What is Financial Modeling: All you need to know about Financial Modeling

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What is Financial Modeling: All you need to know about Financial Modeling

Financial modeling is a potent analysis tool/skill for financial officers worldwide. All types and sizes of corporations use financial modeling to represent a company’s expenses and earnings in the summarised form of a spreadsheet. 

What is Financial Modeling?

The model can be used to show the company’s past performance, compare it with the present position, and predict the future. Large companies also use financial models to calculate and estimate the costs of new projects, return on investments, profits, net present value, etc. The mathematical model is used to make critical decisions based on the model’s output. 

MS Excel can be used to build Financial Models. There is various other software that can be used, but this decision may vary among individual analysts and companies depending on their comfort and preference. Many times, giant corporations build their own software to solve this problem.

However, excel is the most widely used software to build financial models because of its user-friendly design and because it is a much cheaper investment. A financial modeling course to build on your financial modeling skills can be an excellent way to develop expertise to create such models for your companies. 

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Uses of Financial modeling

Financial modeling has multiple uses for businesses. They help in making accurate and informed decisions. Financial modeling skills are essential to creating such models. Some of the most common benefits of building financial models are as follows:- 

  • Prediction of the future: Predicting future financial statements like cash flow statements, income statements, balance sheets, etc. It is used to estimate the profitability of an investment in a project, asset, etc. These models are particularly helpful in budgeting, controlling outflows, capital allocation, etc. This information is extremely crucial and is used as a basis to make management decisions that determine the future of the company. 

  • Estimating the net worth of businesses: Businesses are valued in different ways, and one of the ways is to value them based on their ability to generate future cash flows through financial models. 

  • Raise capital: These models are shown to the investors so that they can make a decision about funding or equity purchases. It helps them make informed decisions about the valuation of shares and other securities, or even analyze a company for Mergers and Acquisitions. 

Hence, getting into a financial modeling course and learning financial modeling skills has a lot of advantages for any candidate. 

Advantages of knowing how to make Financial Models 

After looking at the various uses, it is clear that financial modeling skills are beneficial and cater to making decisions keeping in mind the future.

Someone who knows how to build a model is at a considerable advantage because companies actively look for individuals who understand and can analyze a problem and build relevant models. A list of a few of the benefits of good models is below:-

  • Helps to minimize the financial risk of a business by preventing them from making bad financial investments. 
  • Helps in understanding the business and its past, present, and even future trends. 
  • Helps in proper allocation of the funds of the company. 

Financial modeling courses and financial modeling skills are definitely the future. 

Financial modeling tools

Financial modeling, an essential tool, cannot be inaccurate or with flaws. The analyst building a model needs to have the skills and knowledge relating to the built model. Financial modeling tools and financial modeling skills required by an analyst include: 

  • Strong Base in Finance: Since you will be dealing with three primary financial statements- cash flow statement, income sheet, and balance sheet, the basic accounting knowledge should be strong so that mistakes can be avoided.
  • Excel Skills: Knowing how to use excel is essential as it is the most basic and beginner-friendly software available. To be able to use various excel functions and shortcuts to be efficient and accurate is critical.
  • Forecasting: Every model is built on certain assumptions. These assumptions will vary from analyst to analyst, and the requirements of the model opted. Historical data coupled with foreseeable future estimates are used to make assumptions, but they need to be close to accurate. 

  • Eye for detail: The company’s financial statements will consist of various line items. The analyst must look into every item and sometimes read between the lines to retract information. 

  • Presentation skill: The information gathered needs to be conveyed in the simplest form and in the least possible time is very important. 

All of this and more about financial modeling tools can be learned in a financial modeling course. 

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How to Build a Financial Model 

After understanding the financial modeling tools, here are a few basic steps needed to build a good model. These are just the basic steps; you as an analyst will have to customize them based on why you’re making the model. Every analyst has a different thought process and method to execute the model; no two analysts can arrive at the same value. 

The objective of the model: Financial modeling forecasts can be used for various purposes. Depending upon the purpose, decisions are made regarding the choice of model, techniques to apply, etc.

Valuation Method: Once the objective is decided, the method to calculate the decision-making factor is selected. There are various methods like the discounted cash flow (DCF) Model, M&A Model, LBO Model, etc., which can be used as per the purpose.

Assumptions: Most of your time should be spent gathering assumptions for your model. It is said that “your model is as good as your assumptions”. Taking realistic factors and assumptions will help make the model as accurate as possible. 

Entering the data: You have to make a template for your model and enter the data into the spreadsheet template. Usually, historical data is used to predict future values. Taking data from not more than the last 5-10 years is recommended to help with the model’s accuracy. Also, predicting values of more than five years becomes very unrealistic. 

Forecasting and Analysis: once the data is entered, the forecasts will come up on the spreadsheet based on the formula applied. Now comes the next foremost step of the process.

Make sense of the data that you have created. Analyze how it is relevant, comparing it with the company’s historical data, competitors, and the industry. And if any decision needs to be made with the results of the data, that needs to be analyzed and justified. 

Sensitivity Analysis: Since the model is based on assumptions and is just predictions, it is better to predict the data for various scenarios. For example, if you have taken the growth to be at 10%, you can use the What-If analysis in excel and make changes to this rate and get different results at different values. 

Such things are covered in detail in a financial modeling course. 

Types of Financial Models 

The most common types of financial models include:

  • Three Statement Model
  • Initial Public Offering (IPO) Model
  • Leveraged Buyout (LBO) Model
  • Budget Model
  • Forecasting Model
  • Option Pricing Model
  • Discounted Cash Flow (DCF) Model
  • Merger Model (M&A)
  • Some of the Parts Model
  • Consolidation Model

The different types of financial models are covered in detail in a financial modeling course. 

Frequently Asked Questions 

  1. What is the scope of financial modeling?

Ans. There is an extremely wide scope for financial modeling. It includes gathering information and making decisions on topics ranging from mergers and acquisitions, and capital raising to internal planning, budgeting, forecasting, and valuation. 

  1. What are the basics of financial modeling?

Ans. To be able to do financial modeling, one needs to be proficient in finance and accounts as well as Excel. 

  1. What do financial models look like? How do you build them?

Ans. Financial models can be built on Excel by considering the following items :

  1. Historical assumptions and results
  2. Income statement
  3. Balance sheet
  4. Supporting schedules
  5. Cash flow statement

4.What is Excel financial modeling?

 Financial modeling in Excel refers to tools used to prepare future financial statements predicting the company’s financial performance in a future period using the assumptions and historical performance information.

Conclusion 

A financial modeling course is a very appropriate skill/tool to have in the world we live in because the world is dominated and backed by data and numbers. It also sets you apart from others who do not know how to build efficient and effective models. There is not a single sector that cannot benefit from financial modeling course. There are ‘n’ a number of financial modeling courses that teach you from the basics of excel to how to forecast and interpret data. Investing in excelling at this skill will not go to waste.

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