, a complete and comprehensive understanding of the business case is essential.
And sometimes the information provided by – or elicited in Socratic discussion from the client – needs to be supplemented by intelligent research.
Effective financial planning – relating to existing businesses – needs to be reviewed in the light of prevailing business conditions- such as:
- the state of the economy
- the specific market segment
- the competition and traditional competitive advantage
- the product range
- government legislation
- human resources
- financial resources
- technological competence, amongst others
Clearly all of the above considerations need to be assimilated in the context of the purpose of the model and the detailed results the model should produce.
Financial models can be divided into three broad categories, namely:
- Existing businesses where historical information exists which can be used as a base for future performance – and adjusted for the considerations above,
- Start-ups or new projects where the model will be based on an extensive business plan or underlying technological models such as mining plans, real estate development cost and program schedules or renewable energy calculations.
- Businesses or business activities or processes which have not previously existed. i.e. the creation of some new method of learning or some new digital application. These models invariably require the use of probabilities and Monte Carlo simulations.
Irrespective of the category and presence or absence of history, it is paramount that all relevant model drivers – input assumptions – must be clearly identified and are capable of easy modification.
Furthermore, best practice international modelling process and methodology are vital elements. Basic characteristics are flexibility, logic, sequence, structure and 3 statement financials.
Bearing in mind that financial models are predictive tools it is important to accept that when we attempt to explore or predict the future, certainty disappears.
The real value of a financial model lies not in its surgical precision but in being properly researched, properly built and flexible to allow ‘what -if” analysis, sensitivity identification and alternative scenarios.
Colin Human CA(SA)
Goalfix Financial Modellers