Description of the Financial Model - Essay Example

In some cases, financial models may also quantify the financial impact of the policies of the firm, and covenants or restrictions imposed by lenders or investors. A cash budget is a basic financial model.

The engineering consulting firm generates a stream of $48,000 in monthly revenue for the first year from six customers, two per partner. A lot of time is spent on travel, about 30 trips per partner, in a year for $2,000 per trip. Every partner buys a new computer and updates software for $5000 per year. The firm looks forward to expanding to four customers per partner by the third year with assumed monthly revenue of $3000.

The following cash flow will be the firm’s financial model.

Item

Amount($) Year 1

Growth rate

Year 2

Year 3

Year 4

Year 5

Revenue

8000 per month

96000

Expenses

Traveling expenses and conferences

30 per partner (3 partners) @2000

(18000)

Computers and software

5000 per partner

(15000)

Gross Profit

63000

The firm is likely to have a gross profit of $63,000 per year if the trend continues. However, changes are possible due to taxes, interests, and inflation rates.

Description of the financial model

The financial model is the gold standard for valuation. Cash budget and cash flow have been indicated as the best proxy for the financial performance of corporate. The above financial model is easy to build just like cash flow. One column holds annual cash flow estimates, and rows hold individual itemized expenses. The model states yearly estimates depending on the firm’s revenue generation. In the case of existing growth rates, one can create bulk estimates that apply the same rate of growth for five years.

It is significant to note that sophisticated or detailed modeling does not substitute discretion or judgment. Reality checks will be conducted periodically concerning the core assumptions. The financial model illustrates what the firm must do to grow, the value of the growth, and what is expected of the firm. Financial models, even though take time to build, can pay for the consumed time and result into bein investment decisions.