“What is financial modeling?”
“Do you teach financial modeling?”
“Can you give me a sample financial model that I can fill with numbers and present in the interview?”
“Do you cover macros while building financial models?”
I’m constantly bombarded with such questions on financial modeling. And, the funny thing is—when I ask the person,”what is financial modeling?”, that person doesn’t have any clue.
So, I thought it’s apt to write on this subject today.
What is financial modeling
As per Invesopedia,
The process by which a firm constructs a financial representation of some, or all, aspects of the firm or given security. The model is usually characterized by performing calculations, and makes recommendations based on that information. The model may also summarize particular events for the end user and provide direction regarding possible actions or alternatives.
As per my experience,”financial modeling” involves building financial models, sometimes from scratch or sometimes maintaining and updating the existing financial models. Financial modeling is a skill and you can learn it through lessons and practice.
What is a financial model?
According to Moneyterms,
A financial model is anything that is used to calculate, forecast or estimate financial numbers. Models can therefore range from simple formulae to complex computer programs that may take hours to run.
In short, financial models are mathematical models in which variables are linked together.
For sophisticated models such as Discounted Cash Flow (DCF) model, you need to use computer.
Microsoft Excel skills are must to build or update financial models.
There are computer programs built for high-end and complex financial models such as—Value-at-Risk(VAR) models used in risk management.
Where can you use financial models
Financial models are used in:
- Historical analysis of a company
- Projecting a company’s financial performance
- Project finance
- Real estate investments
- Oil & Gas projects
- Banks & Financial Institutions
- Personal finances
- Non-profit organizations
- Investment banking
- Equity research
Users of Financial Models
There are four main groups of users that use financial models.
- Business owners and entrepreneurs
- Finance and Accounting professionals
- Financial Modelers and Consultants
- Individuals for personal finance
Let’s see the areas where you, as a financial analyst, can use financial modeling skills.
- Forecasting future raw material needs
- Valuation of a security
- Benefits of a merger
- Check the size of the market opportunity
- See the roadmap to profitability
- Check investment requirement
- Quantify and predict risk
- Portfolio performance
- Identify undervalued securities
The question comes to mind that only one financial model is useful or we need to use different types of financial models.
Types of financial models
There are different financial models that you can use as per the need.
- Discounted Cash Flow model
- Comparative Company Analysis model
- Sum-of-the-parts model
- Leveraged Buy Out (LBO) model
- Merger & Acquisition (M&A) model
- Industry-specific financial model
- Option pricing model
- Corporate finance models
These financial models are used to solve different problems.
As a financial analyst you should know the time and type to use a financial model.
To gain expertise in financial modeling, you should know the financial modeling basics.
Financial modeling basics
Are you preparing for financial modeling jobs? Then only downloading financial modeling templates won’t help. This will help:
- You should be good in Accounting, Finance and Valuation and financial modeling Excel skills.
- Ask yourself, “What problem I’m going to solve by creating this financial model?”
- You should know the scope, benefits and limitations of financial modeling.
- Remember: Garbage in garbage out principle. So, check your inputs.
- Your model should be simple, easy to understand and flexible enough to accommodate future revisions.
- Time management is a key aspect in financial modeling. Don’t get overwhelmed by numbers and calculation part in spreadsheets.
- Lastly, you should be able to take a decision based on your financial model.
In short, financial modeling is a skill and you can develop this skill by learning Excel Financial Modeling Training, applying and practicing it well. Have queries? Speak Your Mind