A financial model is a critical decision-making tool that allows users to make accurate and informed financial decisions about a company. A financial model needs to serve as a powerful communication tool to clearly and effectively tell the story of a company to executives and stakeholders.
A builder of financial models requires skills in accounting, finance, spreadsheets and overall business knowledge in order to effectively forecast a company's financial statements into the future.
With excellent modeling skills, a professional can:
A strong financial modeler will be able to:
Mastering the discipline of financial modeling facilitates the communication of outputs and recommendations with poise and confidence.
To achieve the goals set out above, a model needs to be developed with the following attributes:
Flexible: The model contains scenarios with multiple cases (i.e. base case, best case, worst case) for the most critical variables.
Intuitive: The reader can easily follow and understand the model based on the flow of the pages.
Transparent: Every formula can be understood whether the reader clicks into the cell, or looks at a printout on paper.
Dynamic: Any changes to the assumptions should properly flow through the model.
Tells a story: The model is a powerful communication tool that allows for optimal decision making.
Transferable: When a model is well designed and well built, colleagues and clients will be able to use the file as if they built it themselves.
When a model achieves the criteria above, it creates tremendous credibility for the builder and inspired confidence with the reader.
A well-designed model needs to work in two ways:
It is critical to properly plan and design a model before it can be built.
Whenever a model becomes filled with errors, it is often because the modeler did not properly devise a model plan. A model built without forethought is often chaotic and requires many additions on a weak foundation.
A model builder needs to first understand how a business operates, which requires the following:
Review historical financial statements: Review management discussion, analysis and financial statement notes.
Learn about the company's industry: Reading industry journals and equity research reports.
Decide on key drivers: Key drivers that are critical success factors for the industry / company.
Understand the purpose of the model: Is the model used for valuation, credit assessment, project evaluation, etc?
Identify required schedules and components: Plan for all specific calculations such as revenues, costs, working capital, etc.
Identify the required schedules and components to be included in the model.
As part of the planning process, the model builder should also be able to answer the following questions: