In this article we will explain the following aspects in more detail:
- What does it take to learn to build a financial model/financial modeling
- Types of financial models
- 3How to build a financial model-Tips to build a perfect financial model
1. What does it take to learn to build a financial model / financial modeling
• Excel: To date, Excel is still the most widespread program, there are indeed other alternatives, but for now, and for a long time, Excel will prevail. You don’t have to be an Excel expert, with basic knowledge you can make a good model, although it is true that the more “Excel ninja” you are, the better, especially because it gives you a competitive advantage in your work as an analyst compared to others. (if you need help, visit our Excel course for financial modellers)
• Accounting: To build a model it is necessary to know accounting, fundamentally understanding the three financial statements, the conceptual items that compose them and the relationships between accounts that exist between them.
The good news is that you do not have to be an expert in this part, with basic notions you can build a model, although as in the previous point, the more accounting you know, the easier it will be.
• Financial Knowledge: As with the previous skills. It is not necessary to be a financial director of a company to make a model, but it is essential to be clear about some basic financial concepts, such as the concept of time in the value of money, rates of return, simple and compound interest, some ratios fundamentals and little else. Neither of these concepts are complicated, but they are fundamental.
• Design: yes, it is not a typo! A model must be well presented and organized, just like a CV or any other document. A well-organized, presented and structured model is the result of the work of someone who knows what he is doing, on the contrary, a chaotic sheet, conveys a feeling of lack of control, of not having it clear .. The design is not nonsense, and It is something that we take great care of in our custom models.
• Forecast of Financial Model: The ability to project a financial model is important because the projection of a financial model in excel is to understand the future scenario of any financial situation. Using logical assumptions while predicting results will give you a close and attractive idea of the company or investment in future periods. Having the ability to know the future forecast increases the confidence of the model.
• Presentation: A financial model is full of details, figures, and complex formulas. The financial model is used by different profiles in the company such as operations managers, clients, management. These professional profiles will not be able to decipher anything significant about the model if the model is poorly presented, cluttered, and difficult to understand. Therefore, having a presentable and detailed model is very important.
2. Types of financial models
In reality, there are countless financial models, depending on various factors. We are going to try to categorize them, if another classification happens to you, we encourage you to comment on it with us.
- By sector: In which market we are, for example, Software models, a store, a Hotel, a photovoltaic plant … think that each sector has its jargon and peculiarities, and similar margins and ratios, so it is normal refer to models of … “the corresponding sector”
- By business model: How the company in question makes money, for example, an e-commerce, a Marketplace, a traditional model, a distributor, etc. It is another way of understanding the model, because again, the models by type of business will have certain similarities.
- By capital structure, or financing: Here we talk about models in which we focus on financing the company or project, for example a start-up, in itself it does not say anything about the sector, or the business model, if not that it speaks of a company with special financing characteristics, or an IPO (IPO) model, or debt refinancing, project finance, etc.
Now we are going to combine the three classifications, so we can talk about a financial model for an e-commerce software startup, or a model for the refinancing of a traditional car factory, or the capital increase of a beverage distributor.
There are also other types of financial models, which do not depend so much on either the sector, the business model or its financing, we refer to departmental models, such as a human resources model, or budgeting, Rolling forectast etc.
These models are built to monitor, usually monthly, the evolution of the company or project, and are maintained by finance teams to analyze and report. In these models it helps a lot to have more advanced knowledge of Excel, especially to achieve productivity increases.
At modelandun we can help your company through our online training courses full of examples based on real cases.
Here is an explanatory video on how to calculate CAPEX, an important indicator that determines the life cycle of a company. Your analysis is key to knowing what decisions to make regarding financial projections.
3. How to build a financial model. The Perfect Financial Model.
Financial models can be as easy as they are complex. If you look over a financial model it can be complicated. However, financial models are a set of modules, and the key here is to build the model in an orderly way, combining the different modules.
The following steps will help you get organized:
- Planning and outline: Before rushing into putting historical data and starting with the model, you have to start with planning the entire outline of the project. Decide on a timeline, the degree of the years of historical data, projection of years, reading of the industry and company. Take an in-depth look at the latest annual reports or the current situation. This will help keep your head stable when starting.
- Quality: As you go through the modeling process, don’t forget to maintain quality at all times. Be patient and work with confidence. Take breaks if you need them. If you put the wrong data, you will have wrong results
- Start with the time structure of the model, annual, monthly etc, and keep it constant in the model
- Build the structure of the financial statements, which will be nothing more than a summary of the additional work that you will do in other tabs
- Differentiates very well the operating model (up to EBIT), from the financial (capital structure)
- Integrate the financial statements
- Enter the historical data, from which we will make the projection
- Visually mark what are hypotheses against formulated calculations
- Always check the results, for this it is useful to implement ratio
- Assumptions: What we project into the financial model is only as good as the assumptions we will build on. If the assumptions are twisted and lacking in reasoning, the base of the projections will be useless not reaching precision. Making assumptions should be realistic and reasonable thinking. It should be accompanied by industry standards and a general market scenario. It should not be very pessimistic or very optimistic
- Do sensitivity analysis
Do not forget that the financial model is the tool in Excel, but the quality of the hypotheses and the analysis are essential. Double check the results, it’s easy to be wrong!