When it comes to creating business documents, such as business plans or an information memorandum, Financial Modeling is key. In most cases, financial modeling is utilized by parties on both sides of the document, the one presenting it and the one reading it.
An information memorandum is only as strong as its parts. Two of the primary parts that create the foundation of the document are the market research and the financial modeling. When these parts are not tended to properly, they severely limit the effectiveness, cohesiveness, and believability of a plan.
It should be starting to become apparent just how important financial modeling can be. Below, we dig in deeper to understand the two of the main ways they contribute to the overall the Information Memorandum. As a seller, some of these are within your control, while others are not.
Financial Projections
One of the most obvious ways that financial modeling applies to the information memorandum is creating financial projections. The same it true for business plans or any other place financial projections are created and used.
Most people don’t even realize they are doing financial modeling when they create them, simply because they don’t call it that. But, it’s pretty difficult to determine your projections without it. Typically, you will put down your historic actuals and use a percentage of growth expectation or other type of assumption.
You apply this in the spreadsheet via a formula that calculates the next month or years numbers. This is an extremely basic example but, that is financial modeling. You will then typically go through those numbers and again adjust for any reasonable assumption.
When it comes to the information memorandum, the Financial Projections are key. They let potential buyers know where your business has been and where it is likely going. This will give valuable financial insight that will also feed into the next main use of financial modeling, the valuation.
Business Valuation
A valuation is the process by which you – and likely your potential buyer – will calculate the current market value of the business you have for sale. Valuations, in terms of financial modeling, are usually far more complex.
When you prepare your information memorandum, you are also going to be thinking about the price you would like to receive for your business. You are most likely going to base this off of your valuation. However, there are several methods of financial modeling that can be applied. There are also several assumptions that can change the figures as well.
This is where things get interesting. As part of the buyer’s due diligence, they will conduct their own valuation. This is partially how they will determine what price to offer for the business. If they take the same approach and have the same assumptions, their Financial Modeling will likely lead to about the same value. In that case, great! Chances are you will come to a deal.
This is not always what happens though. Often, the numbers will be significantly different. This is completely natural. After all, your objectives are different. You will want to use a method that will help you receive top dollar for the business, while the buyer will want to purchase it for as little as possible.
Don’t Overlook the Financial Modeling
It should be much clearer now just how important financial modeling is to the Information Memorandum and business sale process. The above examples are very simplistic and there are often other factors that go into the price a business will fetch when up for sale. But, at the heart of it will always be financial modeling.
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