Posted : 25 Apr,2023 | Admin
3 business situations when a monthly financial model should be used.
A financial model plays a pivotal role in almost all corporate finance transactions. It provides the basis for making a business case, negotiating the terms, and closing the deal. There are different decisions to be made as a financial modeller before starting the model build and design part, some of which include worksheet structure (setting up the header, column definitions, freeze panes), length of the model timeline (start and end date), and most importantly the frequency of the model timeline (monthly, quarterly, or annual).
Model timeline frequency is critical because it determines the granularity of input assumptions, calculations, and analytics inside the model. Financial models built on higher frequency timelines, especially annual ones, are good for the initial assessment of the business, but they often fail to answer questions required for dealing with external investors and lenders.
In my experience, most finance professionals are familiar with annual timeline financial models. This is because they are relatively easy and quick to put together, and you can even find online templates. However, in real corporate finance transactions, a granular timeline (monthly in most cases) is required to understand the details of the business and answer investor queries. Let us look at three business situations where a monthly timeline model can be used.
1) Equity fundraising: There are different stages of equity fundraising in a business lifecycle, like angel round (Idea stage), seed round (Product/service ready), pre-series A (customer adoption and early cashflow visibility), Series A (product market fit achieved with solid growth projections), and later rounds for mature businesses. For very early angel or seed rounds, investors are more interested in understanding the idea and its scalability as the business is at a pre-revenue stage and has very little or no financial history. Therefore, the founders may use an annual financial model to present their business plan, as the objective is to demonstrate the business’s future potential after the product market fit is achieved and it is successfully launched.
The need for a granular and professionally built monthly financial model arises when a company deals with institutional venture capitalists, private equity funds, or another corporation. Such investors ask many questions to understand the current and future positioning of the business (like seasonality in sales, monthly growth rates, profitability margins, cash burn, cash runway, the funding required, etc.) before even giving a term sheet which is followed up by thorough due diligence.
2) Debt fundraising: Banks usually fund businesses that demonstrate a credible history and can pay the debt service in the future. Borrowing companies use the financial model to prove their creditworthiness and negotiate key loan terms like debt sizing, cost of debt, loan covenants, etc.
Again, calculating the drawdown period, loan amortisation schedule, loan covenants, and their impact on business financials can be most appropriately determined on a monthly timeline. However, in cases where the model timeline is substantial such as the project finance models with 25 to 30 years of concession term, it is advised to decide the timeline frequency based on the frequency of debt service payment to be agreed upon with the bank.
3) Ongoing business reporting: In most cases, financial models are assumed to be a one-time tool built to support financial transactions. After the transaction is over, it is not used. The transaction models contain very critical information in the form of business drivers and target financial outputs. If the
structure of the model is flexible and calculations transparent, then it can be converted into a powerful forecasting and reporting tool for the business.
Most businesses report monthly to internal management, so a monthly timeline model can be used to capture budgets/plans, do continuous re-forecasting, and report variance against the actual results.
There can be situations where the requirement is to report weekly, such as weekly cash flow analysis and business KPIs analysis, for it is advised to build a separate tool with a weekly timeline.
In conclusion, deciding the model timeline frequency is critical and should be decided before starting the model build. Changing the timeline frequency after the model is completed can be very challenging and may lead to errors in the model. Therefore, a financial modeller should understand the stage of the business, the objective, and the audience of the financial model to make the right decision. An annual timeline model may be enough if the aim is to create a five-year business plan to raise seed funding for an early-stage business. However, a monthly timeline model is recommended for fast-growing or mature companies seeking external funding through debt or equity or to do ongoing business forecasting and reporting.
At FAB Analytics, we specialise in building granular monthly models in Excel for corporates, funds, financial consultants, and advisors. Our team is professionally trained in the best practices standards, such as the FAST standard. We provide full spectrum financial modelling services, from transaction modelling support to running ongoing reporting and analytics for our clients.