Financial Modelling: What You Need To Know

3 Mins read
Illustration showing financial modeling

This article explains what you need to know about financial modelling.

Key takeaways

  • Financial modelling is the process of creating a mathematical model or representation of a financial situation or system.
  • Financial modelling helps in company valuation.
  • Financial modelling can be applied in a variety of areas such as Corporate finance, Investment banking, Asset management and Real estate.
  • Financial modelling is typically done using Microsoft Excel and can involve complex calculations, statistical analysis, and data visualization techniques.

Jump to a section

What is Financial Modelling?

Financial modelling is the process of interpreting the financial operations of a company, taking into consideration its growth and risk assumptions to predict its future performance.

A financial model depicts a company’s financial position in the past, present, and future.

Financial modelling can be used in a wide variety of applications, including:

  • Corporate finance: analyzing financial statements, performing sensitivity analysis, and valuing companies
  • Investment banking: creating financial models for mergers and acquisitions, initial public offerings (IPOs), and other transactions
  • Asset management: creating models to manage investment portfolios and assess risk
  • Real estate: modelling cash flows for real estate investments, analyzing commercial real estate transactions, and forecasting trends in the housing market.

What is the purpose of financial modelling?

1. Financial evaluation

With financial modelling, a company can document and evaluate its financial performance within a period.

2. Company valuation

A financial model helps to tell the value of a company and what it’s worth. It is also a way for investors to how if the company can make returns on their investment.

3. Decision-making

With a financial model, a company can know its financial position and avoid decisions that will negatively impact the company. 

How do you do financial modelling?

Some ways to go about financial modelling include;

  1. Data collection: The first step is to collect and gather financial data for the company for at least 3-5 years.
  2. Calculation of metrics: After gathering data, calculate the metrics of previous transactions to monitor growth rates, assets turnover, changes in inventory, etc  
  3. Making informed assumptions: This is made based on the trends and results observed from previous data of the company.
  4. Forecasting: With this data, financial statements such as future income, balance sheets, and cash flow statements can be predicted. Learn more about financial forecasting.
  5. Company valuation: This involves valuing the company according to the expected financial trends. A good example is using the discounted cash flow model.
  6. Review: A review of the model is done to ensure that it’s accurate, trying out different scenarios and predictions to reduce the error margin.

Types of financial modelling

  1. Three-Statement Model
  2. Discounted Cash Flow (DCF) Model
  3. Merger and Acquisition (M&A) Model
  4. Initial Public Offering (IPO) Model
  5. Leveraged Buyout (LBO) Model
  6. Sum of the Parts Model
  7. Budget Model
  8. Option Pricing Model

Advantages of financial modelling

  • Understanding the business
  • Periodic performance review
  • Business valuation
  • Risk minimization
  • Accurate financial forecasts

Who builds financial models?

Any trained personnel with a good knowledge of financial management can build a financial model. Some specific professionals build and use financial models daily. For example; 

  • Chartered Financial Analysts (CFA)
  • Investment bankers
  • Accountants
  • Equity research analysts
  • Corporate development analysts
  • Data analysts, etc

What skills do you need for financial modelling?

A financial modeller should have the following skills: Proficiency in Excel, attention to detail, model review, and analytical and presentation skills.

Is financial modelling difficult?

Financial modelling involves complex calculations, statistical analysis, and data visualization techniques but with the appropriate training and experience, anyone can become a professional.

Can a CFA do financial modelling?

A Chartered Financial Analyst (CFA) is a financial professional who is competent in investment and financial management. They are trained to understand and analyze financial models, so it is safe to say they can do financial modelling.

What software is used for financial modelling?

Excel is the most widely used software for financial modelling. Other financial modelling software includes Jirav, Cube, Finmark, Synario, Oracle BI, IBM Cognos and Quantrix.

What is the difference between financial analysis and financial modelling?

While financial modelling is a mathematical model or representation of a company, financial analysis is using these financial models to forecast the future earnings and performance of the company. Without a financial model, a proper financial analysis cannot be done.

Bottom Line

Financial modelling is a very important aspect of any company’s financial operations. It helps to give perspective to the growth of the company while ensuring that the best decisions are made. It is important to get a trained professional to do the financial modelling and analysis for your company to get the best results.

Leave a Reply

Your email address will not be published. Required fields are marked *