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05
Nov
2010

Financial planning is always a critical part of corporate plan & strategy. It is not merely a number game in isolation with what markets offer and what a corporate strategy has to convert to frame results that we present as financial projections.

I see financial modeling in below aspects of financial planning:

Objectivity in development

Business Sensitivities

Price of Finance & Value of Returns

Technical issues & real time adjustments

1- Objectivity in Development

The objective of financial modeling is far beyond projections of what can happen. It is actually an integration of financial planning & desired outcomes. Here the concept of desired outcomes is not merely a numeric representation of desires but posting of valid probabilities [assumptions] that bridges plan and desired results.

In this regard financial model represent the sensitivities of current standings, strategy for future & technical impacts of the results that we can have once our strategy hits the financial & market environment of business.

2- Business Sensitivities

Below are some points that financial analysts have to care while developing these models on sensitivity fronts:

We can not be so liberal while posting the projected earnings. Massive trust or over confidence on what we can earn ensure weak risk assessment and then psychologically [financial psychology] poor risk management framework. It is though recommended to strongly deflate our intentions to see brisk revenue scenarios for the sake of planning.

Costs and Expenses [C&E] are the most disloyal attributes of business finance. They can turn volatile more than anything else. It is always recommended to over inflate C&E to the rational levels so projections shall not present brisk index of company’s financial strengths. This helps us giving direction to financial execution not to relax on cost management. Sometimes we estimate cash flows at conservative and sometimes we adjust this effect by inflating discount rate in valuation models.

Financial Modeling is not a one desk work. It is actually a horizontal integration of various operationally turned financial models. We can benchmark our operational cost structures via benchmark industry ratios e.g. Inventory over revenues or we can analyze regression of our own corporate results but the matter of the fact is that business sometimes react contra market and contra regression. The crucial fact is that the financial modeling is not an analysis of historic postings neither it is merely based on what markets behave in certain point of times. We are more concern to analyze causes rather than impacts. It is recommended to forecast causes to ensure stable financial models rather than impacts.

Whatever happened in past was not reasonless. Our financial model is actually representing future that is always uncertain but we can have valid reason to say something. The things that are probable is considered as prospective happenings and the within these probable events an amount of negative probability has to be taken as discount factor to reach a net probable position. This step need a real concentration and grip over market and business sensitivities via continuous research process. This is why the first step in financial modeling is to develop assumptions and deriving numeric representation of these assumptions that actually become the basis of developing projected financial statements.

3- Price of Finance & Value of Returns

It is not only operations that actually construct scenarios of success for business. An operationally successful business can be a failure without a successful tax and financial cost planning. It is always recommended to see financial cost and taxes in isolation over a business base in first shot and then plug it in with the operational activities to arrive a net position.

First of all we need to know how much of financial cost and taxes we will incur if we work on our desired operational plan. If we anticipate negative hit due to taxes and finance cost then we have two options. The first is to tailor our operations according to the best ops-finance cost mix and second to find smart financio-Taxation solution. Second one is always a best way but need a lot of financial innovations.

We can work with financial engineering to structure our finance and taxation to alter the timing of financial & tax flows that can work great impact on value of business. The financial models always have to be flexible to cater strategy alteration over a period of time.

Financial models have to be equipped with separate analysis and projections of each business unit so do for price of finance and taxation. It is then we can sum each of these to reach a master financial model that shall represent the totality of business derived from cluster analysis.

Even the impact of depreciation is crucial. The decline in the value of asset due to its usage and obsolesce has to cater in distinct manner. The depreciation method has to reflect both these attributes that can help us understanding the revenues we retrieve from usage of these assets and the value of company’s asset in the context of up gradation of asset’s technical features in new assets available in the market. May sometimes the book value that is shown in balance sheet is merely the index of the value that is net of usage depreciation but we ignore the perspective of obsolete technology.

We sometimes ignore the factor of obsolesce. The most important fact is that fix assets are being financed by equity [internal or external] or debt. We need to synchronize this scenario to assess what we are paying to have an asset and how fast we are loosing the value of asset in this specific period then what we get from it.

We can not avoid the concept of value over each and every account because mere balances of forecasted financial statement can never be termed as financial models. We always have to reach the corporate value and value of company’s share for business decision making. The worth of shareholders can not be assessed in accounting sense but what they derived in term of value over a certain period of time in comparison to the money value at the time of investment.

4- Technical Issues & Real Time Adjustments

Financial Models are not static models that we develop for once and carry all through the tenure of our financial cutoff. We always have to adjust our models with developing scenarios, market and business sensitivities. If we have a five year period that we are projecting so with every one passing month we can have a different picture that can affect the remaining time of our planning horizon.

Financial modeling in above regard is not a one time exercise. It has to be equipped with strategic flexibility that they can be adjusted real time while deviations are witnessed due to market volatility or level of business incapability to convert plan in action. Actual result can also suggest us whether the standards set was realistic or not.

It is always recommended to companies to have a technical base that assist financial planning and control on real time bases. Companies need to invest in financial software that should be well connected with each unit of operations to assess the performance and variation from standards. We always have to be dressed with sound technology that once a single variable get altered we can have a new financial model within no time that can set our direction for future financial and operational strategy.

Even on accounting front our software needs to be really responsive via class MIS that we can better carry the role of financial control. Accounting & Audit are the regulatory requirements but they are not the index of value anyways. We need to have severe technical infrastructure within our financial software that can show us the projected value of business if we continue the results that we are having anytime within the tenure of operating financial plan for the term.

Conclusion

Financial Analyst of the company in coordination with finance units manufactures financial models. In my view analysts need to coordinate with different units of business regularly to understand business firmly. They even need to interact with the markets. In addition they need to understand the science of management so that they can forecast management of diverse and scattered operational and financial variables. Consistent allocation of time on research is the key for mastering financial modeling skills that an analyst can develop once he tries to work with objective of having close results in comparison to his projections. The point that financial analysts have to understand is that the numbers are not self appearing. There is a hell business and markets that produces these numbers. So better we allocate a lot time to understand business and markets that shall provide life to our financial structure awareness.


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Mr. Omer

Mr. Omer [1982 born] started  his professional career as a commercial / investment banker after achieving Gold Medal in Finance at master level from University of Karachi in 2006.

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