Once you have a financial model in draft form, it is important to verify that at current sales levels, the level of profit produced by the model closely matches the actual profit. You should also run some what if kinds of scenarios to be sure the model is producing results that make sense and are of the right order of magnitude. In a what if scenario, you change something such as the markup on goods, or the sales volume and see how profit is affected.
What kinds of questions do you want to ask? In general, you want to change things that are in your control and see the effect. You are looking to find things that have an oversized impact on profit. For example, you might increase advertising and see an increase in sales. The model might show you one of three outcomes: (1) Profit is increased significantly, (1) profit is unchanged, or (3) profit is actually decreased. In the first case, you can then focus on increasing the general sales level and grow your way to higher profitability, spreading your costs over a larger sales base. If you did not increase profits, it is probably that the cost of increasing sales is very high or that your profit per unit sold is at a low level. In the third case, your cost of customer acquisition is high or you might actually not be making any money on a per unit basis on what you are selling.
If the model showed that you did not increase profits, you want to be smart here and try to increase sales of your most profitable items or increase sales to your most profitable types of customers. This of course requires you to identify which products or customers are most profitable and why and build it into the model. You might also think about new lower cost sales channels, more effective advertising approaches, etc.
What other questions can you try to answer with a financial model? The list is long but here are some to consider:
Should I hire more sales people?
Should I increase my retail store space or production space?
Do I need to cut costs?
Should I begin production or start selling a new product line?
Should I drop a product line?
Should I raise or lower prices?
What can I do to have the greatest impact on profitability?
In general, any business decision you need to make is likely to be easier and more informed when gaining the insights the model can provide.
The most valuable thing to gain from a financial model is to learn what are the best actions you can take to increase profitability. More on this in my next post.