Financial modeling is a tool that can be used to forecast a picture of a security or a financial instrument of a company’s future financial performance based on the historical performance of the entity. Financial Modeling includes the preparing of detailed company-specific models which are then used for the purpose of decision making and performing financial analysis.
Financial modeling is the constructing of a financial representation of the aspects of the firm or given security consisting of the mathematical models of financial health of a given company. This model can be made on a simple notebook paper or in Excel, which is then analysed for the impact of different assumptions or changes in value of various variables.
Financial modeling is a mirror that shows whether an organization is in need of additional funds (debt or equity) and how a business will react to different financial situations or market conditions. It helps to understand if the company would be a good investment for better returns i.e. comparative analysis and risk level, such as identifying if the company has had a recent change in direction, loss of customers, lack of demands and overabundance of supplies, etc.
It is a technique to value and analyze Firms, IPOs and FPOs.
A good financial model should:
Financial Modeling forms a core of various other finance areas like equity research, investment banking, credit research, etc. If you are searching for a Financial Modeling Online Course/Training then you may consider one of our Financial Modeling courses here.
The purpose of Financial Modeling is to build a Financial Model which can enable a person to take better financial decision. The decision could be affected by future cash flow projections, debt structure for the company etc. All these factors may affect the viability for a project or investment in a company.
The Applications of Financial Modeling mainly includes the followings:
One application of Financial Modeling may be Business Valuation which is deciding the fair value for a business. Financial Modeling will help participants to reach to a price they are willing to pay or accept for the selling business. The second application of financial modeling is an organization’s decision making and scenario preparation. Financial Modeling is used by organizations for future planning their long term goals according to different situations that may arise.
To decide the Cost of Capital – if a company is going to invest in a new project then Financial Modeling for it will give analysis for debt/equity structure and expectation in return by investors, thus setting benchmarks for project to meet.
Capital Budgeting – Financial Modeling helps companies determine allotting resources for major expenditure or investment etc.
Purpose – increasing the value for the firm.
Basic Financial Analysis tools include:
In Financial Modeling it is desired that the working should be error less and should be easier to read and understand for audit purposes. By following these key principles, model will be easier to navigate and check, and reliable.
For most obvious results we need to follow the Firms standard format:
The following points should be kept in mind:
1) Spreadsheet Design
2) Better Document Your Assumptions
3) Use Linking and Not Hard-coding
4) Facilitate Data Entry at One Place Only
5) Good Practice is Using Consistent Formulas
6) Formatting Charts
7) Format and Label Clearly