Financial Model – Structure and Importance
A typical financial model comprises of the Income statement, Balance Sheet and Cash Flow.
• The information presented is an inter-linked version of three statements, interlinking makes it
dynamic and enables the user to witness a change in each of the 3 statements by changing any
of the parameters.
• Like the human body a model has parts too! Each of these parts must be in good health in order
for the output to remain stable and represent facts rather than discrete numbers.
Model parts briefly - The assumption (control sheet), debt schedule (debt sweep), depreciation
schedule (Asset schedule), working capital, amortization, short term debt (revolver) and
investments schedule. Each of these parts is finally integrated with the 3 statements to build a
model, and that’s when stress testing and error proofing techniques are applied! (Error proofing is
partly done during the model building stage).
• The heart of a model is its schedules - Mainly the debt and depreciation schedules.
• Although a lot of users oversimplify the process by modeling all items as a % of sales, such models
will rarely give desirable results and will fail miserably in complex real-world situations.
• Creating a good model takes far more time than perform a valuation, or merger/LBO analysis on
it. The quality, user friendliness and customization of models made by some of the bulge-bracket
investment banks may be the difference between them and their closest rivals.
• Remember, the quality of a model will determine the quality of analysis performed on it.
Financial Model – Need and Importance
• Financial modeling supports management in making important business decisions.
• It involves the quantification of the potential impact of decisions on the profit and loss account,
balance sheet and cash flow statements.
• Through financial models, managers can determine the outcome of a proposal before even its
execution and rely on a rational and comprehensive justification for their decisions.
Moreover, these models enable managers to study different options and scenarios without imposing
any risk on the business. To avoid the common pitfalls related to financial modeling, designers should
follow five basic principles. They should make sure that the model satisfies its objectives, maintain model
flexibility, take inflation into consideration, present the model clearly and interestingly, and measure
outcome.
Financial Model – Possible Applications
• Business plan performance &valuation
• Scenarioplanningandmanagementdecisionmaking,(expansions&strategicplanninganalysis),
• Project finance
• Equity Investment
• Portfolio & Risk Management
• Credit Analysis
• Fair Valuation
These models are generally built around
• Financial statements,
• inputs (assumptions)impacting outputs
• External inputs/global variables(exchange rates, tax percentage, etc…)
• Internal inputs/company specific variables(wages, unit costs, etc)
• Mathematical relationship
• Output
A typical financial model comprises of the Income statement, Balance Sheet and Cash Flow.
• The information presented is an inter-linked version of three statements, interlinking makes it
dynamic and enables the user to witness a change in each of the 3 statements by changing any
of the parameters.
• Like the human body a model has parts too! Each of these parts must be in good health in order
for the output to remain stable and represent facts rather than discrete numbers.
Model parts briefly - The assumption (control sheet), debt schedule (debt sweep), depreciation
schedule (Asset schedule), working capital, amortization, short term debt (revolver) and
investments schedule. Each of these parts is finally integrated with the 3 statements to build a
model, and that’s when stress testing and error proofing techniques are applied! (Error proofing is
partly done during the model building stage).
• The heart of a model is its schedules - Mainly the debt and depreciation schedules.
• Although a lot of users oversimplify the process by modeling all items as a % of sales, such models
will rarely give desirable results and will fail miserably in complex real-world situations.
• Creating a good model takes far more time than perform a valuation, or merger/LBO analysis on
it. The quality, user friendliness and customization of models made by some of the bulge-bracket
investment banks may be the difference between them and their closest rivals.
• Remember, the quality of a model will determine the quality of analysis performed on it.
Financial Model – Need and Importance
• Financial modeling supports management in making important business decisions.
• It involves the quantification of the potential impact of decisions on the profit and loss account,
balance sheet and cash flow statements.
• Through financial models, managers can determine the outcome of a proposal before even its
execution and rely on a rational and comprehensive justification for their decisions.
Moreover, these models enable managers to study different options and scenarios without imposing
any risk on the business. To avoid the common pitfalls related to financial modeling, designers should
follow five basic principles. They should make sure that the model satisfies its objectives, maintain model
flexibility, take inflation into consideration, present the model clearly and interestingly, and measure
outcome.
Financial Model – Possible Applications
• Business plan performance &valuation
• Scenarioplanningandmanagementdecisionmaking,(expansions&strategicplanninganalysis),
• Project finance
• Equity Investment
• Portfolio & Risk Management
• Credit Analysis
• Fair Valuation
These models are generally built around
• Financial statements,
• inputs (assumptions)impacting outputs
• External inputs/global variables(exchange rates, tax percentage, etc…)
• Internal inputs/company specific variables(wages, unit costs, etc)
• Mathematical relationship
• Output
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