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Financial Modelling featured quite prominently in my previous roles. I have often been asked "What is Financial Modelling exactly?"
Financial Modelling is a general term and can mean different things to different people. It's no wonder there is confusion around the term so how should we define it?
Financial Modelling is the practice, or some may say art, of building a mathematical model to evaluate or assess a financial situation. These models are most commonly built in Excel. The purpose is as wide and varied as the business opportunities out there. However there are three core elements common to all financial models.
- Inputs
- Calculations
- Results
The purpose of building a financial model is often to assist in decision making. The model gives the end user the ability to play with the inputs or assumptions and view what the result will be. For example a manufacturing manager could change an assumption about the number of man hours rostered for a week. Therefore, he can view the impact it will have on the profitability of a particular function. Alternatively, a Trader could change the assumption of expected defaults and see the impact on the price of a given bond. A Designer could change her suppliers costs as see the forecasted impact on her cashflow.
The models are different but in essence take raw inputs and convert them into meaningful results. Consequently which have the ability to support judgement and guide decision making. They key to building financial models is to make sure they are dynamic so that the user can vary the assumptions and see the impact. This ability to perform scenario analysis is what makes the model so valuable.
Dashboards are often layered onto Financial Models and can be a powerful addition. Visuals can communicate key metrics quickly and clearly. Therefore, the end user can focus on the most important results allowing them to spot trends, opportunities or threats.
Is Financial Modelling only for Financial Markets?
No. Financial Models are clearly used to a great deal within financial markets. To determine the value of a range of investments but the application of financial models is much wider than the markets. Models are used in all businesses to determine value, monitor forecasts and budgets, assess performance etc. They may or may not include a full set of financial statements, that will be driven by the purpose of the model.
Excel is still the go to application for building Financial Models. Its robust and flexible but as all users proceed with caution and audit your models. If you are beginning your journey into Financial Modelling or just want to understand more about the models you deal with in your role then you may be interested in our Financial Modelling Course. You will work through several case studies on our course, learning how to design models, use formulas, functions and tools relevant for modelling. Financial functions are introduced but the course is not a financial theory or financial maths course it is an introduction to building models in Excel in accordance with our Best Practice Framework.
