A financial model is developed to forecast a business’ performance in the economic front and that’s the reason it is highly valued. However, it is one skill that is thinly understood in the field of finance. The purpose of such models is to combine finance, accounting and business metrics to create a conceptual representation of a firm in Excel, projected into the future. It is used in analyzing the financial performance of the company and take actionable decisions accordingly. Financial modeling has high demands in sectors like banks, public accounting, institutions and corporate.
Most of the students have questions like how to learn financial modeling? What are the basic skills required for it?
Skills required to prepare a financial model
Master Microsoft Excel
To become an expert, you need to practice, be proficient in Excel and its different techniques. Few of the basic things are to try to limit usage of a mouse and relying more on keyboard shortcuts, learn simple formulas and breaking down complicated calculations into a simpler one. Excel INDEX and MATCH, equations, functions are very important in financial modeling.
To advance to the next level, one needs to understand the integration of various hlookup, vlookup, multilevel logic, conditional formatting, basic macros, array formulas, sensitivity analysis advanced VBA programming etc.
The structure of a financial model is very critical for the success of modeling. It is the best practice to develop a model on one worksheet with different sections. If you wish to know how a financial model looks like click here.
Below are some guidelines to develop a financial model:
- Developing a financial model is an iterative process; first, you have to break down the entire model into steps and then at the end try to join all sections together with a link.
- The financial model starts with the organisation’s historical data and assumptions. You can gather past data and put into excel format. Next step by calculating growth rate, gross margins, fix and variable costs, you need to develop assumptions.
- Then you can focus on the balance sheet; taking the income statement as a base, we can fill the balance sheet.
- Building a supporting schedule for capital assets, debts and interests is a significant activity. With the help of historical data and calculating expenditures and depreciation, we can build this schedule.
- After completing the income statement and balance sheet, we can start for cash flow calculations using the reconciliation method. Cash flow statement begins with net income, add depreciation and adjust the changes in non-cash working capital.
- DCF – Discounted cash flow is again an essential part of financial modeling. It is forecasting of the company’s non-levered free cash flow discounted back to today’s value.
- Sensitivity analysis is the last part of financial modeling. It determines the worth of an organisation getting impacted by changes in assumptions.
- It is good practice to show all the results of financial models in chart or graphs.
Learn Colour Coding
Usage of colour coding is again a very interesting and important presentation tool in financial modeling. This colour coding makes it easy to identify the manual input.
Some conventions we use are:
- For hard coded numbers, historical data – Blue or yellow background
- Formulas and references, calculations – Black
- Other files – Red or green
- Shading colour formatting
- For heading – Dark blue with white font colour
- Subheading – Light grey with black font
- Featured line – Light orange with black font
Business intelligent tool (BI tool), Quantrix, Oracle BI, GIDE, Maplesoft are a few software solutions available in the market for advanced financial modeling. So besides with excel expertise, one can try to learn these software tools for advanced financial modeling.
Uses of financial model in decision making
The financial models are used in any organisation for taking significant decisions about:
- Making acquisitions (organisations and assets)
- For raising capital (debt and/or equity)
- Developing the business organically
- Planning and forecasting (making arrangements for the years ahead)
- Capital allotment (need of which undertakings to put resources into)
- Estimating a business
There are many certified courses on professional financial modeling that help you to enhance your skills and thus help you kick-start your career on a strong foot in this role.
Explore more on how to become an ace financial modeling specialist.