Building a financial model that lasts beyond listing

A financial model is a must. When you look through any checklist of things that a company must complete ahead of an initial public offering (IPO), a working capital model is always a crucial item. But developing a financial model isn’t a compliance task to be rushed through before moving on to the next item on the IPO preparation list. A well-built model can add real value to a business before, during and after listing.

Role of a financial model in an IPO process

There are three main ways a strong financial model can support a listing process:

1. Developing the strategy and equity story

Before listing, a financial model is critical to developing a company’s strategy and equity story by allowing the profitability and cash flow impact of different strategic options to be quantified and assessed. A robust strategic planning process, including an assessment of downside risks and mitigating factors, enables management and the board to align with a strategy underpinned by robust financial projections. The strategy and the business plan can then be the starting point for discussions with advisers, analysts and potential investors ahead of embarking on an IPO transaction.

2. Underpinning the sufficiency of working capital

As part of a listing process in the UK, the directors need to be confident that they have sufficient working capital for 18-24 months following an IPO or provide a statement setting out available cash resources. This assessment needs to be underpinned by a forecast financial model that accurately reflects the key working capital and cash flow dynamics of the business. The model should also allow for stress testing of a company’s base case forecasts by running downside scenarios, also known as sensitivity analysis, as the model will undergo diligence by the reporting accountant during the IPO process.

3. Good corporate governance 

A robust financial model that management use for ongoing strategic planning and forecasting purposes is a great example of good corporate governance. This would be included in a company’s financial performance and prospects procedures (FPPP) memorandum.

Thinking beyond the IPO

A good financial model will have lasting value beyond the IPO process. After listing, a company faces increased reporting requirements to the market and other stakeholders, with the ongoing need to maintain and refresh operational and strategic forecasts. This is made much easier by a well-designed model that’s integrated into a company’s broader FP&A processes, including for going concern statements in annual and interim financial statements, and viability statements for UK Corporate Governance Code disclosures.

For an IPO, an Excel-based model remains a pragmatic choice. It offers universal familiarity and ease of use among stakeholders, while still allowing for a future transition to enterprise planning tools as the organisation scales.

In a world of accelerating change, management teams also need to be able to quickly respond to external circumstances. A well-built financial model allows quick and easy scenario analysis to quantify the impact of changes to their business.

For example, UK firms have recently had to consider external challenges, such as tariff uncertainty, national minimum wage changes, and National Insurance rises. A flexible financial model can help management to quickly quantify the potential impact of changes like these. This is not only vital when considering the impact on cash flow and banking covenant compliance, to ensure the overall survival of the business and to meet any regulatory disclosure obligations, but also being able to take mitigating measures and respond to potential opportunities faster than competitors.

Here’s one I prepared earlier

Your IPO sponsor or advisor may provide a model template to support your listing process. While these models can be helpful in meeting regulatory and investor expectations, they’re often designed with the transaction in mind rather than the needs of the business and management team. As a result, they may not fully reflect the intricacies of your business and may not have the flexibility or utility needed for use after listing. 

Alternatively, it may be tempting to dust off a previous financial model perhaps developed for a different purpose, but it’s worth reflecting on whether this is really suitable. For example, does it really reflect the current dynamics of your business? And are you confident that the model still works correctly, and that your team still understands how to use it?

Even your existing financial model will need review. It may not cover the full period required for the working capital statement, for example, and almost certainly won’t look far enough ahead to be suitable for longer-term business planning. While it can be tempting to just add a few columns on the end to extend the timeline, budget models tend to focus on detail and not on flexibility, which isn’t what you want for longer-term planning and scenario analysis. 

One size does not fit all in financial modelling

A good financial model should be designed and developed for your specific business. There’s no one-size-fits-all approach to modelling, even for businesses in the same sector. It’s essential that the drivers and dynamics within a model reflect how your specific business works and match the way that you think about forecasting and strategic planning as a management team.

The best model is one built in line with best-practice principles and with a clear focus on the end user in mind throughout. This includes the following factors:

• An intuitive model structure with clear labelling and signposting so anyone using the model can easily find the information they nee
• All input assumptions separated and easy to find so they can be quickly updated as part of any forecasting process, and understood by any stakeholders looking at the projections
• A quick, easy process to update the model for new monthly actual profit and loss and balance sheet results on an ongoing basis, and to refresh the forecasts on a rolling basis each month to ensure they’re based on the most recent information
• High-level sensitivity and scenario functionality to allow for quick and easy what-if analysis
• Clear and insightful presentation of output forecasts, including KPIs and graphs, to bring the business plan and strategy to life
• Fully integrated financial statements, with the profit and loss, cash flow, and balance sheet forecasts all built up from the same source assumptions (without a balancing figure in sight)
• Simple formulas using straightforward functions that are easy to understand, reduce the risk of error, and help users understand the flow of logic
• Built-in integrity checks that alert the user if something doesn’t look right

A slick, well-presented model will inspire confidence from internal and external stakeholders. It demonstrates that management has undertaken a robust strategic planning process, as well as meeting the IPO requirements for the statement that refers to sufficiency of working capital.

Building your model – IPO or not

When market conditions are favourable, potential IPO candidates must be able to move quickly.You don’t need to wait to develop a high-quality strategic planning and working capital model, however. By investing in one early, you can ensure that it’s tested, refined and embedded within the business well before any IPO. Such preparation streamlines working capital and FPPP processes, giving you a head start toward a successful listing.

And, if for any reason you ultimately choose to remain private, the model remains a highly useful and effective tool for ongoing strategic business planning and decision making.

For insight and guidance, get in touch with David Mountjoy.