Financial Modeling: Pitfalls and benefits for a new project

By Shalen Young

Financial modeling is necessary prior to any decision that is made to move forward with any new project, whether it is as small as expanding a current service or as large as building a new hospital. Before committing the necessary resources, you need an expectation of the financial impact the project will have on the organization in both the short and long run. Properly designed models will provide an expected financial impact, as well as sensitivity analysis, to easily understand the impact of changing assumptions.

The biggest pitfall to modeling new projects is identifying all the unknowns that need to be addressed. This will require many assumptions regarding new business growth, staffing requirements, construction costs, equipment purchases, consumable expenses, pharmaceutical expenses, licensing, etc. It is also crucial to have as many stakeholders involved as is possible in vetting these assumptions and adding their input and knowledge. The best driver for these assumptions should be historical data, which may or may not be available, especially in emerging economies where the risk of meeting ones targets is higher. Consequently, newer businesses or established businesses entering new markets will have to depend on uncertain or very little data. The best approach is: the more uncertain the data the more conservative the estimate.

The benefit of financial modeling is that it will provide a good understanding of how the project will impact the organization financially. This will generally mean completing, at a minimum, a project income statement and a few financial measures, such as internal rate of return (IRR), net present value (NPV), payback, etc. For larger projects, such as construction of a new hospital, the model will be more in-depth and should also include a statement of cash flows and a balance sheet. The model should be designed for an expected outcome, but also should also easily project the impact of changing assumptions.

Financial modeling for new projects is difficult and requires many knowledgeable individuals working together to accomplish. While the final decision of whether to move forward with a project is typically up to the executive team or a committee, it is the responsibility of the individuals involved in the financial modeling to ensure that decision makers have the best information to make decisions.

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