Implementation in practice

Capital budgeting and investment feasibility studies

Typically, in any organization, investment possibilities of significant size, need to be revised carefully regarding technical-, risk-, market-, environmental- and economic factors. Also, non-economic benefits should be considered, but the focus is on economic factors. As the decision will be made regarding future actions, often the decisive numbers can’t be found in historical data. The new project/ business venture must be modelled based-on: offers, forecasts and qualified guesses. A financial investment model needs to be done and revised many times before the investment request can be handled by management.

Economic analysis of projects

For bigger projects with long-term impacts, the situation is very much the same as with capital budgeting. Projects can also often be short-term and could have no capital expenditures, however, short-term projects still need to be modelled to simulate profitability and cash flows. The term is shorter, and the periods may be months or quarters, but otherwise, the modelling is done the same way to make sure the project gives the required return.

Business planning, budgeting and forecasting

When it comes to business planning, budgeting, and forecasting - the picture looks a little bit different. Although here the focus is also on financial statements and forecasting, the basis for the forecast is on actual data from accounting, with adjustment for changes. Close cooperation with accounting requires good integration with accounting. Especially if the actuals are updated monthly and the forecasts are adjusted regularly. Budgeting is often done per account, per month and per cost center with specific budgeting tools. Then the budget is compared with actual figures monthly.

Valuations of businesses and assets

Valuations of businesses are often done by analysts at investment banks and consulting companies with their own valuation models. The larger corporations have their own M & A departments as well. There is a need for small and mid-sized companies to be able to make their own in-house valuations easily. The basis for valuation is again financial modelling based on historical data plus forecasting, which gives a good estimate for coming cash-flows and some key-performance ratios. The ideal situation is when you get a valuation of your own business based on your long-term business planning.

Life-cycle costing

Too much focus is often put on the investment costs at the beginning, and too little on the use costs and maintenance costs later. Also, it is difficult to compare buying vs. leasing, unless you use financial modelling to generate the cash flows over the whole life-cycle of the object. The most reliable method to make cost comparisons of competing solutions is to estimate all costs over the whole life-cycle and then discount the cash flows of the alternatives to make a comparison.

Strategic scenario planning

When a business is making long-term plans, there are different paths to steer against. Each selected path opens new possibilities. It requires some high-level financial modelling for each scenario to consider the options that each path might open later. The tough part is to estimate the numbers, otherwise, it is normal financial modelling combined with probabilities and valuations of options.

Project finance and corporate financial planning

It doesn’t matter if the project economics are good - if you can’t finance it. Modelling project financing is the next step after profitability analysis. Often it is an iterative process to find the optimal financing. It requires some special knowledge and modelling capabilities to deal with complex banking conditions. Also, it is important to show the financing items correctly in financial statements and NPV calculations. When it comes to business planning, the challenge is even higher, as you have a whole portfolio of loans to model.