The Most Important Part of the Business Plan | The Financial Model
During the 2000s, business planning and entrepreneurship experienced a resurgence due to the massive and expansive growth of Web 2.0 businesses and the solid GDP growth of the US. There was a deep hiccup in terms of the 2008 Great Recession, but for all practical purposes, this was nothing more than a major market correction that signaled the exponential change business has undergone with the integration of technology in the way we live life and build wealth.
As the saying goes, though, “the more things change, the more things stay the same, and this is true of starting and/or expanding a business. Business planning remains the cornerstone of improving the probability of survival and success in commerce.
The tools of planning have improved and changed, but the purpose and foundation of it have not. This valuable resource is more than a “glorified document”; it is a roadmap that keeps the business owner and his / her team focused and also serves as a lever to enhance the business’s investment prospects with both debt and equity sources of capital.
The definitive part of the plan rests in the logic of the financial model because it provides a comprehensive and integrated layout of how all the other components of the business work together to produce a sustainable flow of cash and ultimately profit.
What Is A Business Financial Model?
This part of the plan documents and explains how the business makes, spends and accumulates money in the language of numbers. The reality of business is that the operations of the firm must provide a reasonable value to the marketplace to justify an exchange of resources (i.e. products/services for money).
The numbers included in the financial model provide the narrative of how the firm will accomplish these objectives. In order for these figures to have merit, the entrepreneur must provide “proof” of the business model via a sample of actual sales or rely on primary market data segmented specifically by location and industry.
Depending on the stage of the business cycle, this portion of the plan includes financial projections of the main business financials (i.e. balance sheet, income statement, and cash flow statement), assumptions that motivate these projections, and supplemental disclosures such as notes to these projections.
What Are The Benefits of Producing and Using A Business Financial Model?
There are 2 main benefits of including this model in the business plan:
(1) Quick Access and Review by Capital Providers
For most entrepreneurs, debt and equity providers are key components of aiding the business in establishing or growing operations to a profitable level. The downside to this reality is that a majority of business owners are not prepared to pitch their businesses properly because they lack the proof. All is resolved, though, once the financial model of the business plan is completed. Not only does the entrepreneur have the proof of an actual document, he/she she will also have the ability to tell the story behind the numbers in a concise and targeted manner. The ability to tell the business’s story in such a way increases the odds of investment substantially because both management and business risk are mitigated by both knowledge and action.
(2) Forces The Business Owner to Validate the Business Model
Once the entrepreneur completes the financial model, he/she will have a solid understanding of the business’s prospects of sustainability and profitability. The “mousetrap fallacy” cripples many prospective entrepreneurs into believing that their business is a necessity to the market when in reality they have not taken the time to really validate (i.e. prove) the business model. In the immortal words of the Apostle Paul, just because you can do a thing well does not mean you should do it. In order to give yourself a head start in business, do the homework and put in the action to build out the business financial model.