FINANCIAL MODELLING: A GUIDE TO TAKE BUSINESS DECISIONS What is it Financial modeling is the process by which a company constructs a financial representation of some, or all, aspects of the business. The model is usually characterized by performing calculations and makes recommendations based on that information. Financial modeling works with historical information on companies and analyses the company/industry performance on relevant financial parameters. This analysis is then used as an input to build financial models. These models then project the future financial performance of the companies analyzed and hence give us an estimate of the valuation of the companies. We can say that financial modeling is the task of building a model, on an excel sheet, of a real-world financial situation. This is a mathematical model designed to represent a simplified version of the performance of a business. Using Excel for business has almost no limits for applications. Here are some examples:
Excel creates revenue growth models for new products based on new customer forecasts.
When creating a budget for a small product, you can list expense categories in a spreadsheet.
You can calculate customer discounts based on monthly purchase volume by product.
Users can summarize customer revenue by product to find areas where to build stronger customer relationships etc.
For running business past performance is available but for start-ups it purely subjective. But in both the cases, financial modeling works. It helps in getting:
Brand Valuation and many more
Let’s focus on it……….. 1. It is not an easy task Just like the complex nature of any business, financial modeling also becomes tough and complex or rather say business makes it complex. However, it is sure that tough financial modeling, if done well, results in the fruitful result. 1. Not just mastering into a spreadsheet; it is much more A spreadsheet is just a tool and not the result. Therefore, it is completely a myth that if one can master in working on excel spreadsheet he can master in financial modeling. Financial modeling is really very vast but yes it is interesting too. 1. Think the inputs, pose these, work on and get the real one In finance there are two cardinal rules:
Cash is the king
Cash today is more important than cash tomorrow
Whatever affects the above two is going to have an impact on the valuation of the firm. Therefore all the inputs must be considered to get the best result. 1. Financial Modelling is science in working but art in understanding and interpreting. Working on the spreadsheet looks like working on methods. Financial modeling may look like science but understanding it interpretation it is purely an art. It does provide and support not only financial decision making but also helps in business interpretation. Uses/applicability of Financial Models Financial models are used for many different reasons. The most common of which are a business valuation , scenario preparation for strategic planning, cost of capital
calculations for corporate finance projects, capital budgeting decisions and the allocation of corporate resources. Financial models are also used in the creation of projections and trends for forecasts and many other uses related to industry comparisons, ratio analysis, and common size financial statements. Few more areas are: Investment Banking: Financial Modelling is the basic tool of any Investment Banker. It is used to value the company by forecasting its revenues & financials. With the valuation as a foundation, the banker can then recommend the buyer or seller on the acquisition of funds or investments in funds respectively. Equity Research: Financial Modelling aids analysts in investigating an organization’s financial projections, competitor’s projections, and other dynamics to determine the risk and estimate the return behind any investment. Credit Rating: Financial Modelling enables Credit Analysts to translate historical information such as outstanding debts into growth forecasts. These forecasts then determine the nature and degree of various risks which is then collated to give a rating to a firm. Project Finance: Financial Modelling is very useful in assessing the financial viability of a project. It is also the primary tool used to create a funding plan using relevant debt and equity components Mergers & Acquisitions: Financial Modelling helps organizations in assessing the value of any company. It hence gives them clarity about any “merge or acquire” decisions by forecasting the revenues, preparing debt schedules and by performing competitors’ analysis. Corporate Finance: Financial Modelling is used by companies to assess their own finances and projects. It is hence an input in creating funding plans for corporate projects. Application of Financial Modelling in non-finance areas: Critical Thinking and Analytical Skills: Critical thinking and analytical skills are two of the most important skills required of any manager. These skills are a byproduct of
your financial modeling training. Preparation of a financial model requires analyzing different options critically. Every model that you create honest these skills further. Business Plan Preparation: Another necessary prerequisite for a manager is the preparation of diverse reports such as business plan reports, project reports and revenue/ cost projection reports. Financial Modelling provides you with relevant skills that are helpful to understand business plans for a range of sectors. Decision Making: The daily life of a manager is replete with situations that involve decision making. Financial Modelling helps you in quantifying the situations and hence aid you in decision making by comparing different scenarios. Theory to practical: In the past, we have learned about various topics such as financial statements, accountancy, economics, budgeting, and financial management, theoretically. Financial modeling elucidates the practical applications of these theories. To conclude, Financial modelling may be tiring because it is vaster than involved thinking. But it is enjoying because you consider all the subjective and objective inputs/assumptions and combine them scientifically and do scenario and sensitivity analysis which helps in making financial and business decisions.
FINANCIAL MODELLING: A GUIDE TO TAKE BUSINESS DECISIONS
FINANCIAL MODELLING: A GUIDE TO TAKE BUSINESS DECISIONS What is it Financial modeling is the process by which a company constructs a financial represe...