Financial Modelling is a versatile and essential practice in the world of finance, often regarded as both a skill and an art. It involves the construction of mathematical models, primarily using tools like Microsoft Excel, to assess and evaluate various financial scenarios. While the specific applications of financial models can vary widely, there are three fundamental elements that are consistent across all financial models: inputs, calculations, and results.
Inputs: Inputs are the foundation of any financial model. They encompass all the relevant data, assumptions, and variables that influence the financial situation being analysed. These inputs can range from market data and economic indicators to business-specific metrics and forecasts.
Calculations: The heart of a financial model lies in its calculations. These calculations are built upon the inputs and are designed to transform raw data into meaningful insights. The complexity of these calculations can vary greatly depending on the purpose of the model, and they often involve mathematical formulas, statistical techniques, and financial ratios.
Results: The results generated by a financial model are its ultimate output. These results provide valuable information for decision-making. For instance, a financial model might produce projections of future cash flows, profitability, or investment returns. The key is that these results should be relevant and actionable, helping stakeholders make informed choices.
The primary objective of creating a financial model is to facilitate decision-making. By manipulating the inputs or assumptions, users can visualise the potential impact on financial outcomes. For instance, a manufacturing manager can adjust workforce assumptions to gauge profitability, a trader can modify risk assumptions to assess bond prices, or a designer can tweak supplier costs to understand cash flow implications. The ability to perform scenario analysis is a key feature of financial models, allowing users to explore different what-if scenarios and make informed decisions.
Moreover, financial models can be enhanced with the integration of dashboards, which provide visual representations of key metrics. These visuals enable users to quickly and clearly grasp critical information, helping them identify trends, opportunities, or risks.
Contrary to common misconceptions, financial modelling is not exclusive to financial markets. While it is extensively used in the world of finance for valuing investments, risk assessment, and trading strategies, its applications are much broader. Financial models are employed across various industries and functions to determine business value, monitor financial forecasts and budgets, assess performance, and support strategic planning. The depth and complexity of financial statements included in these models depend on their intended purpose.
Microsoft Excel remains the go-to application for building financial models due to its robustness and flexibility. However, it is crucial to exercise caution and conduct regular audits to ensure the accuracy and reliability of the models.
If you are embarking on your journey into financial modelling or seeking to gain a deeper understanding of the models within your professional domain, consider enrolling in a Financial Modelling Course. Such courses typically offer hands-on experience with case studies, teaching you how to design models, utilise formulas, functions, and relevant tools, all in accordance with best practices. While they introduce financial functions, they are not focused on financial theory or advanced financial mathematics but rather on practical modelling skills.