Uncertainty is a given for many businesses, whether it’s around where the next customer is coming from or the size of the next electricity bill. However, these uncertainties can multiply for businesses looking to scale-up. Growing too fast can be just as disastrous as not growing at all.
SMEs can easily overextend themselves as they expand. Incurring large liabilities that can no longer be serviced can lead to complete closedown. In many cases the lure of an improving economy or expansion into an untested market can lead to failure. Using a well-designed financial forecast model to underpin a business plan can help to avoid these problems.
A financial forecast model shows a business how it is likely to perform based on a series of assumptions. It can help determine the validity of a business’ expansion plans by forecasting expected revenues and costs. Critically, a good financial model will highlight fixed costs to determine the Global Insight April 2018 | 18 required breakeven level of revenue. In many cases, costs such as leases and wages become unsustainable if demand for products or services falls away.
Proper business modelling includes forecasting what’s expected to happen, as well as alternative scenarios of what could happen. Scenarios will be built around a number of alternative assumptions to determine their impact on the business. These mightinclude new projects, rent increases and factors affecting the underlying drivers of demand.
Scenarios help businesses to reduce the uncertainty of a course of action by determining the upper and lowerlimits ofthe impact of both positive and negative factors. Armed with this knowledge, a company can act with greater confidence based on an understanding of whether actual results are within acceptable benchmarks.
For example, effective financial modelling could have prevented a number of recent business failures in Australia by putting the companies involved in a stronger position to consider the impact of large increases in leasing costs when opening new stores and their ability to secure the revenue required to meet these costs. They might have asked themselves whether demand would still be sufficient in, say, 6 or 12 months, and perhaps considered delaying opening a new store by a few months.
Financial modelling has traditionally only been available to large corporations or government-owned utilities, but recent business failures show that it is a fundamental discipline that every business should use. Without a full picture of the possible consequences, the potential risks of aggressive growth plans are too significant to ignore.