What is financial modeling?
It’s one of the most essential things an e-commerce business needs, but it’s often skipped by business owners. We’re talking about a financial model.
A financial model helps you see the big picture and spot trends so you know how well your business is performing. Whether you run an online health and wellness store or you design and sell a line of clothing Amazon, a well thought out financial model can help your business perform infinitely better.
What is e-commerce financial modeling?
Financial modeling is a form of business forecasting, or making informed predictions. It’s a data-backed estimation of how well your online business will perform in the future, and it lets you plan strategies or make changes accordingly.
For example, a financial model can help you project your future product sales based on your performance so far. You can then make informed decisions that get you closer to your business goals.
How do financial models work?
Financial models are created using simple spreadsheet software. Every aspect of your business — funds, sales, capital, customers, profit, staff, and so on — is represented in the model as a variable. Identifying the variables helps you predict the likely outcome of shifting any of these variables. Want to see the effect of raising your price per cookie? Financial modeling can help you.
There are a few ways to create a financial model for your e-commerce business. By far the most common is the three-statement model, which builds off financial statements you may already be familiar with.
Three-statement model
The most basic financial model uses three financial statements: an income statement or profit and loss (P&L) statement, a balance sheet, and a cash flow statement. These statements are the outcome of various accounting principles and are based on a set of assumptions. In this model, you get to observe how these three variables interact with one another and affect the business as a whole.
Discounted cash flows
The discounted cash flows model evaluates your business’ present value by using estimated future projections of free cash flows. The result is called the “net present value.”
Leveraged buyout
The leveraged buyout model determines the value of a business as well as the returns expected over a period of three to five years. It’s commonly used when a private firm buys a company using a mix of cash and debt, with the intention of selling it after a period of time.
Mergers and acquisitions (M&A)
The merger and acquisition model helps shareholders see the effect of acquiring a business. It shows what the earnings per share (EPS) would be like post-acquisition as compared to existing earnings.
9 reasons your online business needs a financial model
A financial model essentially takes an aerial view of your e-commerce business, which lets you:
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Make decisions to improve your business performance
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Measure business performance objectively
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Track your business growth
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Set and hit your goals
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Allocate your budget based on the forecast
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Identify your business’ future operational needs
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Determine a valuation for your business to secure funding
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Estimate your future expenses
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Get prepared for challenges
A financial model helps you predict how well your business will perform in the future based on how it has already performed in the past.
However, a financial model isn’t just about predicting how your business will perform based on underlying assumptions. It also helps you visualize how your business can grow if you change those assumptions.
In other words, a financial model plays a pivotal role in decision-making to boost your business performance in the future.
A proper financial model values your business in concrete terms. You’ll be using hard data, numbers, and charts to validate whether your business is economically viable.
You can get a fair idea of how far your business has come and decide how much further it can grow in the future. This is how you make sure your vision turns into an economically viable business.
You’ll have a good grasp on things such as how high your sales need to be for you to surpass the break-even point or how much you’ll need to work to double last year’s revenue.
Forecasting is the primary function of any effective financial model. By looking at your entire business as a cohesive whole, you can make informed decisions about how to allocate your budget to reach your performance goals.
A financial model can help you spot underperforming areas of your business so you can decide how much you need to focus on them. For example, the projections could help you decide what time of year is best to run an ad campaign and how much your ad spend should be.
If outside investment is part of your growth plan, a financial model goes a long way to help you convince potential shareholders to invest in your idea. Figures and growth projections are persuasive for investors — so when you tell them “There’s a big market for this,” you can back it up.
A financial model helps you reasonably anticipate future expenses that arise as your business grows.
A financial model gives you a realistic picture of your business. Not only can you use it to plan for the best, but you can prepare for the worst by adjusting your assumptions.
Create a sustainable e-commerce business through financial modeling
If you aim to make your e-commerce business more sustainable, consider building financial models and testing outcomes so you can discover new ways to help your business grow. Learn how to build your e-commerce financial model and best practices for its creation.
