Financial models unpacked

The business world of 2025 and beyond is dynamic, with shifting tides that can quickly sweep an unsuspecting business off its feet.

To stay standing, businesses need robust forecasting tools that clearly display their current and expected future financial performance. Financial models are a key tool to deliver this essential insight and are used to support a wide variety of business decisions – ranging from cashflow management to merger and acquisition (M&A) undertakings.

Introduction to financial modelling

Financial modelling is the science art of creating a driver-based representation of a company's financial performance. These models are used to forecast future performance, evaluate potential investments, and support informed business decisions. There are various types of financial models, ranging in complexity and output, with some examples including: 

• Discounted cash flow (DCF) models to support a valuation process. 
• M&A models to help potential buyers understand target performance and impact to capital structure and performance to the group post-acquisition.
• Leveraged buyout (LBO) models, where the acquirer looks to lever up (read: add debt!) the target business to help fund the potential acquisition. 

Every model should serve a specific purpose and help answer a question or problem statement that requires further insight for a business.

Why is financial modelling an essential part of business strategy?

At its core, financial modelling serves as a management tool to help businesses navigate their future. A model allows stakeholders to break down the moving parts of a business and forecast what lies ahead. It offers ‘what if’ scenario analysis that can support and build confidence in decision-making. 

For example, in property development projects, which are typically capital intensive and require material upfront investment, the development team can understand (with the help of a purpose-built model) the project’s potential performance and returns, considering a range of build cost scenarios, and the optimal capital structure for each.

The power of cash flow forecasting

One area where financial models shine is cash flow forecasting. At the start of my career, a wise man once told me, “Profit is an opinion; cash is a fact” (Thanks, MB!).Jokes aside, the bottom line in profit and loss statements is subject to accounting policy and judgment due to technical accounting requirements. On the other hand, unlike other financial metrics, cash flow is straightforward and not influenced by accounting standard treatments." 

A well-structured cash flow model provides insights that go beyond just profit and loss statements. As alluded to earlier, non-cash items are included in the profit and loss, which means there can be significant differences between a business's earnings and its net cash flow movement. 

Consider this example:

• A business recognises revenue upon completing project milestones. 
• However, the customer payment terms allow the corresponding cash payment to be received in the following month (i.e. Debtors / Accounts Receivable / Working Capital impact). 
• In this case, the profit and loss statement would give a misleading picture of the business's cash flow generation profile.

Cash flow forecasts are valuable because they offer an unbiased perspective on a business's outlook. Having a clear view of the future cash on hand is essential for understanding a company's solvency and long-term sustainability. Most importantly, it allows management to see the business's capacity to distribute capital, which is crucial for any debt or equity provider.

There are two key methods for displaying movements in cash:

1.    The direct method

The model starts with the opening cash balance, then calculates all the required movements to give the forecast closing balance.

2. The indirect method

The model starts with the opening cash balance again. However, it builds a cash movement by summing an accounting-based starting position (i.e. Net Profit After Tax), adding back non-cash items (i.e. Depreciation) and the changes in balance sheet accounts (i.e. movement in Debtors).

Whether you prefer the direct or indirect cash flow build-up methodology, it’s safe to assume that whoever coined the phrase, ‘cash is king’, probably wasn’t an accountant. Cash flow forecasts are critical to understanding the financial stability and performance of a business.

The evolution of financial modelling tools

Financial modelling has changed and become more sophisticated over the years, but whilst AI is starting to make strides in automating part of the process, it’s not ready to replace the need for human expertise (…yet!). For the immediate term, tools such as Excel, which can consolidate business data, provide a flexible user interface and offer granular insights, remain crucial in ensuring businesses have a robust foundation for informed decision-making.

There are other tools available that offer innovative features, such as cloud-based inputs and data storage. However, it’s important to consider whether the benefits of these tools outweigh the risks. Additionally, the user experience and licensing requirements of these tools can be significant roadblocks. In contrast, Excel is typically already available for users, and Microsoft continues to invest in developing new functionality and improvements on a regular basis.

There are projects and use cases that require more advanced or powerful tools (like Python scripting, Power BI visualisation, etc.), and we approach each project with an open mind to determine the optimum technical solution to balance user experience, functionality requirements and costs.

Advice for startups and small businesses

Financial modelling is not just for large corporations. Startups and small businesses can benefit from having a clear, simple, and scalable model (the growth will come!). Keep it simple and laser-focused on the key requirements, and add additional functionality when required. Managing cash flow and not overcomplicating the model are vital; scaling can come later as the business grows.

Key points for learning financial modelling

For professionals aiming to specialise in financial modelling, it is important to develop strong skills in accounting and finance. However, whilst understanding the impact of transactions, profit and loss statements, and cash flow forecasts are key components, you also need curiosity, problem-solving abilities and listening skills to develop fit for purpose solutions.

Financial modelling, at its best, reflects a deep understanding of a business’s unique operations and structure and creates a user-friendly tool to reflect it.

Our key tips when considering requirements for a new model

• Understand the purpose of the model - what is the fear to resolve?
• Be clear on the objectives of the model. Do not expect one model to be all things to all people. 
• Establish (and agree upon!) the key business drivers - what moves the dial?
• Engage early (and regularly) with stakeholders early in the process.
• Remain agile – be ready for the inevitable event that puts current workings / approach on its head.
• Use scenario analysis / consider ‘what-ifs.’
• Check, check, and recheck.

Partner with RSM for expert financial modelling services

Financial modelling doesn’t have to be daunting. RSM is well-equipped to help businesses of all sizes optimise their financial strategies. Whether you’re in real estate or retail, mergers and acquisitions or accounts payable, or just simply looking to streamline your cash flow forecasting, our team is here to guide you.

Ultimately, seeking professional guidance can save time, money, and stress. At RSM, we’re here to take the complexity out of the process, so your business can focus on growth.

Contact RSM today to discover how our financial modelling services can unlock the full potential of your business.
 

To learn more about models, contact our national Financial Modelling Services lead, Tim Linke.