Financial Modelling in Uncertain Times
I was asked by a student the other day: "how do we derive any value from our financial models, when no one can possibly predict what's around the corner in this ever-changing world of ours?"
Well, to answer this question I had to think back to my final years working in investment banking. These were very difficult times for businesses in the mining space. In 2015 we witnessed the greatest commodity price slump ever recorded since the global financial crisis of 2009. I was working as a dealmaker in one of the largest investment banks in South Africa during the 2015 crash, as part of their mining team. What we witnessed during that time was a whole host of mining companies engaging in operational and financial restructuring, in order to cope with the quote: "New Normal".
Some companies fared better than others, but the common questions asked by all of the companies were:
How long can we survive in this current environment if we adopt a "business as usual approach"?
Where is the low hanging fruit internally, i.e. what can be cut now or capitalized upon now, to ensure that we weather the storm without doing any long-term damage to the company?
Are we actually viable as a going concern in future, and if so, is there anyone out there willing to save us if we can't save ourselves?
To answer my student I simply stated that the only way to answer the questions above would be to study the financial model of each company, and use that as a departure point to decide on what steps to take next.
In my experience financial modelling is at the cornerstone of any strategic debt or equity funding decision. Although a very small percentage of all the companies I analysed in my career actually followed the operational predictions of their models consistently over time, one thing remained true: The clients that demonstrated the greatest resilience, creativity in problem solving, and ingenuity in adapting to difficult periods were those who best understood their operations. The depth and granularity of analysis which is required to accurately understand one's business is best achieved through effective financial modelling.
In conclusion, I believe that modelling alone is not a magic pill or silver bullet that can be used by management teams to effectively hedge "the world". However, it is an invaluable tool to use in understanding a business' weakest links, and its most robust areas. Through stress testing and compartmentalization of key risks, management can better prioritize their action points, leading to more effective strategy development to weather the storms of uncertain times.
Written by Perry Fisher - Trainer and Course Developer at the Tauro Group (www.taurobiz.com)
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