Picture yourself in a boardroom, surrounded by charts, graphs, and a sense of uncertainty. Your company stands at a crossroads, with important decision looming on the horizon. Should you expand into new markets? Invest in emerging technologies? Or streamline operations to weather economic volatility? In the midst of all these, one thing is clear: you need a roadmap — a tool that can help you navigate the twists and turns of financial decision. This is where financial modelling can help.

In this blog, we will discuss what is meant by financial modelling, who uses it, the skills required for it, and how you can create a financial model. We’ll also talk about why you should enrol in Nexacu’s financial modelling course.

What is Financial Modelling?

Financial modelling is the art and science of building mathematical representations of financial situations or scenarios. These models are constructed using historical data, assumptions, and mathematical equations to forecast future financial performance, analyse investment opportunities, or evaluate the impact of business decisions.

What are the Components of a Financial Model?

A financial model typically consists of several key components, each serving a specific purpose in the analysis process:

  • Historical Financials: These include past financial statements like income statements like income statements, balance sheets, and cash flow statements to establish a base for projections.
  • Assumptions: The foundation of the model, where all input variables such as growth rates, margins, and tax rates are defined.
  • Revenue Projections: Estimates future sales based on historical data, market analysis, and growth assumptions.
  • Expense Forecasts: Predictions of future costs, taking into account fixed and variable expenses from projected revenues.
  • Balance Sheet: A projected snapshot of what the company owns (assets) and owes (liabilities), including equity at a future point in time.
  • Cash Flow Statement: An estimation of the cash inflows and outflows over a period, showing how changes in the balance sheet and income affect cash and cash equivalents.
  • Supporting Schedules: Detailed calculations that feed into the three main financial statements, such as depreciation schedules, and debt schedules, among others.
  • Sensitivity Analysis: Examines how changes in assumptions impact the model's outcomes, often presented in tables or charts.
  • Output: The final results of the model, which typically include key financial metrics and ratios used for decision-making.

Who Uses Financial Models?

Financial models are used by a wide variety of individuals and organisations across different industries. Here are some key stakeholders who commonly rely on financial models:

  • Corporate finance professionals: CFOs, finance managers, and analysts use financial models to analyse financial statements, project cash flows, and assess the financial health of companies.
  • Investment bankers and equity analysts: Investment bankers and equity analysts employ financial models to value companies, evaluate mergers and acquisitions, and advise clients on investment opportunities.
  • Entrepreneurs and startups: Entrepreneurs use financial models to create business plans, forecast revenues and expenses, and secure funding from investors or lenders.
  • Consultants and advisors: Management consultants and financial advisors leverage financial models to provide strategic guidance, conduct feasibility studies, and support decision-making for their clients.
  • Government agencies and nonprofits: Government agencies and nonprofits use financial models to budget resources, assess the financial impact of policy decisions, and allocate funds effectively.

What Software is Used in Financial Modelling?

While there are plenty of financial modelling software programs available in the market, Microsoft Excel remains the top choice of individuals and businesses. Excel offers a powerful yet flexible platform for creating, customising, and analysing financial models. Its widespread adoption can be attributed to several key factors:

  • Versatility: Excel allows users to build a wide range of financial models, from simple budgeting spreadsheets to complex valuation models.
  • Accessibility: The program’s widespread availability and user-friendly interface facilitate seamless collaboration and exchange of financial models, enhancing teamwork and organisational coherence.
  • Flexibility: Excel’s comprehensive customisation capabilities lets users personalise models to exact specifications, integrate specialised formulas or macros, and craft interactive dashboards for visual data analysis.

What are the Skills Needed to Create a Financial Model?

Building a reliable and effective financial model requires a combination of technical proficiency, domain knowledge, and analytical acumen. Here are the skills you need to master if you want to create a financial model:

1. Basic Understanding of Microsoft Excel

As mentioned, Excel is one of the top programs used for financial modelling, so it’s important to have a solid grasp of its core functionalities and features. You must be familiar with basic spreadsheet operations like data entry, formatting, and formula calculations, and learn how to use functions like SUM, AVERAGE, and IF statements, as well as more advanced functions like VLOOKUP, INDEX-MATCH, and SUMIFS.

2. Some Accounting Knowledge

Knowing accounting principles is crucial for creating accurate and insightful financial models. A solid understanding of revenue recognition, expense classification, and balance sheet is required. You must also understand the relationship between key financial statements—income statement, balance sheet, and cash flow statement—and how changes in one statement can impact the others.

3. Understanding of Financial Theory

While not essential, learning financial theory can significantly enhance the quality and depth of your financial models. Concepts such as time value of money, risk and return, and valuation methodologies provide the theoretical framework for building robust financial models. Gain insight into financial markets, investment principles, and economic indicators to better interpret and analyse financial data. Incorporating financial theory into your models will help you make more informed decisions and generate more accurate forecasts.

How Do You Build a Financial Model?

To create a robust financial model, you need to go through a systematic process of gathering data, analysing trends and making informed projections about future financial performance. Let’s take a look at these steps in more detail:

1. Gather required information

This step typically includes getting historical financial data, market research, and industry benchmarks. Annual reports released by companies are valuable sources of financial information, providing insights into revenue, expenses, assets, liabilities, and cash flows.

2. Use Financial Ratios

Financial ratios play a crucial role in financial modelling by providing valuable insights into a company's financial condition and performance. While there are numerous financial ratios used in financial analysis (including liquidity ratios, profitability ratios, and leverage ratios), they all serve the common purpose of evaluating a company’s operational efficiency, profitability, and financial performance stability.

3. Forecast

Forecasting future growth rates is a critical aspect of financial modelling as it allows analysts to project future revenues, expenses, and cash flows with a reasonable degree of accuracy. One basic technique for this is to calculate the average growth rate over a specific period, such as the last three years.

While this approach provides a simple framework for forecasting growth rates, it’s important to supplement it with qualitative analysis, market research, and industry insights to account for potential changes in market conditions, competitive dynamics, and other external factors that may impact future growth.

Become a Financial Modelling Pro with Nexacu

Want to learn more about financial modelling and how it can help businesses? Why not enrol in our Excel Financial Modelling for Beginners course? Under this program, we will guide you in creating effective financial models using Microsoft Excel.

You will learn various techniques like separating inputs, calculations, and outputs, avoiding hard coding, and using reconciliations and zero checks, among other things. Finally, you’ll learn to validate data, so you can ensure the accuracy and reliability of your financial models.

Whether you prefer remote or in-person classes, we can accommodate you. Enquire today and become a financial modelling expert.

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