Some executive decisions in a professional’s career are as complex and sensitive as a billion-dollar investment with a payback timetable that can stretch on for several years to come. The right call can positively improve a company’s value while the wrong one can draggle the share price of a company, draw public criticism, and even can cost responsible managers their jobs.
Perhaps the most important decision a company makes is the allocation of its capital in order to stimulate business ventures and determine which paths they should take to have the most positive impact on their organization. Company finance managers are expected to create financial investment strategies and forecast the future earnings or performance of financial scenarios that should give their company the opportunity to operate successfully.
Financial modeling is instrumental for critical investment decision-making. It is crucial for creating these strategies and intelligently planning for future financial outcomes, and gaining insight into specific financial scenarios. That’s why financial modeling is widely practiced by companies for budgeting strategy, raising capital, and making acquisitions.
What is Financial Modeling?
Financial modeling is a method of building an abstract model or representation in compliance with a real-world financial scenario. It is designed to represent a financial asset’s performance to help in making business decisions. Financial modeling includes spreadsheet models, applications for investment analysis, company valuation, forecasting, and modeling techniques.
Crucial Financial Modeling Techniques
First of all, financial models are aimed at showcasing an organization’s past and future financial performance. The right way to design a financial model is through using a tool like Excel to accurately forecast a company’s future operations. To build it, you will require in-depth knowledge about Excel to build an accurate model as well as a foundational understanding of corporate finance and accounting.
See here some most widely used and effective financial modeling techniques to design and roll out the decision-making process
Historical Data: It is crucial for determining future trends. As the data collected from past references is going to be the basis of your future predictions, this is necessary that the data is accurate and credible.
Assumptions: Assumptions entail evaluating a company’s historical data and planning a strategy to build a financial model. As the term signifies, it’s mere guesswork. Assumptions in financial modeling must be vivid and well-defined. That’s why they are used as the ‘inputs,’ or ‘drivers’ for financial models of a business while also representing expectations and realities of a company.
Colour Coding or Linkages: Building financial models through color codes is an essential part. You will find many cells containing values corresponding to different parameters. Colour coding spreadsheet cells and a financial model will be helpful for your colleagues to understand the model more easily.
How Many Types of Financial Models?
There are several financial models, namely three statement models, ratio analysis or comparable company analysis model, credit rating model, discounted cash flow models, and leveraged buyout model.
Three Statement Model: Income statement, balance sheet, and cash-flow statement are three components of this model. Typical financial institutions or banks adopt this model to assess the past financial performance of their corporate borrower.
Credit Rating Model: Designed to project data predictions for three to five years, the credit rating model inculcates many other parameters such as strength and quality management, future demand growth, the conduct of existing loan accounts, and collateral quality.
Ratio Analysis or Comparable Company Analysis (CCA): When it comes to comparing a company’s current financial value and standing with its competitors, this CCA model is used. The size of the company, top and bottom line and other factors are evaluated.
Leveraged Buyout (LBO) Model: The purpose of this LBO model is to adjust the balance sheet or debt-heavy capital structure, coming up with an acceptable IRR (Internal Rate of Return). This LBO model is used when an acquirer company uses a considerable amount of debt financing to cover the cost of acquisition.
Discounted Cash Flow (DCF) Model: Generally used by investors, this DCF model helps investors to understand the actual value of a startup before they invest capital into it.
Financial Modeling Training for Professionals
In the corporate world, the demand for professionals with financial modeling skills is increasing. This is likely due to the growing need for businesses and organizations to make informed and effective financial business decisions, thereby intending to eliminate the risks that may incur that decision.
Are you a professional, looking to acquire the financial modeling skills to understand the financial dynamics of an organization and enhance your professional career. The management experts and their business management modules at Promise Training & Consultancy can help you acquire the skills.