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What are the different financial models?

An insight into financial modelling, its meaning, objective, types, categories and ten points to follow while creating financial models.

  • Finance Process

Financial modelling is interpreting numbers of features of a company’s operations. Financial modelling is the task of building an abstract representation, called financial models, of a real-world financial situation. It is a mathematical model constructed to denote a simplified version of the performance of a financial asset or portfolio of a business, project, or any other investment.

Financial models are activities that prepare a model representing a real-world financial situation. they are intended to be used as decision-making tools. Company executives might use financial models to estimate the costs and project the profits of a proposed new project. Financial analysts use financial models to anticipate the impact of an economic policy change or any other event on a company’s stock.

Common types of financial models are Initial Public Offering (IPO) Model and Leveraged Buyout (LBO) Model.

Financial modelling: meaning

Financial modelling is the method performed to build a financial representation of a company. Financial analyst forecast future earnings and performance of the company using these financial models. The analysts use numerous forecast theories and valuations provided by financial modelling through these financial models to recreate business operations. Financial models once completed, display a mathematical depiction of the business events. The primary tool utilized to create the financial model is the excel spreadsheet.

Investopedia definition of Financial modelling: The process by which a firm constructs a financial representation of some, or all, aspects of the firm or given security. The model is usually characterised by performing calculations and makes recommendations based on that information. The model may also summarize particular events for the end user and provide direction regarding possible actions or alternatives

Financial modelling: objectives

Financial models help in steering historical analysis of a company, projecting a company’s financial performance used in various fields.

These financial models are predominantly used by financial analysts and are constructed for many purposes. Financial modelling supports the management in the decision-making and the preparation of financial analysis by creating financial models.

The following are the objectives of creating financial models:

  • Valuing a business
  • Raising capital
  • Growing the business
  • Making acquisitions
  • Selling or divesting assets and business units
  • Capital allocation
  • Budgeting and forecasting

The best financial models offer a set of basic assumptions. For example, one commonly forecasted line item is sales growth. Sales growth is documented as the increase, or decrease, in gross in the most recent quarter compared to the previous quarter. For financial modelling, these are the only two inputs financial models need to calculate sales growth.

Financial modelling will create one cell for the prior year’s sales, cell A, and one cell for the current year’s sales, cell B. The third cell, cell C, would be used for a formula that divides the difference between cell A and B by cell A. This will be the growth formula. Cell C, the formula, would be embedded into the model. Cells A and B are input cells that can be changed by the user.

In this case, the purpose of financial modelling and creating financial models is to estimate sales growth if a certain action is taken or a possible event occurs.

Financial modelling: ten points to follow

Financial modelling is an iterative process. Analysts creating financial models must chip away at different sections until they are finally able to tie it all together.

Below is a step-by-step breakdown of where they should start and how to finally connect all the dots.

  • Historical results and assumptions
  • Start the income statement
  • Start the balance sheet
  • Build the supporting schedules
  • Complete the income statement and balance sheet
  • Build the cash flow statement
  • Perform the Discounted Cash Flow (DCF) analysis
  • Add sensitivity analysis and scenarios
  • Build charts and graphs
  • Stress test and audit the model

Financial modelling: categories

There are multiple varieties of financial modelling tools that are exercised, based on the purpose and need of doing it. Each category of the financial models solve a different business problem. While the majority of the financial models concentrate on valuation, some are created to calculate and predict risk, performance of portfolio, or economic trends within an industry or a region.

The key to being able to model finance effectively is to have good templates and a solid understanding of corporate finance.

Examples of financial models available include:

Project finance models

When a sizable infrastructure project is being evaluated for feasibility, the project finance model helps determine the capital and structure of the project. Project finance is only possible when the project is capable of producing enough cash to cover all operating and debt-servicing expenses over the whole tenor of the debt.

Loans and the associated debt repayments are an imperative part of project finance models, since these projects are normally long term, and lenders need to be sure if the project can bring sufficient cash against the debt. In other words, project finance model is used as a financial model when the company needs to assess economic feasibility of the project.

Metrics such as debt service cover ratio (DSCR) are included in this category of financial modelling and can be a handy yardstick of the project risk, which may affect the interest rate offered by the lender.

Right at the start of the project, the DSCR and other metrics are agreed upon between the lender and borrower such that the ratio must not go below a certain number.

While the output for a project finance model through financial modelling is uniform and the calculation algorithm is predetermined by accounting rules, the input is highly project specific. Generally, it can be subdivided into the following categories:

  • Variables needed for forecasting revenues
  • Variables needed for forecasting expenses
  • Capital expenditures

Pricing models

This category of financial models is built for the idea of establishing the price that can or should be charged for a product.

Price is one of the key variables in the marketing mix. There are four general pricing approaches that companies use to set an appropriate price for their products and services: cost-based pricing, value-based pricing, value pricing and competition-based pricing. The cost of production sets the lower limit while the upper limit is set by consumer perception about the product/service.

The input to a pricing model is the price, and the output is the profitability. To create a pricing model through financial modelling, an income statement, or profit-and-loss statement of the business or product should be created first, based on the current price or a price that has been input as a placeholder. At a very high level:

Units × Price = Revenue

Revenue – Expenses = Profit

However, this category of financial models can be very complex and involve many different tabs and calculations, or it can be quite simple, on a single page. When this structure model is in place, the person doing the financial modelling can perform sensitivity analysis on the price entered using a goal seek or a data table.

Integrated financial statement models

This category of financial models is also known as a three-way financial model.

The three kinds of financial statements included in the financial modelling of an integrated financial statement model are the following:

  • Income statement, also known as a profit-and-loss (P&L) statement
  • Cash flow statement
  • Balance sheet

Not every category of financial model needs to contain all three types of financial statements, but many of them do, and those that do are known as integrated financial statement models.

From a financial modelling outlook, it’s very important that when the financial modelling for an integrated financial statement takes place, the financial statements are linked together properly so that if one statement changes, the others change as well.

Valuation models : This category of financial models value assets or businesses for the purpose of joint ventures, refinancing, contract bids, acquisitions, or other kinds of transactions or deals.

The people who build these kinds of models are often known as deals modelers.

Building this kind of financial models requires a specialized knowledge of valuation theory and using the different techniques of valuing an asset, as well as financial modelling skills .

When valuing a company as a going concern there are three main valuation methods used by industry practitioners:

  • DCF analysis
  • Comparable company analysis
  • Precedent transactions

These are the most common methods of valuation used in investment banking , equity research, private equity, corporate development, mergers & acquisitions (M&A) and most areas of finance. A common example of these category of financial models is Initial Public Offering (IPO) Model and Leveraged Buyout (LBO) Model.

Reporting models

These financial models condense the history of revenue, expenses, or financial statements, like the income statement, cash flow statement, or balance sheet.

Because they look historically at what occurred in the past, there is school of thought that these financial models are not real financial models. The fundamentals like principles, layout, and design that are used in financial modelling are identical to other financial models.

Reporting models are often used to create actual versus budget reports, which include forecasts and rolling forecasts, which in turn are driven by assumptions and other drivers.

Financial modelling: types

In practice, there are many different types of financial models. We have outlined the 10 most commonly used financial models used by financial modelling professionals.

Three-Statement Model

A three-statement model links the income statement, balance sheet, and cash flow statement into one dynamically connected financial model. These financial models are the basis on which more advanced financial models are built such as discounted cash flow DCF models, merger models, leveraged buyout LBO models, and various other types of financial models.

It falls under both the categories of financial models: Reporting models and Integrated financial statement models.

Discounted Cash Flow (DCF) Model

These types of financial models fall under the category of Valuation models and are typically, though not exclusively, used in equity research and other areas of the capital markets.

A DCF model is a specific type of financial model used to value a business.  DCF model is a forecast of a company’s unlevered free cash flow discounted back to today’s value, which is called the Net Present Value (NPV).

The basic building block of a DCF model is the three-statement financial model, which links the financials together. The DCF model takes the cash flows from the three-statement financial model, makes some adjustments where necessary, and then uses the XNPV function in Excel to discount them back to today at the company’s Weighted Average Cost of Capital (WACC).

Merger Model (M&A)

The M&A model also falls under the Valuation category of financial models.

As the title suggests, this type of financial modelling is towards a more advanced model applied to assess the pro forma accretion/dilution of a merger or acquisition. It’s common to use a single tab model for each company, where the consolidation is represented as Company A + Company B = Merged Co. The level of complexity can vary widely and is most commonly used in investment banking and/or corporate development.

Initial Public Offering (IPO) Model

Like the previous two type to financial models, the IPO model is also a Valuation model.

Financial professionals like investment bankers develop IPO financial models in Excel to value their business just before going public. These financial models equate company analysis with regards to an assumption about how much investors would be willing to pay for the company in contention. The valuation in an IPO model includes an IPO discount to ensure the stock trades well in the secondary financial market.

Leveraged Buyout (LBO) Model

A leveraged buyout (LBO) is a transaction where a company is acquired using debt as the main source of consideration. These transactions typically occur when a private equity (PE) firm borrows as much as they can from a variety of lenders (up to 70 or 80% of the purchase price) and funds the balance with their own equity.

An LBO transaction typically requires financial modelling with debt schedules and are an advanced form of financial models. An LBO is often one of the most detailed and challenging of all types of financial models as they many layers of financing create circular references and require cash flow waterfalls.  These types of models are not very common outside of private equity or investment banking.

When it comes to an LBO transaction, the required financial modelling can get complex. The added complexity comes from the following unique elements of an LBO:

  • High degree of leverage
  • Multiple tranches of debt financing
  • Complex bank covenants
  • Issuing of Preferred shares
  • Management equity compensation
  • Operational improvements targeted in the business

Sum of the Parts Model

Another type of financial model that belongs to the Valuation category of financial models, this model is developed by taking in account a number of DCF financial models and adding them together. Further, any sundry factors of the business that may not be apt for a DCF analysis are added to that value of the business. So, for example, you would sum up, that’s why ‘Sum of the Parts’, the value of business unit A, business unit B, and investments C, minus liabilities D to arrive at the NAV for the company.

Consolidation Model

The Consolidation Model belongs to Reporting Model category of financial models. It includes several business units added into one single model for financial modelling and further analysis. Typically, each business unit is its own tab, with consolidation tab that simply sums up the other business units.  This is similar to a Sum of the Parts exercise where Division A and Division B are added together and a new, consolidated worksheet is created.

Budget Model

The Budget model is used to do financial modelling in financial planning & analysis (FP&A) to get the budget together for the next few years, typically in the range of one, three and five years. Budget financial models are meant to be based on monthly or quarterly figures and rely strongly on the income statement.

This is one more model belonging to the Reporting model category of financial models.

Forecasting Model

Similar to the budget model, the forecasting model is also used in FP&A to come up with a forecast that compares to the budget model. Since it is similar to the forecasting model, it also belongs to the Reporting model category of financial models.

The budget and the forecast models are represented one combined workbook and sometimes they are totally separate.

Option Pricing Model

As the name suggests, this model is part of the Pricing model category of financial models. Binomial tree and Black-Sholes are the two main option pricing financial models and are based purely on mathematical financial modelling rather than specific standards and therefore are an upfront calculator built into Excel.

Though financial modelling is a generic term that means different things to different users, the reference usually relates either to accounting and corporate finance applications, or to quantitative finance applications.

What are the areas where you have applied financial modelling and created financial models for your company or clients? Or what are the other specifics on financial modelling, particular financial models or their application that you might be interested in? Do let us know by writing to us .

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Financial Model: What is it?

The basics of financial modeling

Adin Lykken

Currently, Adin is an associate at Berkshire Partners, an $16B middle-market private equity fund. Prior to joining Berkshire Partners, Adin worked for just over three years at The  Boston Consulting Group as  an associate and consultant and previously interned for the Federal Reserve Board and the U.S. Senate.

Adin graduated from Yale University, Magna Cum Claude, with a Bachelor of Arts Degree in Economics.

Patrick Curtis

Prior to becoming our CEO & Founder at Wall Street Oasis, Patrick spent three years as a Private Equity  Associate for Tailwind Capital  in New York and two years as an Investment Banking Analyst at Rothschild.

Patrick has an  MBA  in Entrepreneurial Management from The Wharton School and a BA in Economics from Williams College.

  • What Is A Financial Model?
  • Financial Modeling Process
  • Types Of Financial Models
  • Uses Of A Financial Model
  • Financial Modeling Software

A financial model represents how an organization’s financial health is expected to evolve over time under certain assumptions. They are often created using spreadsheet software such as Microsoft Excel.

business financial model meaning

They are most commonly used for investment analyses, as they help identify risks and potential returns on investments. They can also be used to test pricing strategies for new products or evaluate alternative investments like real estate and commodities.

Although “financial modeling” is an umbrella term defined flexibly by different users depending on its intended uses, it is usually used in the context of corporate finance, accounting, or quantitative finance. 

In accounting and corporate finance, modeling usually involves forecasting the financial statements and financial analysis. In quantitative finance, it involves developing complex mathematical models dealing with market movements, asset prices, and portfolio returns.

This article explores what these models are, how to build one, the common types, and what software you can use and is a great starting point if you are new to them.

What is a financial model?

“Are financial models always large and complex? Do they always have an enormous amount of data?”

“Do models always use formulas that I have never heard of?”

“Is an Excel workbook a model?”

If you have wondered about or asked similar questions, you’re at the right place to learn more about these magical things called financial models.

Models can be of varying sizes and complexity. However, all models share some commonalities. They may be used for statistical investigation, optimization, simulation, or forecasting. They can be applied in various fields ranging from natural sciences and engineering to economics and finance.

SR 11-7 is a regulatory standard set out by the US Federal Reserve that guides model risk management. The standard defines a model as “a quantitative method, system, or approach that applies statistical, economic, financial, or mathematical theories, techniques, and assumptions to process input data into quantitative estimates.” 

It also tells us that “a model consists of three components: an information input component, which delivers assumptions and data to the model; a processing component, which transforms inputs into estimates; and a reporting component, which translates the estimates into useful business information.”

Therefore, a structured representation must meet the following criteria to be considered a model:

  • Uses academic theory.
  • Converts data into useful information.
  • Gives quantitative output. (Inputs may be partially or wholly qualitative)

I am something of a financial modeler myself

A model is a simplified representation of a finance setting from the real world. It is a structured representation of how an organization’s financial health, indicated by its assets, liabilities, revenues, and expenses, is expected to evolve over time under certain assumptions. Capturing all the complex and dynamic real-world settings is impossible, so some simplification is inevitable.

They are often created using spreadsheet software such as Microsoft Excel due to large amounts of data and complex functions, but simpler ones can even be built with pen and paper. For example, a simple household budget is a model too!

Difference between good financial model and a "normal" financial model

Financial modeling process

Depending on what type of financial model is required, different steps may follow.

For example, a standard model known as a three-statement model links the three financial statements and forecasts them based on assumptions about the future. Again, the key is to understand what you want the result to look like and who the end-users are which can generally be achieved by asking the right questions.

Where to start modeling?

Although the steps involved in building different types of models may differ, we have listed a broad outline of the process that is common to most types.

  • Data collection and validation

Collecting historical data to use as inputs is the first step in building a model. It is of paramount importance that modelers validate input data before proceeding further because the model's accuracy will depend on the quality of data provided. It can be done manually or through software. Remember, Garbage in = Garbage out.

  • Model drivers

The validated data is analyzed for trends and patterns to establish some assumptions, also called model drivers, as they drive all forecasts in the model. 

They generally include the revenue growth rate, the expected operating margin, the return on investment (ROI), and working capital needs. In addition, modelers must ensure that the assumptions are rationally sound as the model's accuracy depends on it.

  • Project forecasts

Using the inputs and the assumptions, users can now make the desired forecasts which may be presented as a result or further analyzed.

  • Further analyses

We can add additional analyses to the forecasted data or build other models upon it depending on the objectives of the exercise.

For instance, if the objective is to find the intrinsic value, we may further build a discounted cash flow (DCF) model. If we are forecasting the results of a merger, we may build a mergers and acquisitions (M&A) model. 

  • Stress testing and audit

A good model must be foolproof. The chances of errors and misuse must be minimized. It is important to find flaws in the model and them. Hence, the model is tested with extreme inputs and assumptions to see whether it behaves as expected. 

Certain audit tools and techniques can be useful in confirming whether the model is accurate and that the formulae are working correctly.

  • Presenting the results

Presenting the results of a model is equally as important as the modeling process itself. The model's usefulness is determined by its ability to assist in decision-making. If the results of a model cannot be effectively communicated, it cannot help in the decision-making process. 

Visual tools like charts and graphs are a great way to communicate information to executives who do not have the time to look at minute details in blocks of text.

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Types of financial models

“You said there are many types of them? Where’s my Poké Ball? Gotta catch ‘em all!”

Although all models differ to some extent, they can be categorized into a few types based on their objectives. 

The most common type of financial model is the three-statement model. It dynamically links the three financial statements – the income statement, the balance sheet, and the cash flow statement. In addition, it is often used as a base to build other use- or industry-specific models.

Here are some other common types.

It is developed on the three-statement model. It is used to value companies by discounting their projected cash flows. The resulting value of the company represents the present value of all its future cash flows. It is based on the intrinsic value approach and is part of fundamental analysis.

It is often used for investments that generate or are expected to generate a steady cash flow and for investments with no comparable investments.

  • Trading comps model

This model uses comparable analysis by employing trading valuation multiples of comparable companies to derive the value of a company. Unlike the DCF method, it uses the relative value approach to valuation.

  • Precedent transaction model

This model is similar to the trading comps model. However, instead of trading multiples, it uses precedent transactions to derive the value of a company. Transaction multiples are calculated based on the transaction price of an M&A transaction. Like the trading comps model, this method also uses the relative value approach to valuation.

It is prepared for LBO transactions which involve modeling for complex debt schedules. It is considered one of the most challenging types of models. There are often many layers of circularity.

  • Accretion-Dilution model

It is used to assess the accretion or dilution from potential M&A transactions. In addition, it evaluates whether a prospective deal creates value for the shareholders or destroys it.

  • Real estate model

In real estate modeling, the risks and returns of investing in a property are evaluated from an investor’s point of view.

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Everything You Need To Master Financial Modeling

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Uses of a financial model

“What good is a financial model anyway?” 

“Do I even need to learn financial modeling?”

Where do you use financial modeling?

The end goal of a model is to provide insight into the potential future of an organization. It is used by internal departments within a company and external stakeholders such as investors. Industries that use it include healthcare, automotive, banking, insurance, and retail.

A key goal while creating one is to make it concise and clear. Reading through a model should allow users to understand it quickly and make decisions.

The users need to understand its objectives before building one because the focus will vary depending on that. For example, if your objective is to find a fair value for an early-stage company, the model would be created differently than if the objective was to determine the intrinsic value of a call option.

The objectives of building these models can range from something as simple as linking the three financial statements to something complex like evaluating a potential merger. The most common objectives of are listed below.

  • Building a three-statement model to dynamically link the three financial statements
  • Forecasting the future performance of a business
  • Valuing companies or investment opportunities
  • Modeling different scenarios to understand each of their impact on the company’s financial health
  • Understanding the sensitivity of the company’s growth prospects to the changes in market factors
  • Evaluating mergers and acquisitions (M&A) transactions

The video below explains why modeling is important and why you need to learn it ASAP.

Financial modeling is a requisite skill for many jobs. Companies increasingly seek professional talent to process raw input into meaningful forecasts and insights. Although traditionally speaking, this skill has been associated with investment banking , it is now commonly sought after by corporates, institutions, and banks alike. The most common job functions that involve this skill are:

  • Investment banking
  • Portfolio management
  • Financial planning and analysis
  • Private equity analysis
  • Venture capital analysis
  • Commercial banking

Hence, it is of utmost priority to get proficient at this skill if you are pursuing a career in finance. To help you learn modeling better with a hands-on approach, seasoned finance veterans at WSO have made some amazing templates for different kinds of models, resumes, presentations, and more!

Free templates!

Free WSO Financial Modeling Templates

Sign up to receive a FREE swipe file containing a collection of quality financial modeling templates to help your finance skills and prepare for interviews.

Financial modeling software

“Is Excel all I’ve got?”

The most used software for financial modeling is Microsoft Excel followed by Microsoft Access (very rare but still used, especially with large datasets), and both are offered as a part of the Microsoft Office suite by Microsoft. Excel is a spreadsheet program that allows users to create models quickly and easily. It also comes with a wide range of built-in functions for manipulating data and performing calculations. 

Access is a database management software that includes features like business intelligence (BI) and data mining tools, making it a powerful tool for financial analysis, especially when working with vast data.

Each allows users to choose between a flat database and a relational database data structure. A flat database is a database that stores data in a single table, like a single spreadsheet. On the other hand, a relational database uses information in one table to structure information in other tables. Although relational databases are like Excel workbooks, they are generally more flexible and powerful.

Both Access and Excel are complex software that can take long periods to master. That said, Excel seems to be more popular because of how easy it is to use. Beginners can get started with creating spreadsheets in it quickly. In addition, its large userbase acts as a useful source of unlimited learning resources.

If users find themselves having to manage multiple worksheets with large amounts of data and complex calculations, Access might be better suited to meet their needs. Although it may require some time and effort initially to design the layout of the database, it is efficient to create the formulas that produce the final results. In addition, users can review the templates offered by both software and pick the one that suits their requirements better.

More about financial modeling

To continue learning and advancing your career, check out these additional helpful WSO resources:

  • Advanced Financial Modeling (AFM)
  • Financial Modeling Best Practices
  • What Makes a Good Financial Model?
  • Scenario Analysis vs Sensitivity Analysis
  • Valuation Modeling in Excel

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An Overview of Financial Modeling, Including Examples, Templates, Careers, Salaries and Training Courses

What is financial modeling, and why does it matter.

We get many questions about what “financial modeling” means, how important it is in the finance industry, and why so many students and professionals are obsessed with learning it.

So, let’s start with the basic definition:

Financial Modeling Definition: A financial model is a spreadsheet-based abstraction of a real company that helps you estimate the company’s future cash flows, financing requirements, valuation, and whether or not you should invest in the company; models are also used to assess the viability of acquisitions and the development of new assets.

Suppose that your crazy rich uncle calls you and tells you about his latest investment: a tequila company into which he just “poured” $100,000.

He shares data about the company’s sales, employee count, and market share, and then he claims that his $100,000 investment will be worth $1 million in 5 years.

He then gently encourages you to put your life savings into this tequila company.

Financial Modeling

A robust financial model lets you input these parameters, project the company’s future cash flows, and assess the likelihood of your uncle’s $100,000 investment turning into $1 million in 5 years.

Financial models cannot predict any outcome with a high degree of certainty.

The goal is to be “roughly correct” rather than “precisely wrong.”

If a financial model tells you that a company is undervalued by 5% or 10%, that is a meaningless result because the margin of error is so high.

But if the model tells you that the company is undervalued by 90% or overvalued by 200% , those are much more useful results.

Even if you’re wrong about the percentages, you can still make money if you are directionally correct .

Returning to this tequila company example, perhaps your model produces the following results for your uncle’s $100,000 investment:

  • $1 million in 5 Years: This would require the tequila company to grow from 1% to 10% market share in a very crowded market within 5 years. Alternatively, the company could also get there by selling its tequila at 3x the normal price and capturing 3% of the market.
  • $500,000 in 5 Years: This would require the company to win 5% market share within 5 years or sell its tequila at 2x the normal price while capturing 2% of the market.
  • $200,000 in 5 Years: This would require 3% market share within 5 years or tequila sold for 2x the normal price and 1% of the market (the same as the current share).

What’s the conclusion?

It’s unlikely that your uncle’s $100,000 investment will turn into $1 million within 5 years because the required pricing and market share are unrealistic.

We can’t assign a specific probability to this outcome, but we can say that no food & beverage company in history has ever achieved this performance in this time frame.

  • If the company does achieve this performance, it will likely take more than 5 years.
  • And the other outcomes here, especially the last one, are more plausible.

Doubling or quintupling your money over 5 years is still a great result, so you might take your uncle’s advice and invest some amount.

Or, perhaps you do further research into the company and its market, become more skeptical, and decide against investing.

A financial model is just a PART OF the investment process; it’s like a piece of evidence in a courtroom murder trial.

It can help persuade others that you are correct, but a spreadsheet by itself doesn’t solve the case or convince everyone on the jury.

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Types of Financial Models

There are 4 main categories of financial models used at normal companies, investment banks that advise companies on transactions, and investment firms:

  • Category #1: 3-Statement Models (Income Statement, Balance Sheet, and Cash Flow Statement) or “Budgets” at normal companies (see here for more on 3-Statement Models)
  • Category #2: Valuations and DCF Models (Discounted Cash Flow Models)
  • Category #3: Merger Models (also known as M&A Models or Accretion/Dilution Models)
  • Category #4: Leveraged Buyout Models (slight variations include the Growth Equity Models and “Investment Models”)

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3-Statement Models

In these financial models, you project a company’s revenue, expenses, and cash flow-related line items, such as the Change in Working Capital and Capital Expenditures.

You then use these numbers to forecast the company’s financial statements , i.e., its Income Statement, Balance Sheet, and Cash Flow Statement, over several years.

The Income Statement shows a company’s revenue, expenses, and taxes over a period of time and ends with its Net Income (i.e., its after-tax profits).

The Balance Sheet shows a company’s Assets , or its resources that will deliver future benefits, and its Liabilities & Equity , or its funding sources that have direct or indirect “costs.”

The Cash Flow Statement provides a reconciliation between a company’s Net Income and the cash it generates, which is often quite different.

For example, accounting rules state that cash outflows for spending on long-term items such as factories and properties should not appear directly on the Income Statement because these items could be useful for many years.

So, companies record the cash outflows for this spending as “Capital Expenditures” on the Cash Flow Statement.

If a company buys a new factory for $100 million, its cash flow is reduced by $100 million – but you wouldn’t know it by looking at the Income Statement.

The company’s Income Statement only shows the “Depreciation” representing the allocation of this $100 million over many years.

For example, if the factory is expected to be useful for 20 years, the company might record $100 million / 20 = $5 million of Depreciation per year on its Income Statement.

The Cash Flow Statement records all the cash inflows and outflows, which gives you a full picture of the company’s business health.

It prevents companies from hiding behind non-cash revenue and expenses that might distort their Income Statement.

These 3-statement models are widely used at normal companies for budgeting purposes and at banks and investment firms to assess companies’ financing requirements.

For example, a 3-statement model might tell you that a company will need additional capital in 3-4 years to continue its aggressive expansion strategy:

Cash Flow Statement Financial Modeling Example

If a company has already borrowed money, a 3-statement model might tell you how well it can repay that Debt over the next 5 years.

3-Statement Model Examples

Here are a few examples of 3-statement models:

  • Illinois Tool Works – Sample 3-Statement Modeling Test and Tutorial
  • Industrials Investment Banking – Screenshots from an airline 3-statement model
  • Healthcare Investment Banking – Screenshots from a bio/pharma 3-statement model

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Valuations and DCF Models

In valuation models, you estimate the range of values an entire company might be worth today .

For example, if a public company’s market capitalization (market cap) is $10 billion, is it overvalued, undervalued, or appropriately valued?

Should it be worth closer to $5 billion, or something closer to $15 billion?

Valuations are designed to answer these questions.

You can value a company using different methodologies, but two of the most important ones are the Discounted Cash Flow (DCF) analysis and trading multiples , also called “comparable companies,” “public comps,” or “ comparable company analysis .”

In a DCF, you project a company’s cash flows far into the future (5, 10, or even 20+ years) and discount them to their “Present Value” – what they’re worth today, assuming that you could invest your money elsewhere at a certain rate of return.

With trading multiples, you calculate other companies’ values relative to their financial metrics, such as revenue or profits, and you apply those “multiples” to value your company.

For example, if similar companies are worth 3x their annual revenue, and your company has revenue of $200 million, perhaps it should be worth about $600 million.

In a DCF model, similar to the 3-statement models above, you start by projecting the company’s revenue, expenses, and cash flow line items.

Unlike 3-statement models, however, you do not need the full Income Statement, Balance Sheet, or Cash Flow Statement.

Many of the items on these statements are non-recurring or have nothing to do with the company’s core business, so a partial Income Statement and Cash Flow Statement are sufficient:

Partial Income Statement used in Financial Modeling

This approach saves time and results in nearly the same output in most cases.

Valuation and DCF Model Examples

You can get examples of valuation and DCF models below:

  • Comparable Company Analysis
  • Uber Valuation
  • Snap Valuation
  • DCF Model – Walmart Valuation

The Walmart example also explains the “big idea” behind valuation and DCF analysis.

Merger Models (AKA M&A Models or Accretion/Dilution Models)

A merger model is different because it involves two companies rather than one.

The goal is to assess whether a larger company’s acquisition of a smaller company provides a financial benefit .

For example, will the acquirer’s Earnings per Share (EPS), defined as Net Income / Shares Outstanding, increase after the acquisition closes?

Will the acquirer’s valuation increase after it acquires the target company and properly integrates it?

Is the acquirer paying a fair price for the target based on the financial metrics of both companies?

If the acquirer is issuing new stock (shares) to acquire the target, will each company own appropriate percentages after the deal closes?

Merger models are designed to answer these types of questions.

Similar to valuations and DCF models, you do not need a company’s full Income Statement, Balance Sheet, and Cash Flow Statement to build a merger model.

You just need the Income Statement and a partial Cash Flow Statement for the acquirer and the target:

Combined Income Statement for Financial Modeling

More complex merger models often include the full financial statements, but they’re not required for a basic analysis.

Other key assumptions include the price paid for the target, the form of consideration (Cash, Debt, or New Shares Issued), and the expected synergies (ways for the combined company to cut costs or increase sales).

As with all other financial models, a merger model is just one piece of evidence in the process of negotiating a deal.

A company’s Board of Directors would never approve of an acquisition solely because of a merger model’s output.

There must be other perceived benefits, such as strategic, market, and competitive advantages from the deal.

For example, maybe the target company gives the acquirer access to a high-growth market that would have taken years to enter independently.

Or maybe the target company has valuable intellectual property (IP) that the acquirer cannot easily develop on its own.

M&A and Merger Model Examples

You can view a few sample M&A and merger model tutorials below:

  • Merger Model Walkthrough: Combining the Income Statements
  • Merger Model: Cash, Debt, and Stock Mix
  • Merger Model Interview Questions: What to Expect

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Leveraged Buyout Models (AKA Growth Equity Models or “Invest Models”)

This last category is a variation on the first category (3-statement models).

We’re listing it separately because most people consider them separate, despite the similarities.

In leveraged buyout models (LBO models), the goal is to calculate the multiple or annualized rate of return you could earn by investing in a company, holding your stake, and eventually selling it.

For example, if a private equity firm acquires a company for $1 billion, operates it for 5 years, and sells it, could it potentially earn an average annualized return of 20%?

Or would that require implausible assumptions, such as the company going from a 10% profit margin to a 30% margin within 5 years?

The full financial statements are not required for these models because the investment returns are linked primarily to the company’s cash flow and cash flow growth rate.

And the “exit value” when the company is sold is usually linked to metrics that act as proxies for cash flow, such as EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) .

As with the other models above, you start building an LBO model by projecting the company’s revenue, expenses, and cash flow line items.

These give you a sense of the company’s Free Cash Flow , or the cash it generates from its core business operations after paying for funding costs, such as interest on Debt:

Debt Repayment Schedule for Financial Modeling

Based on the purchase price, the exit value, and the cash flows generated in the holding period, you can calculate the multiple of invested capital (MOIC) and the internal rate of return (IRR) , also known as the average annualized return.

This model is known as an LBO model or leveraged buyout model because private equity firms use a combination of Debt and Equity to fund acquisitions of entire companies.

It’s similar to buying a home using a down payment and a mortgage, but on a much larger scale.

The private equity firm operates the company, uses the company’s cash flows to repay the Debt, and sells the company after several years.

The need to track this Debt repayment and the associated line items makes the Excel formulas more complex than those used in a standard 3-statement model.

If the private equity firm does not use Debt, the model is much simpler because you need only the cash flow projections, the purchase price, and the exit value.

This variation is often called a “growth equity model” or simply an “investment model.”

Regardless of the model variation, though, the goal is always the same: determine plausible ranges for the multiple of invested capital and the annualized returns.

You can get example LBO models, growth equity models, and leveraged buyout tutorials below:

  • Growth Equity: Full Tutorial and Sample Case Study
  • Simple LBO Model – Case Study and Tutorial
  • IRR vs. Cash-on-Cash Multiples in Leveraged Buyouts and Investments

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Industry-Specific and Specialized Financial Models

In addition to the categories above, there are also specialized financial models in industries such as commercial real estate , project finance , and infrastructure private equity .

In these industries, financial modeling is based 100% on cash flows rather than accounting profits, so the three financial statements are not used.

Revenue and expense projections also differ significantly.

For example, in real estate financial modeling , revenue and expenses are based on individual tenants and the terms of their leases, including annual rent escalations, the expenses paid by the tenant, and the probability of leases expiring.

In project finance and infrastructure, the projections are often based on individual contracts as well – and there may be hundreds or thousands of them.

Another difference is that in addition to modeling the acquisitions of existing assets, you may also model new developments in both these industries.

To do that, you assume that a new development initially draws on Equity (i.e., cash from outside investors) and then switches to Debt once a funding threshold has been met.

When the asset is under development, it does not generate cash flow, so the interest and fees on this Debt are capitalized.

Once the development is complete, a loan refinancing occurs , the construction lenders are repaid, and new lenders fund the stabilized asset.

Specialized Financial Models for Real Estate and Construction

If you want examples of these specialized models, please see our coverage below:

  • Real Estate Financial Modeling
  • The Real Estate Pro-Forma
  • Infrastructure Private Equity
  • Project Finance Jobs

There are model variations in other industries as well.

For example, with oil & gas companies, the Net Asset Value (NAV) model is a variation of the traditional DCF analysis that does not have a Terminal Value – because oil & gas assets have limited economic lives.

Once enough oil or gas is extracted from a field, further extraction is no longer economically viable – even if some resources remain in the ground.

The asset is effectively “dead” until market conditions change.

Therefore, you cannot assume that the asset will keep generating cash flows indefinitely into the future.

With banks and insurance companies, there are DCF variations such as the Dividend Discount Model (DDM) and the Embedded Value (EV) model for life insurance.

These models have some differences, but they still value companies based on their future cash flows or proxies for cash flow, such as dividends.

Which Careers Use Financial Modeling?

The financial models described here are widely used in the following industries:

Financial Modeling in Investment Banking

Investment Banking

Investment Bankers assist companies in raising capital and executing transactions such as mergers and acquisitions (M&A).

Financial Modeling in Private Equity

Private Equity

Private equity firms raise capital from outside investors then use this capital to buy, operate and improve companies before selling them at a profit.

Financial Modeling in Venture Capital

Venture Capital

Venture capital firms raise capital that is invested in early-stage, high-growth companies with a view to exiting via acquisition or IPO.

Financial Modeling in Hedge Funds

Hedge Funds

Hedge fund managers raise capital from institutional investors and accredited investors and invest it in financial assets.

Financial Modeling in Corporate Banking

Corporate Banking

Corporate bankers aim to win and retain clients who hire the bank for M&A deals, debt and equity issuances, and other transactions with higher fees.

Financial Modeling in Corporate Development

Corporate Development

Corporate Development focuses on acquisitions, divestitures, joint venture (JV) deals, and partnerships internally at a company.

Financial Modeling in Equity Research

Equity Research

Equity research relates to the sell-side role at investment banks where you make Buy, Sell, and Hold recommendations on public stocks.

Financial Modeling Salaries

If you look at the articles above, you’ll see compensation estimates for fields such as investment banking, private equity, and hedge funds.

As a senior professional in these industries, you can earn $1 million+ if you count the base salary, bonus, and other incentive-based compensation.

However, you rarely do “financial modeling” at the senior levels in these fields.

Senior-level roles are almost always sales or negotiation jobs , where your role is to generate revenue by bringing in new clients, raising capital, or closing deals.

Most of the financial modeling is done by junior-to-mid-level professionals, such as Analysts, Associates, and Vice Presidents.

The total compensation for these roles might range from $100K USD on the low end up to $500K USD depending on the industry, firm size, and location.

For example, Investment Banking Analysts often earn total compensation in the $150K – $200K USD range in major financial centers in the U.S.

Private Equity Associates might earn $150K up to $300K or even $350K, depending on the firm.

And a Vice President will progress toward mid-six-figure compensation.

Outside of these fields, financial models are used in other industries, such as corporate finance , corporate development , and Big 4 Transaction Services .

The compensation in these fields is lower than the ranges quoted above; for more details, please click through to the links above.

How Much Does Financial Modeling Matter for Investment Banking?

If you poke around online, you’ll see a wide range of opinions on the importance of financial modeling:

  • Some people claim you need to know it perfectly, even for entry-level interviews and internships.
  • Others say that it’s overhyped and not that important; they point out that many groups are not especially technical and do not do much Excel-based modeling.
  • And others say it’s only important for the “ exit opportunities ” following investment banking, such as private equity.

As usual, the truth is somewhere in the middle.

You do not need to know financial modeling “perfectly” for entry-level interviews and internships, but you do need a solid base of technical knowledge to be competitive.

For example, how do the 3 financial statements link together? How do you set up a DCF and use it to value a company? What are the trade-offs of different valuation methodologies?

You could memorize the answers to these questions, and that might work to some extent.

But the best way to mastery this technical knowledge is to learn and practice financial modeling. It’s the difference between passively listening to a foreign language and actively practicing by speaking and writing in that language .

Financial modeling matters less for the direct benefit and more for the indirect benefit of mastering the accounting, valuation, and transaction analysis concepts that you’ll be asked about in interviews.

It is true that certain groups in investment banking, such as equity capital markets , do not do much financial modeling work (they spend more time in PowerPoint and Word creating market updates).

But in interviews, they’re still going to test you on the key technical concepts.

Finally, it’s also true that financial modeling is more important in some fields than it is in others.

For example, modeling skills do not matter much in early-stage venture capital investing because investing in startups is a much more qualitative process.

An early-stage startup does not have cash flows to model, and the founder’s personality and drive matter more than any spreadsheet.

But modeling skills matter more at late-stage VC firms and private equity firms since they invest in mature, established companies.

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How to Learn Financial Modeling: Free Tutorials

If you want to learn the fundamentals of the DCF analysis, one of the most important models, you can sign up for our free 3-part tutorial series below:

  • 3-Part Financial Modeling Series: The DCF

This series walks you through each step of the analysis, from projecting the company’s Unlevered DCF to estimating its Discount Rate and Terminal Value.

If you want tutorials on other topics, you can also consult our YouTube channel for hundreds of examples:

  • YouTube – Financial Modeling

Financial Modeling Courses

If you want  comprehensive, structured training that teaches you financial modeling based on global case studies of real companies and deals, here are our most relevant financial modeling courses and packages:

  • Core Financial Modeling – This course gives you a great foundation in accounting, valuation, and M&A and LBO modeling
  • Advanced Financial Modeling – This course delves into more complex models and deal types and is  not for beginners; it’s for professionals with some experience who want to improve their skills even more
  • BIWS Premium – This package combines our Excel, PowerPoint, and Core Financial Modeling training, all at one discounted price
  • BIWS Platinum – And this package gives you  everything we have , for a substantial discount (50%+)

These courses are for candidates who are serious about winning highly competitive internship and full-time offers at banks, private equity firms, and hedge funds.

If you have no interest in working at these firms and you just want quick tips and tricks, these courses are not appropriate for you.

But if you want to gain advanced technical skills, they are perfect.

Of course, there’s more to the job than Excel-based analysis, but mastering the technical side goes a long way toward the rest of the skills.

Core Financial Modeling (BIWS)

Learn Valuation and Financial Modeling

Get a crash course on accounting, 3-statement modeling, valuation, and M&A and LBO modeling with 10+ global case studies.

The Bergden Group

Get In Touch

813-526-6102 [email protected]

What is Financial Modeling And How Does It Work?

Businesses often employ the use of financial modeling as a guide for better decision-making and financial planning. Financial models deliver data-driven analysis to help your company know where it stands. That said, businesses need multiple types of financial modeling suited for different business cases.

What Does the Term Financial modeling Mean?

Financial modeling or data-driven analysis entails combining finance, accounting, and other vital business metrics to have a vivid and abstract model or representation of a business’ financial situation. This model helps a business visualize its financial position in the market and predict financial performance in the future.

Financial modeling is vital for multiple reasons. It can help companies make informed investment decisions and plan well for corporate situations such as mergers and acquisitions. Overall, most companies use financial models to guide them in making financial analyses and business decisions. Executives often use financial modeling to make plans regarding:

  • Organic business growth
  • Forecasting and budgeting
  • Prioritizing projects
  • Acquiring businesses or new assets
  • Distributing the company's financial resources
  • Selling or divesting business units and assets
  • Raising capital or equity

While there are multiple areas in a business that need financial models, most companies usually create Excel templates for financial modeling to expedite their decision-making process. Learn more about what a financial model is and the two approaches to building a financial model here.

Who Creates Financial Models?

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Financial models have a broad scope in business, and financial professionals like investment bankers, accountants, corporate development analysts, and equity research analysts assist in creating these business models. Primarily, in any modern business or company, those dealing with financial analysis and planning (FP&A) are likely to build and utilize these financial models to steer the company toward sustainable growth.

The FP&A department thereby plays an essential role within the company. Aside from its involvement in creating a budget and performing financial analysis, this team also helps in forecasting. Other roles include supporting decision-making for market research projects.

Financial Modeling is Critical for Strategic Analysis

In the context of the current Covid pandemic, most businesses face unique challenges. Even so, we live in an era shaped by technological improvements in business practices. Today’s businesses have more tailored solutions that focus on ensuring they’re agile and better equipped to make quick, strategic, and data-driven decisions.

To forecast the company's financials, companies must analyze and understand key trends that impact the future of their business. More importantly, they should understand accounting and business operations as well as sales and marketing. This gives your company insights into what decisions to make using data-driven information.

How to Set up a Financial Model

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How can you design a financial model? Well, most finance executives often create financial models using Excel. However, creating a realistic financial model isn’t a simple task. First, you have to learn the key Excel hacks and tips. Next, remember that financial modeling entails more than just chugging and plugging equations and data.

You have to consider factors such as your financial model's design, layout, plus formatting. For instance, separating assumptions and historical data from calculations can help minimize input mistakes. A vivid design with well-planned data can highlight the significant takeaways of the model. Importantly, you must have an understanding of accounting in order to acc

Financial Modeling Examples

While financial modeling plays an essential role in any business success, no one model suits every business. Financial models should match your business needs.

Let's look at some of the common financial modeling examples you can implement in your business:

Top-down model  – The top-down model helps separate a good business from a profitable one. Using this model, you work from a micro or outside perspective toward a micro view. In essence, the top-down model helps define a forecast based on a market share you want to capture within a reasonable time frame.

Bottom-up approach model  – Unlike the top-down model, the bottom approach is less dependent on external factors. Instead, it leverages company-specific data and business drivers including but not limited to sales, financing, unit volume, cost of goods, and operating expenses.

Unlike the top-down model, the bottom-up approach starts with an inside view and builds towards an outside perspective.

For example, imagine you own and operate a specialty coffee shop and want to model its performance over the next 12 months. Let's assume the main driver to your coffee shop is foot traffic. So, one effective strategy you can use is selecting a prime location with high-level foot traffic and demand for specialty coffee. You can now estimate the daily foot traffic, rate at which those passing by enter your shop to make a purchase (i.e. conversion rate), and and average ticket price. Now that you have the fundamental drivers established, you can model the shop’s sales as depicted below:

Daily Foot Traffic x Conversion Rate x Average Ticket Price = Daily Sales

Model of Assumptions

Modeled assumptions produce outputs such as financial statements. This includes a Profit & Loss (P&L) Statement, Balance Sheet, and Cash Flow Statement. Each financial statement serves a unique purpose - the P&L shows income and expenses over time; the balance sheet depicts your assets (what you own) versus your liabilities (what you own) at a point in time; and the cash flow statement conveys the inflows and out flows of cash across your core operations, investment, and financing events.

Bottom line

It is vital for businesses to create financial models in line with their changing business needs. Above all, companies need to invest in professionals who understand how to work with different financial models.

If you need advice on building a financial model, we are here to help. Check out our services or contact us today!

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Financial Modeling: Essential Concepts and Techniques

Last Updated on :  July 31, 2023

business financial model meaning

Financial modeling plays a pivotal role in the finance industry, as it encompasses the core principles and methodologies employed to develop reliable models for analyzing and forecasting financial results. These models serve as invaluable aids in decision-making, offering valuable insights into investment prospects, company valuations, and risk evaluations. Proficiency in financial modeling empowers finance professionals to navigate the complex terrain of the financial landscape with accuracy and assurance. 

This comprehensive guide aims to delve into the vital concepts and techniques necessary for constructing impactful financial models, equipping individuals with the expertise to make well-informed financial choices and achieve triumph in the ever-evolving realm of finance.

So, let's get started.

What is Financial Modeling?

Financial modeling entails constructing mathematical models to replicate real-life financial situations. By leveraging historical data, assumptions, and formulas, financial modeling facilitates the analysis and projection of financial outcomes. These models are invaluable for performing critical assessments like financial analysis, valuation, and risk management.

Financial Modeling

Importance of Financial Modeling in Decision-Making

Financial modeling is integral to decision-making processes across diverse industries, providing a structured and quantitative framework for analyzing financial data. Its significance lies in providing valuable insights into various options' potential outcomes, risks, and returns. By incorporating essential variables such as revenue projections, expenses, and market trends, financial models simulate different scenarios, enabling decision-makers to evaluate the financial consequences of their choices.

This empowers stakeholders to carefully consider the advantages and disadvantages, optimize the allocation of resources, identify potential challenges, and make strategic decisions that align with their objectives. Financial modeling is a powerful instrument to enhance decision-making accuracy, strengthen risk management practices, and propel overall business achievements.

You must learn about Finance management: - Meaning, Scope, & Importance to understand the importance of financial modeling in decision-making.

Objectives of Financial Modeling

Now that we have learned what is Financial Modelling. Let’s here are the objectives of financial modeling:

  • To analyze the historical performance of a company or industry by studying past financial statements and other data sources
  • To develop forecasts and scenarios for future performance, such as sales growth, earnings estimates, cash flow projections, and more
  • To identify trends in financial data that can be used to make informed decisions about investments, financing, or operations
  • To assess risk and evaluate potential outcomes
  • To compare companies or industries to each other and measure their performance
  • To facilitate financial planning, budgeting, forecasting, and business decision-making.

How Financial Modeling Works?

Financial modeling utilizes historical financial data, assumptions, and formulas to create models simulating real-world financial scenarios. It involves structuring and organizing information, identifying variables, and formulating assumptions to generate quantitative outputs. 

These outputs provide insights into financial performance, investments, and risks, enabling informed decision-making. Financial modeling is a dynamic process that requires continuous monitoring and refinement to ensure accuracy in an evolving financial landscape.

Excel for Financial Modeling

When it is about financial modeling in Excel, several essential functions and formulas are commonly used. These include:

  • SUM and SUMPRODUCT: These functions help add values and calculate weighted averages, respectively. They help aggregate data and perform calculations across multiple cells or ranges.
  • IF and IFERROR: The IF function allows for conditional calculations, enabling you to apply different formulas based on specific criteria. The IFERROR function helps handle errors by providing alternative values or error messages.
  • NPV and IRR: These functions are used for discounted cash flow (DCF) analysis. NPV calculates net present value of cash flows, while IRR calculates the internal rate of return. They are crucial for investment appraisal and determining the value of projects or investments.
  • VLOOKUP and INDEX-MATCH: These functions help retrieve data from other sheets or tables based on specific criteria. They are valuable for creating dynamic references and analyzing data across different datasets.
  • PMT and FV: These functions assist in calculating loan payments (PMT) and future values (FV) of investments. They benefit from financial planning, analyzing loan terms, or projecting investment growth.
  • COUNT, COUNTIF, and COUNTIFS: These functions are used for counting cells or ranges that meet specific criteria. They are helpful for data analysis, assessing the frequency of occurrences, or generating summary statistics.

How do you build a Financial Model?

  • Define the Objective: Clearly define the objective of the financial model. Determine what specific analysis or decision-making process the model will support.
  • Gather Data: Collect relevant historical financial data, market data, and any other necessary information for the model.
  • Structure the Model: Organize the model by setting up different worksheets or tabs for input data, calculations, and output summaries.
  • Identify Variables and Assumptions: Identify the key variables and assumptions driving the financial model.
  • Build Formulas and Calculations: Use Excel functions and formulas to link the variables and assumptions, perform calculations, and generate the desired outputs.
  • Validate and Test: Validate the model's outputs by comparing them to historical data or benchmarking against industry standards.
  • Document Assumptions and Methodology: Document the assumptions, formulas, and methodology used in the financial model.
  • Analyze and Interpret Results: Analyze the outputs of the financial model to derive insights, draw conclusions, and make informed decisions.
  • Present Findings: Communicate the findings of the financial model effectively to stakeholders, management, or decision-makers through reports, presentations, or visual representations.
  • Review and Update: Regularly review & update the financial model as new data becomes available or circumstances change.

Advanced Financial Modeling Techniques

  • Scenario Analysis: This technique involves creating multiple scenarios by varying key assumptions to assess potential outcomes.
  • Monte Carlo Simulation: Monte Carlo simulation is a great technique used to analyze the uncertainty and risk associated with financial models.
  • Sensitivity and Breakeven Analysis: Sensitivity analysis involves assessing the sensitivity of financial models to changes in input variables. It helps identify which variables have the most significant impact on results.
  • Capital Budgeting Techniques: Advanced financial modeling incorporates sophisticated capital budgeting techniques like net present value (NPV), internal rate of return (IRR) & profitability index (PI).
  • Complex Valuation Methods: Advanced financial modeling includes advanced valuation methods like discounted cash flow (DCF) analysis, option pricing models, or real options analysis.
  • Dynamic Financial Modeling: Dynamic financial modeling involves building models that account for changing variables and time-based factors.
  • Data Analysis and Visualization: Advanced financial modeling techniques often involve leveraging data analysis tools, statistical techniques, and visualizations to gain deeper insights into financial data. Understanding the Instruments of the Capital Market will also help in financial modeling.

How to Learn Financial Modeling

  • Basic Accounting Knowledge: Familiarity with accounting principles, financial statements, and financial ratios provides a foundation for understanding financial modeling concepts.
  • Finance Fundamentals: A basic understanding of finance concepts like time value of money, discounted cash flow analysis, and investment valuation methods is essential in financial modeling.
  • Excel Proficiency: Strong skills in Excel, including functions, formulas, data manipulation, and analysis, are essential, as Excel is the primary tool used in financial modeling.
  • Data Analysis Skills: Proficiency in data analysis techniques, such as organizing and manipulating data, pivot tables, and data visualization, enhances your ability to work with financial data in models.
  • Knowledge of Corporate Finance and Valuation: Understanding concepts related to corporate finance, such as cost of capital, financial forecasting, and valuation methods, provides a solid foundation for financial modeling.
  • Practice and Hands-on Experience: Actively practicing financial modeling by working on real-world case studies or projects helps develop practical skills and reinforces theoretical knowledge.

Financial Modeling

Types of Financial Model

Below are the major types of financial modeling present:

Financial Statement Models:

Discounted cash flow (dcf) models:, mergers and acquisitions (m&a) models:, lbo (leveraged buyout) models:, project finance models:, sensitivity and scenario models:, option pricing models:, monte carlo simulation models:, .css-12zqz9u{-webkit-user-select:none;-moz-user-select:none;-ms-user-select:none;user-select:none;width:1em;height:1em;display:inline-block;fill:currentcolor;-webkit-flex-shrink:0;-ms-flex-negative:0;flex-shrink:0;-webkit-transition:fill 200ms cubic-bezier(0.4, 0, 0.2, 1) 0ms;transition:fill 200ms cubic-bezier(0.4, 0, 0.2, 1) 0ms;font-size:1.5rem;height:0.7em;} what are the key components of a financial model, .css-12zqz9u{-webkit-user-select:none;-moz-user-select:none;-ms-user-select:none;user-select:none;width:1em;height:1em;display:inline-block;fill:currentcolor;-webkit-flex-shrink:0;-ms-flex-negative:0;flex-shrink:0;-webkit-transition:fill 200ms cubic-bezier(0.4, 0, 0.2, 1) 0ms;transition:fill 200ms cubic-bezier(0.4, 0, 0.2, 1) 0ms;font-size:1.5rem;height:0.7em;} how can financial modeling help in making informed business decisions, .css-12zqz9u{-webkit-user-select:none;-moz-user-select:none;-ms-user-select:none;user-select:none;width:1em;height:1em;display:inline-block;fill:currentcolor;-webkit-flex-shrink:0;-ms-flex-negative:0;flex-shrink:0;-webkit-transition:fill 200ms cubic-bezier(0.4, 0, 0.2, 1) 0ms;transition:fill 200ms cubic-bezier(0.4, 0, 0.2, 1) 0ms;font-size:1.5rem;height:0.7em;} how can i build a robust financial model from scratch, .css-12zqz9u{-webkit-user-select:none;-moz-user-select:none;-ms-user-select:none;user-select:none;width:1em;height:1em;display:inline-block;fill:currentcolor;-webkit-flex-shrink:0;-ms-flex-negative:0;flex-shrink:0;-webkit-transition:fill 200ms cubic-bezier(0.4, 0, 0.2, 1) 0ms;transition:fill 200ms cubic-bezier(0.4, 0, 0.2, 1) 0ms;font-size:1.5rem;height:0.7em;} what types of businesses use financial modeling, .css-12zqz9u{-webkit-user-select:none;-moz-user-select:none;-ms-user-select:none;user-select:none;width:1em;height:1em;display:inline-block;fill:currentcolor;-webkit-flex-shrink:0;-ms-flex-negative:0;flex-shrink:0;-webkit-transition:fill 200ms cubic-bezier(0.4, 0, 0.2, 1) 0ms;transition:fill 200ms cubic-bezier(0.4, 0, 0.2, 1) 0ms;font-size:1.5rem;height:0.7em;} what is financial modeling used for.

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Advanced Financial Modeling Best Practices: Hacks for Intelligent, Error-free Modeling

From abstract spreadsheets to real-world application, financial models have become an inextricable part of business life and an indispensable part of every company’s toolkit. But irrespective of its ubiquitousness as a productivity and decision-making tool, many out there still have a love-hate relationship with it.

Finance expert Alberto Bazzana authors a comprehensive “how-to guide,” for both the novices and experts among us, detailing Wall Street’s best practices for intelligent, effective, and error-free financial modeling.

Advanced Financial Modeling Best Practices: Hacks for Intelligent, Error-free Modeling

By Alberto Bazzana

Albert is a seasoned PE executive with over $1Bn in trasactions. Prior to this he led consulting engagements across nine countries.

Previously At

Executive summary.

  • As with all endeavors cumbersome and complex, begin with a sound, thoughtful blueprint for the model. Understand, as part of this process, the timeline for building the model and its expected useful life, as well as the desired tradeoff between “reusability” and “model-granularity”.
  • Next, structure and fabricate your model carefully. At a minimum, break it down into three sections: (a) inputs/drivers , (b) calculations , (the actual model, which will illustrate the projected financial statements), and (c) outputs.
  • Finally, build the model and take the time to format it for a clean, consistent, professional finish.
  • I'll show/share with you some time-tested hacks for creating an error-free model. This will include some of my personal credos such as, "One Row, One Formula", and rules like "No Hard-coded Numbers Embedded Within Formulas". Additionally, I'll show you how to create checks throughout your model via Aggregated Error Checks.
  • The importance of pre-structuring your model. I'll walk you through the most intuitive way to setup your model such that it makes intuitive sense in terms of formula flow as well as ease-of-audit and handover.
  • Color formatting is a must. It sounds simple but is an extremely effective tool that instruct novice model users what inputs mean what. Read on to see how to quickly setup a macro to automate this process.
  • Good old-fashioned Excel formula shortcuts. This section covers a couple of very effective best practices for financial modeling in Excel for our more advanced users. These might require a bit of adjusting, but should save several hours of work later and be relatively simple to implement.
  • By working alongside you as a thought partner to design, structure, build, and deliver a range of polished models or budgets for pre-mandated specific projects, purposes, or decisions.
  • By creating a prefabricated, multi-tab go-to model template that can be adapted uniquely by almost anyone, for any purpose, across your organization.
  • By designing specific outputs and running complex sensitivity analyses using Excel en route to a management-level, board-level, or operator-level strategic decision.
  • By building or creating templates for every sort of financial model type, including "how-to" instructions, ranging from discounted cash flow (DCF) model and leveraged-buyout , to mergers and acquisitions or cash-flow models .
  • By training individuals or groups of individuals within your organization on everything from the basics of modeling to advanced quantitative methods.

Introduction: A Financial Model

Financial models are an indispensable part of every company’s finance toolkit. They are spreadsheets that detail the historical financial data of a given business, forecast its future financial performance, and assess its risks and returns profile. Financial models are typically structured around the three financial statements of accounting —namely: income statement , balance sheet , and cash flow statement . The management of most corporations rely, at least in part, on the details, assumptions, and outputs of financial models, all of which are critical to said companies’ strategic and capital decision-making processes.

This article serves as a step-by-step guide for the novice and intermediate finance professional looking to follow expert best-practices when building financial models. For the advanced financial modeler, this article will also showcase a selection of expert-level tips and hacks to optimize time, output, and modeling effectiveness. Let’s begin.

Planning Your Model

As with all things complex, the first step to building a financial model (“model”) is to carefully layout a blueprint. Unplanned, unanticipated structural changes midway through a modeling exercise can be time-consuming, confusing, and error-prone, especially if the model’s adapter is not the same as its author. Such challenges are easily subverted with a bit of devoted planning time at the onset of the exercise. I recommend that your planning phase go as follows:

1. Define the model’s end goal.

Clearly defining the purpose of a model is key to determining its optimal layout, structure, and end-outputs. As part of this process, take the time to ensure that your model’s key stakeholders sign off on your blueprint and process design before starting to build. This gives them the opportunity to voice any final preferences or intentions, thus avoiding any “scope creep” (industry parlance) or painful redirection down the road.

2. Understand the timelines for both building the model and for its useful life.

Though secondary to the model’s end goal, understanding the timelines for building the model and how long the model will be used for are also important inputs to determining the approach to the modeling exercise. Long-duration and long-tenured (useful-life) models are typically custom built from the ground up and include tremendous amounts of operating detail, flexibility , and sensitivity capabilities . For more immediate, shorter duration operating or capital-project models, modelers will oftentimes use prefabricated templates to maximize speed of construction while minimizing errors. Further, model templates also tend to be more familiar and thus easier to use/manipulate by different stakeholders within organizations.

3. Determine optimal trade-off between “detail” vs. “reusability.”

When deciding the optimal trade-off between desired level of detail and model reusability (i.e., whether the model is intended to be re-worked for multiple transaction-types/purposes or has instead been designed for just this one-off exercise), a useful framework for deciding on one’s model choice/approach, which I have followed through most of my career, is as follows:

Graphic representation of the trade-off between level of detail vs. reusability

With the blueprint/planning phase now complete and key decisions settled up, we may now move onto the next phase of modeling.

Structuring Your Model

At this juncture, we are ready to open Excel and to begin thinking about structuring. At the highest possible level, every model can/should be divided into three sections: (a) inputs/drivers , (b) calculations (projected financial statements), and (c) outputs . The better one is at segregating these sections, the easier it will be to audit and amend the model while minimizing errors and optimizing on time.

I have followed the same structural approach for almost every financial model that I have built; an approach which both my respective stakeholders and I have always found practical, digestible, and ultimately useful. Its sections are as follows:

  • Cover Page (Tab): Project code name, a description of the model’s intent, the author’s contact information, and any applicable disclaimers.
  • Drivers Tab: Inputs and assumptions.
  • Model Tab: Calculations (i.e., the three financial statement projections and calculations).
  • Outputs Tab: A clean, neat summary of the most important highlights of the model.
  • Sensitivities Tab: The range of scenarios, sensitivities , and data outcomes that management will rely on as they transition into their decision-making process.

I will break each of these sections down for you, one at a time. As follows:

The cover page is the first point of contact with your work. While it is the simplest to build, when done well, it leaves a great first impression and clearly explain what is to come. A simple, instructional cover page is generally the best approach and typically includes the following sections:

  • Name of the Model: Self-explanatory.
  • Purpose of the Model: A paragraph describing its intended use(s)
  • Model Index: A brief table detailing each tab’s description and purpose. This section can be especially helpful to non-finance operators, helping them “digest” the model’s structure and flow by highlighting which tabs they need to use for inputs, which outputs to focus on during decision-making, and which complex calculation tabs they should leave untouched.
  • Model Version History: Investing a few seconds in typing, by date, the key changes made to the model as you go along always saves time down the road, especially if you need to retrace and reverse/modify changes. This is especially true for complex models and models that you may use as templates in future periods.
  • Author’s Contact Information: Self-explanatory
  • Applicable Legal Disclaimers (if any, as provided by your Legal Counsel) : Self-explanatory

Please note: I recommend that the cover page always be locked to anyone and everyone without express authority to make changes, outside the author.

Driver’s Tab: Inputs and Assumptions

Immediately following the model’s cover page, must come the drivers (inputs) tab . You must ensure that this tab is clear, concise, and easy to understand, as this is the tab that non-finance operators will likely manipulate most often. I usually recommend implementing two input sections within the inputs tab, one for static inputs and the other for dynamic . By static inputs I mean inputs that don’t change over time, such as the hypothetical “size of a power plant” or “a company’s starting debt balance”; and by dynamic inputs , I mean inputs that are variable over time (e.g., month-to-month, or year-to-year) such as “inflation” assumptions, “cost of debt,” or “revenue growth” assumptions.

Example of a Sample Drivers and Assumptions Tab

Within both of the above static vs. dynamic input sections, I recommend that you also clearly separate your data into two kinds: (1) hard-coded figures that don’t change irrespective of assumptions scenario, and (b) sensitizing parameters that will drive different assumption scenarios and ultimately your sensitivity tables. Note, however, that you never fully know which parameters are going to constitute sensitivity parameters and which you will not until the final stages of the project. For more on sensitivity modeling, please refer to the following article .

Model Tab: Detailed Calculations and Operating Build-up

This tab represents the heart of the model, where all the inputs, assumptions, and scenarios work together to project a company’s financial performance into its outer-years. It is also out of this tab that various assumption-driven scenarios will be run as well as the valuation piece of the exercise that will be conducted ahead of the final strategic decision.

Example of a Sample Model Tab

Scenarios and Sensitivities Tab

Authorized, third-party model operators will use the Scenarios and Sensitivities tab fairly often, even if just to select their choice of pre-programmed scenarios. For this reason, you should build scenarios intuitively, protect the actual scenarios from outside editing, and build sufficiently varied sensitivities such that the handful of pre-programmed scenarios will be sufficient to yield a wide view of possible outcomes once sensitivity tables (sample below) are also built.

For your consideration, the scenarios format structure I have relied on throughout my career is as follows, as just one type of example:

Example of a sample scenarios and sensitivities tab

A Few Notes on the Above Image:

  • The model user should be able to edit only this, as it is where they will select the scenario number. The number refers to one of the scenarios presented on the right side of the spreadsheet. The user will then present the selected scenario (in this case, No. 6) in the first column. This is the only column of the Scenario and Sensitivities spreadsheet that is referenced in the model.
  • Add a couple of description fields here that effectively summarize what the selected scenario represents.
  • I always find it very helpful, especially if someone else will use the model, to add a column that specifies each unit of input.
  • This column pulls in the leverage statistic/field of the selected scenario (in this case, No. 6), which are all displayed on the right (in blue). The formula required to drive it is an offset function, i.e., “=OFFSET (insert empty cell immediately left of the first scenario highlighted in red above ,, Cell where the scenario is selected/highlighted).” Please note that there is an empty space between the two cells so the two commas (,,) aren’t a typo.
  • Group your assumptions in macro-categories and sub-categories. This will help both you (the modeler) and your users gain a clear understanding of which scenario the model has selected.

Example of a Sample Sensitivity Table

The output tabs are the tabs that operators of the model will use most frequently. Over the years, I’ve found myself leaning towards at least three output tabs for mid-to-complex models:

  • Financial Output Tab: This is an abridged summary of the financials detailed in the model tab. They are usually presented on an annual basis (even though the model may be quarterly). This output should be between 50 and 150 rows and should present all the key line-items from the calculation tabs. Please be sure to present enough detail so as to ensure users are not toggling between this tab and various Calculations tabs. Please also note that, as a financial model best practice, no output tabs should re-perform any calculation and this information should only include direct links in.
  • Executive Summary Tab: This tab is pretty standard and usually presents a mix of graphs, charts and tables, illustrating, as simply and as easily digestible as possible, the various trends, analyses and key summary statistics that executives and board members require to navigate their key decisions.
  • Specific Output Tab: This tab contains specific outputs, usually dictated by the template of the investment memo, the investment committee presentation, or requests by executives and board members as required to reach their decision points.

Example of a Model Output Tab, Including Tables, Charts, and Graphs

At this juncture, the construction phase of the model is officially complete. We may turn our attention to some of the expert-level Excel modeling best practices I referred to at the onset of the article. Let’s begin with formatting.

Formatting Your Model

First, it is important to note that each firm/group might have its own preferences or internal practices. As such, while building, it is important to first check in with—and adhere to—whatever format your respective firm prescribes. In the absence of firm-specific practices, however, the content below details Wall Street’s universal language for formatting a model.

The first and lowest-hanging formatting method for financial modeling is to use consistent and identifiable color schemes to denote different types of cells and data. As follows:

Blue = Inputs, or any hard-coded data, such as historical values, assumptions, and drivers.

Black = Formulas, calculations, or references deriving from the same sheet.

Green = Formulas, calculations and references to other sheets (note though that some models skip this step altogether and use black for these cells).

Purple = Links, inputs, formulas, references, or calculations to other Excel files (again, note that some models skip this step altogether and use black for these cells also).

Red = Error to be fixed.

Example of Well-formatted (Color-coded) Financials Summary

Please note that there is no in-built automation functionality to color code your Excel spreadsheets according to the universal color coding standards above. Instead, you may design your own macro(s) to achieve these outcomes, and subsequently create shortcut combinations to automatically color-code your work.

Sometime in my recent past, I received from a colleague (who I thank to this day), the following macros (including detailed instructions), which have since saved me several hours of manual labor. I’d like to share them, if I may.

Macro creation instructions (for both Mac and PC versions of Excel):

  • Hit Alt + W + M + R, concurrently, to name and begin recording your macro.
  • Hit F5 (“Jump to Cell”) and then Alt + S, concurrently, to arrive at the “Go to Special” menu.

Screenshot

  • Now hit Alt + H + FC (or Ctrl + 1), concurrently, and select your blue font color for these constants.
  • Now do the same thing, starting with F5, but select Formulas (F) instead of constants and press “X” to uncheck text.
  • Now hit Alt + H + FC (or Ctrl + 1) and select a Black font color for these constants.
  • Stop recording the macro with Alt + W + M + R or Alt + T + M + R.

Links to Other Workbooks

Finding links to other workbooks and worksheets is tricky, and you will most likely have to use VBA to get this working correctly. Here’s the basic idea: search for the presence of the symbol “!” in each cell that contains a formula across your workbook, and then change the font color to green. You will need to modify this in the VBA Editor and make it a for each loop through all instances of “!” you find, and then change the font color for each of these.

Please be aware that this shortcut still won’t work 100% of the time because some formulas will reference cells in other worksheets without directly linking to them. Fortunately, green cells are rarer than black or blue cells, so the method above works fairly well in most models (and you can organically format the rest of your links to other worksheets manually as they come up or as you come across them).

Best Practices for Auditing a Model

When modeling, I encourage you to always bear this single question at the back of your mind: “Am I making this model easily auditable?” because for every task executed, formula created, and link built, there will always be a faster, “dirtier” (in industry parlance) way to do the job. Such hacks and tricks, however clever they may seem at the time, and especially after time intervals, will invariably be forgotten and will lead to hard-to-track-down errors. Keeping a third-person reviewer in mind will guide you through your process and help you come to the right decision at key junctures.

Below are a series of best practices on how to build with an auditor mindset. As follows:

1. One Row, One Formula

You should have only one formula per row, meaning that whatever formula is used in the first cell of any given row should be the same formula uniformly applied across the entire row. Users should understand the structure of your model by looking at the first cell of each row as they proceed vertically down your model.

While this is simple in principle, it is violated often enough to highlight further. A common instance often takes place when spreadsheets are split between a “historical financials” group of columns and “outer-year forecasts” (see image above entitled, “Example of Well-formatted (Color-coded) Financials Summary,” as a reference).

One easy way to address these instances, is the use of flags (e.g., 1/0, TRUE / FALSE ) positioned at the top of the spreadsheet, then referenced using IF statements through the body of one’s model. A simple illustration of this at work is as follows:

Example of 'The Use of Flags' in Excel Modeling

2. No Hard-coded Numbers Embedded Within Formulas

Never use hard-coded numbers embedded in formulas because they are very difficult to spot if the user is less familiar with the model. Instead, clearly highlight and separate the inputs/hard-codes from the formulas; better yet, gather all the inputs/hard-codes (as appropriate) and aggregate them in the same tab. Subsequently have your formulas pull/reference them as appropriate from the required cell and from the appropriate tab.

3. Simple Is Always Better

It is always better to avoid complicated formulas. Instead, break up your formula into easily digestible steps. Instead of one seemingly neat row, this approach will often create many more rows, resulting in a larger spreadsheet; but one that will be much easier to follow and audit by a third party.

4. Adhere Consistently to Your Sign Convention

You should decide at time-zero what your sign convention/key will be. By way of illustration, ask yourself in the design stage of your model, “Will costs, expenses, deductions, depreciation, CapEx, etc. be presented as negative or positive numbers?” My personal preference is to always present costs as negative numbers for two reasons: (a) The totals will always be straight sums and you will minimize user error, and (b) it will be easier to spot mistakes using just the signs.

5. Avoid Naming Your Cells, Instead Rely on Excel’s Grid Logic

Where possible I strongly recommend avoiding naming your cells as it becomes difficult to locate the source input for said named cell (e.g., “Inflation”) down the road. Instead, I recommend that you rely on the grid convention of Excel within your formulas (e.g., simply linking to cell C4 or location, [Tab Name]l'!G21 , if the reference is in a different tab or workbook).

6. Never Have the Same Input in Multiple Locations

Organize your inputs simply and transparently. It is my recommendation that you consolidate all inputs in a few driver tabs and reference them from their singular points of origin throughout the spreadsheet.

7. Avoid Linking Files

Avoid linking to other files. It is better to input the relevant data you require from a different file as hard-coded inputs, which you then manually update as required. Cross-linking has been known to crash larger Excel models or update inconsistently, thereby creating hard-to-track errors.

8. Don’t Hide Sheets or Rows

Within longer spreadsheet, “group” rows/columns rather than “hide” them.

9. Fewer, Bigger Tabs Are Better Than Multiple Smaller Tabs

This practice is based 100% on experience. It is easier to follow and audit a continuous array for data across one large, contiguous spreadsheet, than across multiple tabs or, worse, multiple spreadsheets that are cross-linked.

10. Create Checks Throughout Your Model via “Aggregated Error Checks” Located in One Tab

Checks are the easiest way to quickly review the integrity of a model. “Checks” encompass everything from ensuring that totals that should tie actually do to ensuring that one’s balance sheet actually balances. I usually build a few checks at the top or bottom of each spreadsheet then consolidate them in a separate “Check Tab.” This ensures that it is easy to find an error in the model and then trace where that error originated.

Sample of a Balance Sheet Check

Please note that relying solely on checks to verify the integrity of a model is never a good idea as checks are usually quite high-level. But it’s a good starting point.

Carve Out – For Advanced Users: Excel Tips

This section covers a couple of very effective Excel best practices for our more advanced users. These might require a bit of adjusting, but should save several hours of work later and be relatively simple to implement. They are as follows, in short, succinct, to-the-point bullets:

  • Modeling Key Cheat Sheet
  • Comprehensive Excel Tips List
  • Use F5 (“go to special”) to quickly locate all hard-coded numbers or formulas.
  • Use Trace Precedents and Trace Dependents to audit the model.
  • Use XNPV and XIRR to allow for the application of custom__ dates to cash flows, en route to a returns analysis; this, as opposed to Excel’s NPV and IRR functions, which implicitly assume equidistant time intervals for the calculation.
  • Use the INDEX MATCH function over the VLOOKUP function for looking up information across large spreadsheets.
  • VLOOKUP is almost always superior to IF statements ; get comfortable with it.
  • Get in the habit of including IFERROR in the syntax of your formulas.
  • Use a combination of the date function, EOMONTH , and IF statements to make dates dynamic.
  • Remove gridlines when presenting or sharing the financial model; it makes for a cleaner, more polished output document.

Love It or Hate It…

Love it or hate it, Excel is omniscient, omnipresent, and omnipotent when it comes to corporate finance , analysis, and data-driven decision-making. And believe it or not, it doesn’t have to be intimidating or painful, even for the novice or uninitiated . Like most things in life, practice, consistency, and attention to detail (an in Excel’s case, shortcuts) will get you most of the way there.

Once you become familiar with the application, you will find it a powerful productivity and numerical storytelling tool, that you will sparsely be able to function without, even in your personal life. As you progress through the various stages of Excel fluency, I wish you the best and encourage you to keep this article as a practical go-to guide that you reference often.

Further Reading on the Toptal Blog:

  • Advantages of Google Sheets: Why It’s Time for Finance Pros to Switch From Excel

Understanding the basics

What are the different types of financial models.

There are nine main types of financial models: (1) three-statement operating models; (2) discounted cash flows (DCFs); (3) merger models (M&A); (4) initial public offering (IPO) models; (5) leveraged buyout (LBO) models; (6) sum of the parts; (7) budgets; (8) forecasting models; and (9) option pricing models.

What is financial modeling?

The exercise of building spreadsheets that detail the historical financial data of businesses, forecast their future performance, and assess their risks-returns profile. Put another way, financial data modeling is the task of building an abstract simulation of real-world financial situations ahead of key decisions. Financial model examples include three-statement operating models, discounted cash flows (DCFs), merger models (M&A), initial public offering (IPO) models, and leveraged buyout models, among others.

What is financial modeling used for?

To analyze the historical financial performance of a given corporation; assess, project, and forecast its future financial performance, and value companies or specific capital projects, including their risk/reward profile. They are used by the operators of companies to come to data-oriented decisions.

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Alberto Bazzana's profile image

Located in New York City, United States

Member since April 4, 2017

About the author

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  • Building Your Business

What Is a Business Model?

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A business model is a plan describing how a business will make money. It is an outline that explains the company’s revenue and cost structure, and how it expects to turn a profit—or at least sustain itself as a going concern.

Key Takeaways

  • A business model is an outline of how your business will generate a profit. The plan includes important information like target market, market need, and details on business expenses.
  • There are lots of types of business models, and models can be combined as well. You’re probably familiar with some of the more common ones like manufacturer, distributor, retailer, and franchise. 
  • When creating a business model, you should be clear about who your target customer is and how you’ll reach them. You’ll also want to know specifics about what you’re selling, and what sets you apart from your competition.

Definition and Examples of a Business Model

A business model is an outline that breaks down the ways that a company makes its profit. It identifies the target market, the market’s need, and how the business will serve its customers. The plan also includes the costs incurred from expenses like producing and marketing the product. There are multiple types of business models, each tailored to fit the unique needs of various businesses.

An example of a business model is one in which the concepts are split into two categories—business ideas and business resources. Under the business idea category lies products and services, target audience, competition, differentiation, advertising, and sales. Business resources, meanwhile, are what’s needed to make the idea work and can be divided into ownership, staffing, facilities, financial model, funding, and balance sheet.

A business is unlikely to be successful unless all facets of the business model provided in the example above allow it to be competitive in its marketplace. 

Types of Business Models

Here are a few commonly used business models that you’re probably familiar with. 

Manufacturer

This type of business model is when a company makes a product from raw materials or assembles prefabricated items to create new merchandise. The business can sell the items directly to consumers itself, which is a business-to-consumer (B2C) model, or it can use a business-to-business (B2B) model in which it sells to other businesses. 

An example of a B2C manufacturer would be a shoe company that sells its products directly to customers. A B2B manufacturer would be a business that sews dresses and only sells its products wholesale to other businesses, which then sell the dresses to the general public. 

Distributor

The distributor business model is when a company purchases inventory from a manufacturer and sells it to either a retailer or directly to the public. A common challenge that distributors face is picking the right price point that allows them to make a profit on the sale, but still offers competitive pricing. An example of a distributor would be a company that buys soft drinks from a manufacturer and sells those beverages to restaurants at a higher price.

There are many different types of business models and multiple models can be combined to create a new approach.

Retail business models are those used by companies that buy inventory from a manufacturer or distributor and sell those products to the public. Retailers can range from a single mom-and-pop shop to huge chain stores—they often have brick-and-mortar locations, an online store, or both. 

An example of a retailer would be a hat store that buys the products from a distributor. A limited selection of the hat store’s products is available at its brick-and-mortar storefront, but its full inventory can be purchased online. 

The franchise business model can be applied to other business models, like the ones we just discussed. The franchisee takes on the business model of the franchise and with it, the latter’s pre-established processes and protocols. Examples of popular franchises include McDonald’s, KFC, Burger King, and 7-Eleven.

When developing your business model, identify your target customer and how you’ll reach them. You’ll also want to familiarize yourself with what you’re selling (costs, margins, features, benefits, etc.) and what your competitive advantage is .

SCORE. “ Do you have a Successful Business Model? ”

SCORE. “ Develop Your Business Model by Answering These 4 Questions .”

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Blog > Finance

Financial Modeling: Definition, Models, and Uses

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What is Financial Modeling?

Financial modeling is a forecasting model to evaluate business decisions, predict financial performance, calculate valuation or comparisons, etc.

What’s covered in the article

Financial modeling is one of the dynamic tools of corporate finance, where it tries to forecast the performance of business units, strategies, or decisions in multiple scenarios.

Like any other model, there is an expectation for financial models to match the real-world conditions to the possible extent. However, such a proper financial model is difficult to achieve as it is limited by its assumptions and varying degrees of input.

Most importantly, all financial models are future-looking models.

To build financial models, a financial modeler uses spreadsheets or Microsoft Excel to reflect the company’s historical performance while integrating assumptions about future scenarios. A financial modeler must have expert-level Excel skills to build financial models.

The source of historical data for financial modeling is usually:

  • Company’s Income Statement
  • Company’s Balance Sheet
  • Company’s Cash Flow Statement

The broad classification of financial models can be based on their usage. There are two basic usages, namely:

  • Internal models that help internal managerial teams with decision-making, like capital budgeting , cash flow management, expansion, etc.
  • External models impact business models and other businesses. This can be related to mergers and acquisitions, diversification, takeovers, etc.

The decision-making process involves a detailed understanding of the business model, including revenue streams, cost structures, and capital requirements. The model serves as a virtual simulation, allowing analysts to explore the financial impact of different business decisions and market conditions

Uses and Significance of Financial Modeling

Within the financial sector, the financial models are used by investment bankers, equity analysts and researchers, accounting firms, underwriters , and other strategic decision-making fields of corporate finance like treasury management, forex management, in evaluating mergers and acquisitions (M&A), initial public offerings (IPOs), raising capital, etc.

The basic goal of all financial models is to enable data-based informed decision-making by ensuring the simulation is as much closer to the real-world situation as possible.

Financial modeling is a fundamental skill in finance, serving as a bridge between historical data and future projections and trying to get a clearer picture by deducing a comprehensible financial narrative.

In investment banking , the financial models enable bankers to assess the viability of transactions, forecast the company’s performance post-transaction, and advise clients accordingly.

When it comes to private equity and venture capital, financial models are used for valuing potential investments, anticipating changes and impacts on stock valuations, capital structure, etc.

Leveraged buyout models, for instance, help in determining the feasibility of acquiring a company through significant debt financing. These financial models calculate expected returns, considering various operating scenarios and the company’s ability to generate free cash flows.

Corporate finance teams utilize financial modeling for strategic planning and financial analysis. It aids in budgeting, forecasting future sales growth, and managing business units organically. Financial models help in identifying key drivers of financial performance, enabling businesses to allocate resources efficiently and plan for future expansions or contractions.

Equity research analysts build financial models to forecast a company’s financial performance, aiding in stock valuation and investment recommendations. These models often include detailed analyses of cash flows, a company’s income statement, and a balance sheet, providing a comprehensive view of the company’s operations.

On a much broader level, the financial model can also gauge the impact of changes in the macroeconomic environment and its financial impact on the company, helping in planning, resource allocation, policy adjustment, etc.

Components of Financial Modeling

The primary components in financial modeling are:

  • The Income Statement , which details revenue, expenses, and net income, offers insights into profitability.
  • The Balance Sheet is another crucial element, presenting a snapshot of the company’s assets, liabilities, and equity, reflecting its financial stability.
  • The Cash Flow Statement complements these by tracking the actual cash inflows and outflows, highlighting the company’s liquidity.
  • Supporting Schedules such as depreciation, amortization, and debt schedules provide detailed breakdowns of specific financial statement items.

In more complex types of financial models, the following components are also added:

  • Sensitivity Analysis and Scenario Planning are included to assess the impact of various assumptions on the model’s outcomes, enhancing decision-making and strategic planning.

Building Financial Models

Building financial models requires a deep understanding of both the company’s operations and the market dynamics.

A financial model integrates historical data, assumptions about future performance, and various financial metrics into a cohesive structure. The computation of these models typically follows two primary approaches: Top Down and Bottom Up.

The top-down approach in financial modeling starts with a broad market perspective and then narrows down to the specifics of the company. It begins by analyzing the overall market size, trends, and the company’s position within the industry.

In a top-down model, financial analysts often begin by examining macroeconomic indicators and industry-wide trends to estimate the total available market. They then determine the company’s market share and project future sales growth based on these broader market forecasts. This method is particularly effective for companies operating in well-established industries where historical market data is abundant and reliable.

The top-down approach is particularly useful in investment banking and equity research, where understanding the broader market dynamics is crucial for forecasting a company’s performance.

Example of Top Down Approach

In a top-down financial model for a retail company, the analysis might start with global retail market trends, followed by regional analysis, and finally focus on the company’s specific segment within that market. The model would incorporate factors like consumer spending habits, e-commerce growth, and competitive landscape, which influence the company’s sales growth and market share.

The bottom-up approach in financial modeling begins at the granular level of the company’s operations and builds up to an overall financial picture. This method is more focused on the company’s internal factors, such as unit sales, pricing strategies, and operational efficiencies. It’s particularly useful for startups and companies entering new markets where historical market data may be scarce or irrelevant.

In this approach, the model is constructed based on the company’s specific revenue drivers and cost structures. Analysts examine the company’s sales channels, product lines, and customer segments to forecast revenue. They also analyze direct and indirect costs, considering factors like production capacity, supply chain logistics, and overhead expenses. The bottom-up approach provides a detailed view of the company’s financial health, making it an essential tool for strategic planning, budgeting, and financial planning.

Example of Bottom-Up Approach

A Bottom-Up financial model for a technology startup would focus on the number of users, subscription fees, and server costs. It would build up these individual components to forecast the company’s overall revenue and expenses, providing a detailed insight into the startup’s financial trajectory.

Basic Assumptions in Financial Modeling

Basic assumptions of financial modeling

Revenue Growth Assumption

The revenue growth assumption states that the company’s sales are expected to increase over a certain period. It’s a prediction of future sales based on various factors like historical sales data, market trends, industry analysis, and the company’s growth strategy.

In different types of financial models, from simple budget models to complex DCF analyses, revenue growth rates are tailored based on historical data, industry benchmarks, and future market expectations.

Cost Assumption

This involves estimating the future costs or expenses that a company will incur. It includes both fixed costs (like rent and salaries) and variable costs (like raw materials and production costs). Accurate cost assumptions are essential for predicting a company’s future profitability.

These assumptions vary across types of financial models, depending on the nature of the business and the specific model’s focus. For instance, in a Three-Statement Model, cost assumptions directly influence the net income and cash flow projections.

Capital Structure Assumption

Capital structure assumption involves assumptions about the mix of debt and equity financing, influencing the company’s balance sheet structure and interest expenses.

This assumption varies in different types of financial models, affecting the overall valuation and investment return projections.

The capital structure assumption is vital in financial modeling, particularly in models like the Leveraged Buyout Model.

12 Common Financial Models

business financial model meaning

  • Three-Statement Model (Income Statement, Cash Flow Statement, Balance Sheet)
  • Discounted Cash Flow Model (DCF Model)
  • Merger Model (M&A Accretion/Dilution)
  • Comparable Company Analysis (Trading Comps Model)
  • Initial Public Offering Model (IPO Model)
  • Leveraged Buyout Model (LBO Model)
  • The Sum of the Parts Model (SOTP Valuation)
  • Consolidation Model
  • Budget Model
  • Forecasting Model
  • Option Pricing Model
  • Capital Budgeting Model (Capital Investment Model)

1- Three-Statement Model (Income Statement, Cash Flow Statement, Balance -Sheet)

The Three-Statement Model integrates the Income Statement, Cash Flow Statement, and Balance Sheet into a comprehensive financial model.

This Three-Statement Model is fundamental for financial analysts and investment bankers, providing a holistic view of a company’s financial health.

The Income Statement details the company’s revenues and expenses, thus computing the net income.

The company’s Balance Sheet or Position Statement provides a snapshot of the company’s assets, liabilities, and equity at a specific point in time, presenting its financial stability and liquidity.

The Cash Flow Statement reconciles the net income with the actual cash inflows and outflows, highlighting the company’s ability to generate cash.

The integration of these three statements allows for a thorough analysis of financial performance, supporting tasks such as valuation, financial planning, and strategic decision-making.

For compiling information about different companies, there are certain public databases maintained by governments, which can be accessed to build financial models:

  • For the US, you can access EDGAR Database , maintained by SEC
  • For Canada, you can access SEDAR
  • For the United Kingdom, you can access the public database known as Companies House .

2- Discounted Cash Flow Model (DCF Model)

The Discounted Cash Flow (DCF) Model is used extensively in corporate finance, private equity, and investment banking. The discounted cash flow model calculates the present value of a company or asset based on its projected future free cash flows.

The core principle of the DCF analysis is the time value of money, which states that a dollar today i.e. present date, is worth more than a dollar in the future.

The DCF model states that the value of a business is equal to the sum of its projected free cash flows, discounted back to their present value using a discount rate, typically the weighted average cost of capital (WACC).

The sum of the discounted cash flows and the terminal value, which represents the value of cash flows beyond the forecast period, gives the net present value (NPV) of the company.

This NPV is used in DCF analysis to evaluate the investment. The NPV reflects the intrinsic value of the company or project/ investment based on its cash-generating ability.

The net present value (NPV) calculation helps determine whether the expected rate of return meets the investment threshold. The DCF model is particularly valuable in sensitivity analysis, allowing financial analysts to assess how changes in assumptions impact the company’s valuation.

3- Merger Model (M&A Accretion/Dilution)

The Merger Model, also known as M&A Accretion/Dilution Analysis, is a financial model used in investment banking to evaluate the financial feasibility of a merger or acquisition.

The merger model focuses on whether the combined entity will create value post-merger, specifically looking at the accretion (increase) or dilution (decrease) in earnings per share (EPS) of the acquirer in a post-M&A (merger and acquisition) scenario.

Key elements of this merger model include:

  • the purchase price,
  • form of payment (cash, stock, or debt), and
  • the expected synergies.

The merger model forecasts the financial performance of both the acquiring and target companies, combining their income statements to assess the impact on EPS. It also considers various financing scenarios and their effects on the company’s capital structure.

In the Merger Model, if the EPS of post-merger entity is larger than the pre-merger entity, then it is “accretive”, otherwise it is “dilutive”. Thus, the merger model helps corporate finance teams to understand the impact of M&As on shareholder value and the company’s financial health.

4- Comparable Company Analysis (Trading Comps Model)

Comparable Company Analysis or Trading Comps Model, is a relative valuation methodology used to value a company by comparing it to similar companies (peer-to-peer comparison) in the same industry.

The Trading Comps financial model is based on the concept that similar companies will have comparable valuation metrics.

To evaluate a company’s market value, financial analysts and equity research professionals identify a set of comparable companies and then analyze their business metrics, such as Price/Earnings, Enterprise Value/EBITDA, Price/Sales, etc.

The Trading Comps Model is essential for understanding market trends, evaluating investment opportunities, and making informed business decisions.

5- Initial Public Offering Model (IPO Model)

The Initial Public Offering Model, or IPO Model, is a specialized financial model used in investment banking to evaluate a company’s valuation while preparing for its public market debut.

The IPO model is used it determining the appropriate price range for a company’s shares during an IPO.

The IPO Model analyses the company’s financial statements, market trends, and comparable company valuations to evaluate the company’s market valuation and the potential impact of the IPO on the company’s capital structure and future financial planning.

The IPO Model focuses on key elements like sales growth, net present value, and financial performance to forecast the expected market reception of the IPO.

IPO financial models are applied in the case of companies that are looking to raise capital in the public market.

6- Leveraged Buyout Model (LBO Model)

A leveraged buyout is the acquisition of a company, where the major part of the acquisition is funded by debt, thereby generating debt leverage.

The Leveraged Buyout Model, or LBO Model, is often used by private equity firms to evaluate the acquisition of a company using a significant amount of borrowed funds by assessing the viability of achieving high returns on equity through the strategic use of debt leverage.

The LBO financial model include the structuring of financing (debt and equity mix), the company’s ability to generate free cash flows for debt repayment, and the potential exit strategies.

The LBO financial model provides a detailed projection of the company’s financial performance, including cash flow waterfalls and sensitivity analysis, to determine the investment’s risk and return profile and ensuring that the leveraged acquisition can yield substantial returns while managing the risks associated with high leverage.

7- The Sum of the Parts Model (SOTP Valuation)

The Sum of the Parts Model or SOTP Valuation is used for the valuation of conglomerates or diversified companies having multiple segments, divisions, business units, etc.

SOTP valuation is a complex financial modeling method where each of the business units or such individual units is analyzed separately and independently because here, each business unit will have distinct characteristics, valuation methodologies, business structure, etc.

Evaluating multiple business units requires using appropriate valuation methods, such as discounted cash flow analysis or comparable company analysis on a case-to-case basis.

The individual valuation for every business unit is then aggregated to derive the total enterprise value of the company. It is achieved by combining multiple discounted cash flow analysis into a single model projection.

This financial model needs a nuanced understanding of the company’s overall worth, highlighting the value contribution of each segment. SOTP Valuation is crucial for strategic planning, corporate finance decisions, and in scenarios like spin-offs, divestitures, or mergers and acquisitions, where understanding the discrete value of each business unit is essential for making optimal business decisions.

8- Consolidation Model

Consolidation model is used to create a unified financial statement that accurately reflects the financial performance and position of an entire corporate group which consists of a parent company and its subsidiaries.

The consolidation model in financial modelling is essential for companies with diverse business units or those that have undergone mergers and acquisitions, enabling them to assess overall performance, allocate resources efficiently, and make informed business decisions.

In corporate finance and accounting the consolidation financial model involves adjusting for intercompany transactions, minority interests, and other consolidating entries to ensure that the consolidated financial statements present a true and fair view of the company’s operations.

The Consolidation Model is particularly valuable in strategic planning and decision-making, as it provides a comprehensive overview of the financial health of the business as a whole, rather than just its individual units.

9- Budget Model

The Budget Model is used by businesses to plan and control their financial resources.

The budget model involves projecting a company’s expenses and revenues over a specific period, typically on an annual basis, to create a budget. It includes all streams of revenues and expenses including non operating expenses and revenues like operating, non-operating, sales, accrued, etc.

The process includes analyzing historical data, considering future business goals, and incorporating key financial elements like sales growth, cost management, and capital expenditure.

The Budget Model is helps in strategic planning that enables companies to allocate resources efficiently, set financial targets, and manage cash flow effectively.

10- Forecasting Model

In financial modelling, the forecasting method is used to predict a company’s future financial performance based on historical data, market trends, and business-specific variables.

The forecasting financial model helps financial analysts and corporate finance professionals to make projections about sales, revenue, expenses, and cash flows.

The accuracy of a forecasting model depends on the quality of the assumptions and the understanding of the business model and market dynamics.

It is used for various purposes, including financial planning, investment analysis, and risk management.

11- Option Pricing Model

The Option Pricing Model is used to determine the fair value of options, which are derivatives with their value based on underlying assets like stocks.

The Black-Scholes Model, is most often used for option pricing, it calculates the theoretical price of European-style options using factors such as the underlying asset’s price, the option’s strike price, time to expiration, volatility, and the risk-free interest rate.

Option Pricing Models are essential for traders and financial analysts to assess the value of options, hedge risks, and make informed trading decisions.

12- Capital Budgeting Model (Capital Investment Model)

The Capital Budgeting Model or Capital Investment Model, involves calculating the Net Present Value (NPV) and Internal Rate of Return (IRR) of the investment, providing a clear picture of the expected returns and associated risks.

The capital budgeting financial model is used for evaluating major investment decisions like the feasibility and value of potential investments, such as new projects, acquisitions, or infrastructure upgrades.

Capital budgeting calculates the initial capital outlay, projected cash flows, and the time value of money.

The Capital Budgeting Model is essential for companies to make informed decisions about allocating their capital resources effectively, ensuring that investments align with their long-term strategic goals and yield substantial returns.

Financial modeling is important for decision-making, course correction, and analyzing the impact of changing variables in the business environment. It helps businesses to evaluate the scenarios before implementing the decisions, thus saving any potential harm. Financial modeling is a simulation or anticipated model based on assumptions. The accuracy of the model depends upon the assumptions and quality of data input.

Small businesses and startups need to use financial modeling so that they can test their decisions before implementing and save capital, time, and strategic advantage.

Visit Akounto’s blog and learn more topics of finance that help grow your business.

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Detailed guide to the financial modeling definition and its types

Detailed guide to the financial modeling definition and its types

Mergers and acquisitions are complex financial transactions with numerous levels and stages. With that in mind, the M&A community aims to provide business leaders and company executives with the most relevant M&A insights, as well as assist them in conducting complex M&A deals for the first time. 

The following article prepared by the M&A community covers financial modeling as part of M&A deals. 

By the end of the reading, you’ll know the definition of financial modeling and its types, discover industry-specific financial models, and learn the main financial modeling tools. Besides, the article provides financial modeling examples that demonstrate what a financial model of a particular type includes.

What is financial modeling: Basics of financial modeling

Financial modeling is a process of building a numerical illustration of a company’s financial activity in the past, present, and forecasted future. Financial models are usually spreadsheet-based.

Financial models are often used as decision-making tools when a company’s executives expect to assess a new project or acquisition’s potential costs, risks, and profits.

Financial modeling and business valuation also aim to decide on budgets, allocate corporate finance resources, define the cost of upcoming projects, and forecast the impact of a specific future event on the company’s stock.

Note: Learn how to do stock pitch in our dedicated article.

Below are the key components of financial modeling:

  • Assumptions and drivers
  • Income statement
  • Charts and graphs
  • Cash flow statement
  • Sensitivity analysis
  • Balance sheet
  • Supporting schedules

What is financial modeling used for?

Executives of a target company opt for financial modeling to decide on:

  • Capital allocation
  • Financial analysis
  • Selling business units and assets as a part of divestiture strategy
  • Growing the business organically (entering new markets, exploring new locations, opening new stores)
  • Planning potential cash flows for upcoming years
  • Valuing the business
  • Management accounting
  • Making acquisitions
  • Raising capital

Types of financial modeling

Professionals outline many types of financial modeling, but let’s define the 10 most frequently used by financial analysts.

1. Three-statement 

This is the basic financial modeling setup. Such financial models always include three financial statements: income statement, balance sheet, and cash flow statement . There are also supporting schedules. As a rule, these financial statements are dynamically linked to Excel files.

With these financial models, you can plan your company’s expenses and revenue. 

  • The income statement includes particulars about the revenues, expenses, and taxes of a target company over some time as well as its net income.
  • The balance sheet showcases the company’s resources or assets that are to deliver benefits in the future.
  • The cash flow statement presents the reconciliation between net income and generated cash.

2. Discounted cash flow (DCF) 

Discounted cash flow analysis builds on the three-statement financial model. It calculates the value of a target company and its free cash flow based on the net present value (NPV) of the business’s future cash flows.

By opting for discounted cash flow analysis, the company’s owners can find out whether its stock is undervalued or overvalued. This type of financial model is usually used in equity research and other capital market areas. 

DCF modeling determines the attractiveness of the potential investment opportunity.

3. Merger and acquisition (M&A)

M&A financial models are used to forecast the profits or losses of a potential merger or acquisition. It primarily aims to figure out the effect on the earnings per share (EPS) of the combined company after closing the deal.

If EPS increases as a result of the merger, then the deal is considered accretive. And if EPS decreases, the transaction is regarded as dilutive.

When building financial models of this type, financial analysts generally use a single tap model for each company, where Company A + Company B = Merged Co.

Investment banking or corporate finance specialists usually build financial models of M&A type.

4. Initial public offering (IPO)

An IPO financial model is used when a company wants to assess its business in advance of going public. Such financial models aim to make a comparative analysis of the company and assume the cost potential investors would be willing to pay for it. 

The assessment in an IPO financial model includes an IPO discount to ensure good stock trading in the secondary market.

The IPO financial model is frequently used in the sphere of corporate development and investment banking.

5. Leveraged buyout (LBO)

In a leveraged buyout deal, one company acquires another company with borrowed (debt) money. Due to this, LBO financial models are more advanced and usually are built on complex formulas. 

This financial structure always requires modeling a complicated debt schedule. Its main goal is to figure out the amount of profit a certain company can generate from such a deal.

LBO financial models are rarely used outside private equity and investment banking industries.

6. Consolidation

The consolidation type of financial modeling suggests multiple businesses uniting into one single model.

As a rule, this financial model includes a separate tab for each business, with a consolidation tab that simply sums up all organizational units. 

The consolidation financial model allows for calculating the possible revenue growth after companies’ consolidation.

The budget financial model aims to forecast the company’s budget for upcoming years. 

Budget financial models imply the analysis of the company’s figures over the last month or quarter and target the income statement mainly.

Budget modeling helps to better understand your company’s financials and, thus, plan the budget for the upcoming period more effectively. That’s the main reason for this financial model usage.

8. Forecasting

The forecasting financial model is often combined with the budget financial model, as they have a similar goal: to compare budgets and make forecasts for the upcoming year (or years). 

It’s usually used in financial planning and analysis and helps specialists to understand the company’s attractiveness to potential investors.

9. Option pricing

Option pricing models aim to define the theoretical value of an options contract. This financial model is based on mathematical formulas and complex calculations and is basically a straightforward calculator built in Excel files. It’s mostly used by investors to determine the true value of an option.

There are three types of option pricing financial modeling:

This model diagrammatically presents possible prices during different periods and uses either a two-period binomial tree or a multi-period binomial tree. The binomial financial model is mostly used to value American options.

  • Black-Scholes

This financial model operates on five input variables: strike price, volatility, risk-free rate, underlying asset price, and expiration time. It’s mostly used to value European options.

  • Monte Carlo simulation

This model usually includes the application of integration, optimization, and probability distribution. Worldwide investors and financial analysts use it to evaluate the probable success of upcoming investments.

10. Sum-of-the-parts

A sum-of-the-parts financial model presupposes taking several DCF models and summing them up. 

This is especially advantageous when valuing a huge conglomerate. Financial analysts value each unit separately and then add them together to get the valuation of the whole conglomerate.

This financial model helps to understand the true value of the company, which is especially important in investment banking. 

Financial modeling for different spheres

Besides the 10 common types of financial models described above, there are also industry-specific types of financial modeling. 

Let’s shortly review the main industries where financial modeling is used.

Real estate

In real estate financial modeling, you analyze the property from the Equity Investor (owner) and Debt Investor’s (lender) point of view. 

Commercial real estate aims to determine whether the property is worth investment and project possible risks and potential returns.

Real estate financial analysis is purely based on cash flows.

Private equity

Private equity financial modeling usually aims to assess the return profile of purchasing a business and consists of leverage buyout financial models.

The main metrics of private equity financial modeling are debt/equity ratio, cash on cash return, net present value, internal rate of return (IRR), and debt/EBITDA ratio.

Venture capital

Venture capital financial modeling implies creating venture funds. Modeling venture funds usually implies two models:

  • Model for the fund (the entity that will make investments)
  • Model for the management company (the entity that will manage the fund)

In a venture capital financial model, venture capitalists expect to see the company’s financial situation over more than a year.

SaaS financial modeling

Financial modeling valuation for SaaS companies is a crucial stage of the growth plan.

SaaS businesses typically come with high costs at the early stage. This is because a SaaS product needs to attract lots of new customers from the very start, and this always comes with high spending. 

The SaaS financial modeling includes a review of the business’s revenues and expenses, as well as forecasts on future revenue and important KPIs.

The key elements of the SaaS financial model are:

  • Profit and loss statement or income statement — demonstrates expenses and profits before taxes
  • Revenue model — demonstrates the revenue at the end of every month
  • Unit economics — calculates the profitability of each business unit

Investment banking

Investment banking financial modeling is used to evaluate the company’s present financial performance as well as forecast its future performance.

Financial modeling investment banking allows deciding on the potential investment.

Mergers and acquisitions

M&A financial modeling is often a part of the due diligence process. It aims to determine the potential firm’s cost of the upcoming merger or acquisition by evaluating possible profits and losses. 

An advanced financial modeler in the M&A industry typically chooses such types of business financial modeling as comparable company analysis, three-statement modeling, and DCF financial model.

As a rule, financial modeling for startups is done to forecast the emerging company’s capital costs, expenses, employees, customers, and revenues.

Financial modeling for start up helps to evaluate the viability of the future business and avoid losses or overspending.

Financial modeling tools

The most common and popular tool used for financial modeling prep is MS Excel. It has all the functions financial analysts need when creating a financial model. The main reason for using MS Excel are:

  • It’s particularly affordable for any business type and size
  • It’s easy to audit
  • It frequently integrates with other types of financial work done in Excel
  • It’s easy to use, even at a basic level
  • It’s flexible and dynamic

Still, there are specialized software products that make the financial modeling process more efficient and straightforward. Some software tools are:

Financial modeling examples

Below are three examples of financial modeling based on its type.

  • Three-statement

The screenshot below demonstrates the balance sheet section of a three-statement single worksheet financial model. The model also includes an income statement, cash flow statement, supporting schedules, and assumptions. Each section can be expanded or contracted to view each model separately.

business financial model meaning

The following DCF financial model screenshot consists of a balance sheet, free cash flow statement, assumptions and drivers, income statement, supporting schedules, and discounted cash flow model sheet. The latter shows historical data and forecasted results.

business financial model meaning

The leveraged buyout model demonstrates the fully developed financial statements, credit metrics, debt modeling, multiple operating scenarios, cash-on-cash and IRR, and sensitivity analysis.

business financial model meaning

Financial modeling is a spreadsheet-based numerical illustration of a company’s past, present, and forecasted financials that helps to evaluate a company’s potential. 

The main types of financial models are:

  • Sum-of-the-parts
  • Consolidation
  • Forecasting
  • Option pricing

There are also such industry-specific types of financial models as real estate, investment banking, venture capital, mergers and acquisitions, startups, and SaaS. 

The main tool financial analysts use for creating financial models is MS Excel. However, there are also modern software products that make the financial modeling process simpler.

Other insights

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business financial model meaning

Business Model Vs. Financial Model

A business model is a holistic framework to describe, understand, and analyze how companies provide and capture value. The financial model is how companies generate profits, cash, and are financially sustainable. A financial model is indeed part of the overall sustainable business model and one of its core components.

What is a Business Model?

business-model

What is A Financial Model?

financial-structure

Table of Contents

Key Similarities between Business Model and Financial Model:

  • Part of Business Strategy: Both the business model and the financial model are essential components of a company’s overall business strategy . They play a crucial role in determining how the company operates, generates revenue, manages costs, and sustains its financial health.
  • Long-Term Perspective: Both models are designed with a long-term perspective in mind. They are not just focused on short-term gains but aim to create sustainable value and financial viability for the organization over time.
  • Interconnectedness: The financial model is a subset of the business model and is closely interconnected with other elements of the business model. The financial model supports and aligns with the overall business strategy and value proposition .

Key Differences between Business Model and Financial Model:

  • Scope and Purpose: The business model is a comprehensive framework that outlines how the company creates, delivers, and captures value in the market. It encompasses various aspects such as value propositions, customer segments, channels, and revenue streams. On the other hand, the financial model is specifically focused on the financial aspects of the business, including revenue forecasting, cost analysis , profitability projections, and cash flow management.
  • Level of Detail: The business model provides a high-level overview of the company’s value proposition and the way it operates, while the financial model delves into detailed financial projections and analysis based on the assumptions made in the business model.
  • Audience and Usage: The business model is often used for strategic planning, market analysis , and communication with stakeholders, including investors, partners, and customers. It helps to showcase the company’s unique selling points and value creation potential. On the other hand, the financial model is primarily used for internal financial planning, budgeting, and decision-making. It helps management assess the financial feasibility of the business model and make data-driven financial decisions.
  • Components and Elements: The business model consists of various components, such as the value proposition , customer segments, key activities, resources, and partnerships. It outlines the overall value chain of the business. The financial model, on the other hand, focuses on specific financial elements, such as revenue projections, cost breakdown, profit margins, and cash flow forecasts.

Business Model Examples :

  • Direct Sales Model : Apple sells its products directly to consumers via its Apple Stores and online store.
  • Freemium Model : Spotify offers a free version of its music streaming service with ads, and a premium version without ads and with added features for a subscription fee.
  • Subscription Model : Netflix charges customers a monthly fee to access its library of movies and TV shows.
  • Affiliate Marketing Model : A blogger promotes products and earns a commission for every sale made through their referral link.
  • Marketplace Model : eBay connects sellers with buyers and takes a commission from each sale.
  • Franchise Model : McDonald’s allows entrepreneurs to operate their own McDonald’s restaurants using the brand , processes, and resources of the parent company for a fee.
  • Advertising Model : Google offers its search engine services for free and earns revenue through targeted advertising.
  • Crowdsourcing Model : Wikipedia relies on volunteers to create and edit content, allowing it to offer a vast encyclopedia for free.
  • Razor and Blades Model : Gillette sells razors at a low cost or even a loss, but replacement blades (which customers need to buy regularly) have high margins.
  • Peer-to-Peer Model : Airbnb allows homeowners to rent out their properties to travelers.

Financial Model Examples :

  • Cost-plus Pricing : A company determines the cost of producing a product and adds a markup percentage for profit. For instance, if a shirt costs $10 to produce, and they want a 20% profit, they’ll sell it for $12.
  • Discounted Cash Flow (DCF) Model : Used to estimate the value of an investment based on its future cash flows.
  • Comparative Company Analysis (CCA) : This model involves comparing a company’s valuation metrics to other firms within the same industry to determine its relative value.
  • Budget Model : Companies forecast their income and expenses for the upcoming year to set budgets.
  • Break-even Analysis : Determines the point at which total costs and total revenue are equal, meaning there’s no net loss or gain.
  • Projected Income Statement : Forecasts a company’s revenues, costs, and profits for a future period.
  • Balance Sheet Projection : Predicts a company’s assets, liabilities, and equity for a future date.
  • Capital Asset Pricing Model (CAPM) : Used to determine a theoretically appropriate required rate of return of an asset.
  • Merger and Acquisition Model : Used by companies to evaluate the financial impact of merging with or acquiring another company.
  • Option Pricing Model : Used in finance to calculate the fair value of an option based on factors such as stock price, exercise price, time to expiration, and volatility.

Key Highlights :

  • A holistic framework used to describe, understand, and analyze how companies provide and capture value.
  • Focuses on finding a systematic way to unlock long-term value for an organization.
  • Delivers value to customers and captures value through monetization strategies.
  • Value model (e.g., value propositions, mission , vision)
  • Technological model (e.g., R&D management)
  • Distribution model (e.g., sales and marketing organizational structure )
  • Financial model (e.g., revenue modeling, cost structure, profitability and cash generation/management)
  • Pertains to how corporations finance their assets, typically through debt or equity.
  • Key elements include cost structure, profitability, and cash flow generation.
  • Is a subset of the business model and one of its core components.
  • Both are vital components of a company’s overall business strategy .
  • Designed with a long-term perspective, focusing on sustainable value and financial viability.
  • The financial model is closely interconnected with the business model and aligns with the overall business strategy and value proposition .
  • Business Model: Comprehensive, outlining how the company creates, delivers, and captures value.
  • Financial Model: Specifically focuses on financial aspects such as revenue forecasting, cost analysis , and cash flow management.
  • Business Model: Provides a high-level overview of the company’s operations.
  • Financial Model: Offers detailed financial projections and analysis .
  • Business Model: Used for strategic planning, market analysis , and communication with stakeholders.
  • Financial Model: Used for internal financial planning, budgeting, and decision-making.
  • Business Model: Includes components like value proposition , customer segments, and key activities.
  • Financial Model: Focuses on specific financial elements like revenue projections and cash flow forecasts.

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Financial Forecasting vs. Financial Modeling: What's the Difference?

business financial model meaning

Natalya Yashina is a CPA, DASM with over 12 years of experience in accounting including public accounting, financial reporting, and accounting policies.

business financial model meaning

Financial Forecasting vs. Financial Modeling: An Overview

Financial forecasting is the process by which a company thinks about and prepares for the future. Forecasting involves determining the expectations of future results.

On the other hand, financial modeling is the act of taking a forecast's assumptions and calculating the numbers using a company's financial statements.

Key Takeaways

  • Financial forecasting is the process in which a company determines the expectations of future results.
  • Financial modeling takes the financial forecasts and builds a predictive model that helps a company make sound business decisions.
  • Financial forecasting and modeling can be used in budgeting, investment research, project financing, and raising capital.

Financial Forecasting

When a company conducts its financial forecasts, it seeks to provide the means for the expression of its goals and priorities to ensure they are internally consistent. Forecasts can also help a company identify the assets or debt needed to achieve its goals and priorities.

A common example of a financial forecast is forecasting a company's sales. Since most financial statement accounts are related to or tied to sales, forecasting sales can help a company make other financial decisions that support achieving its goals. However, if sales are to increase, the resulting expenses to produce the additional sales would also increase. Each forecast results in an impact on the company's overall financial position.

Forecasting helps a company's executive management determine where the company is headed. Calculating the financial impact of those forecasts is where financial modeling comes into play.

Financial Modeling

Financial modeling is the process by which a company builds its financial representation. The model created is used to make business decisions. Financial models are the mathematical models made by a company in which variables are linked together.

The modeling process involves creating a summary of a company's financial information in the form of an Excel spreadsheet. The model can help determine the impact of a management decision or a future event. The spreadsheet also allows the company to modify the variables to see how the changes could affect the business.

As a result of an expected to increase in sales, for example, a company must also forecast the resulting increase in raw material or inventory costs. If the company needs a new piece of equipment, the cost to purchase or lease must be estimated. Credit needs could also be forecasted based on the sales and the resulting expenses to produce the sales. A company might need to increase their working capital credit line with a bank, for example.

Forecasts are helpful, but at some point, the number-crunching must be done via a financial model. The modeling calculates the financial impact that a forecasted increase in sales has on the company's income statement, balance sheet, and cash flow statement.

Financial models are used for several reasons, including:

  • Historical analysis of a company
  • Projecting and budgeting the financial performance of a company
  • Investment research, such as equity analysis
  • Project finance analysis, which is the funding of long-term assets and industrial projects
  • Purchase of another company or merger
  • Raise capital or funding
  • Create pro forma financial statements, which are statements created based on a company's assumptions and forecasts

Financial modeling takes the financial forecasts created during a company's financial forecasting and builds a predictive model that helps a company make sound business decisions based on its forecasts and assumptions.

[Note: Financial Modeling can be used to evaluate a number of businesses and investing decisions; if you are interested in learning to build these models yourself and get ahead on your career check out Investopedia Academy's Financial Modeling Course .]

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Reddit Files to Go Public, in First Social Media I.P.O. in Years

The message board site, founded in 2005, detailed its financial performance in a filing. It is the last of an early generation of social media companies to aim for a public offering.

A hallway with the word “reddit” and the company’s symbol taking up a large wall.

By Mike Isaac

Mike Isaac has covered Reddit and social media companies since 2010 from San Francisco.

Reddit, the community-focused message board site, filed to go public on Thursday, paving the way for it to be the first major social media company to debut on the stock market in years and a test for private companies after a drought in initial public offerings.

In an offering prospectus , Reddit disclosed its financial performance in preparation for selling shares to investors. The San Francisco-based company reported that its revenue rose more than 20 percent as its losses narrowed last year. It added that it had 73 million daily users and more than 100,000 active communities.

The prospectus kicks off a process to the stock market, with the 18-year-old company set to meet potential investors to whet their appetites for buying its shares. Reddit could go public on the New York Stock Exchange in a matter of weeks under the stock symbol RDDT.

Reddit’s bankers are seeking a valuation of at least $5 billion in its I.P.O., according to two people familiar with the matter. That is roughly half of the $10 billion valuation the company fetched in a 2021 private financing round. The talks are continuing, and the price could still rise or fall in the weeks ahead.

Reddit is the last of an earlier generation of social media companies to aim for the stock market, after Facebook’s high-profile offering in 2012 , Twitter’s in 2013 and Snap’s in 2017 . In the years since, the social media industry has changed, facing scrutiny for misinformation, hate speech and other effects. Some of the companies have shifted directions; Facebook was renamed Meta, and Twitter was bought by Elon Musk , who took the company private in 2022 and renamed it X.

Reddit’s move is also highly anticipated after a lull in initial public offerings. Just 108 companies went public in the United States last year, roughly a quarter of the number that debuted in 2021, according to data compiled by Renaissance Capital. Some of the biggest tech offerings last year were Arm, a chip designer , and Instacart , a grocery delivery company.

“We are going public to advance our mission and become a stronger company,” Steve Huffman, Reddit’s chief executive, said in a founder’s letter included in the prospectus. “We hope going public will provide meaningful benefits to our community as well. Our users have a deep sense of ownership over the communities they create on Reddit.”

Mr. Huffman added that the company wanted “this sense of ownership to be reflected in real ownership — for our users to be our owners” and that “becoming a public company makes this possible.” Reddit said it would reserve a chunk of its shares at the I.P.O. price for 75,000 of the company’s most prolific users if they wished to purchase them.

In its prospectus, Reddit said revenue in 2023 was $804 million, up about 21 percent from $666 million a year earlier. The company lost $90 million in 2023, compared with a $158 million loss the year before, according to the prospectus.

Some of its largest shareholders include Advance Magazine Publishers, Tencent Cloud Europe, Vy Capital, Fidelity Management, and Sam Altman, a former Reddit board member and the chief executive of OpenAI.

Reddit’s path to the public markets has been long and rocky. Founded in a University of Virginia dorm room in 2005 by Mr. Huffman and Alexis Ohanian, the site began as a destination for anonymous users to come together and discuss anything from popular TV shows, to guitars, makeup and power washers.

The site was unique in that it largely focused on tightknit communities, mostly anonymous, all moderated by volunteers who self-governed their forums, or “subreddits,” based on rules of their own making. It became known for “A.M.A.s,” otherwise known as the “ask me anything” sessions, sometimes with public figures like former President Barack Obama, Microsoft’s Bill Gates and the actor Nicolas Cage.

The company raised hundreds of millions of dollars in funding over the years, including $250 million and more than $410 million in two financing rounds in 2021. Investors include Fidelity Investments, Andreessen Horowitz, Sequoia Capital and Tencent Holdings.

Like other early social networking efforts, Reddit initially eschewed offering advertising and making money. It instead focused on forms of revenue that came from community ideas, like a user-generated e-commerce system and awards that users could buy one another. Those ideas are still in play.

Reddit eventually embraced advertising based on its topic-focused communities. Brands like Laneige, for instance, targeted ads to a forum called Makeup Addiction, one of the most active subreddits, in which users discuss cosmetics and how to apply them.

The site has also built an emerging data licensing business based on its enormous corpus of conversation data, which has become increasingly important amid a frenzy over artificial intelligence. A.I. models are trained on gobs of such data so that they can become more powerful. On Thursday, Reddit announced a licensing deal with Google, which has used Reddit data to train and build its A.I. systems.

“We expect our data advantage and intellectual property to continue to be a key element in the training of” future A.I. models, Mr. Huffman said in the letter. The company has a number of undisclosed licensing agreements to use its data and expects to make upward of $203 million over the next three years from those contracts, according to the filing.

The site has had its share of struggles. It faced controversy after controversy over its refusal to moderate communities in its early years, including its role in spreading misinformation during the Boston Marathon bombing in 2013 , and hosting racist and misogynistic content in some of its smaller subreddits. Last year, Reddit faced a user revolt after changing some of its rules and restricting third-party developers from using the site’s content without paying for it.

Reddit has reversed its position on moderation and has updated and more strictly enforced its policies in recent years, making it more attractive for marketers to place advertising across the site.

The company also had a revolving door of leaders in its first decade, being helmed by four chief executives before Mr. Huffman returned to lead the site in 2015 .

Reddit cautioned potential investors that it faced challenges and potential risks as a public company, including the rise of large language models, the underlying A.I. systems that could potentially aggregate and synthesize the site’s content and let users view Reddit without visiting the site or seeing advertising.

The company may also face difficulty courting brands in a digital ad market dominated by Meta and Google.

“Reddit may face a daunting challenge in growing its advertising business, given the gap between its platform’s capabilities and those that are best in class,” said Eric Seufert, an independent mobile analyst who closely monitors social media companies and advertising.

The company also warned that it was heavily dependent on its community for moderating the platform, and that future revolts or departures could harm the site.

“We have many opportunities and much to do,” Mr. Huffman said.

Lauren Hirsch contributed reporting from New York.

Mike Isaac is a technology correspondent for The Times based in San Francisco. He regularly covers Facebook and Silicon Valley. More about Mike Isaac

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Is Capital One acquiring Discover?

How much will capital one pay for discover, why is capital one acquiring discover.

  • How does the deal impact customers?

Capital One plans to acquire Discover — here's what that could mean for credit card and banking customers

Our experts answer readers' banking questions and write unbiased product reviews ( here's how we assess banking products ). In some cases, we receive a commission from our partners ; however, our opinions are our own. Terms apply to offers listed on this page.

  • Capital One plans to acquire Discover in an all-stock deal valued at $35.3 billion, pending approval.
  • The deal would integrate the issuers' payment networks, but banking accounts could remain the same.
  • The deal isn't expected to close until late 2024 or early 2025.

Insider Today

On Monday, Capital One Financial announced its plans to buy Discover Financial Services . The online financial institution has entered an agreement to acquire Discover in an all-stock deal valued at $35.3 billion. 

Here's what you need to know about the deal and what it could mean for current Capital One and Discover customers.

The two companies have entered an agreement for Capital One to acquire Discover . The deal still needs to be approved by banking regulators as well as shareholders of each institution.

If it is all approved, the deal could close in late 2024 or early 2025. 

If the deal goes through, Capital One will buy Discover in an all-stock transaction valued at $35.3 billion. According to a press release , Discover shareholders will get 1.0192 Capital One shares for each Discover share. 

One of the primary reasons for the acquisition is to build a competitive global payments network.

Capital One credit cards are part of the Visa and Mastercard credit card networks. Meanwhile, Discover has its own network.

"What it means is that Capital One — if it does buy Discover — is going to be able to integrate not just in the network of merchants that can accept Discover cards, but also play with things like interchange fees and bonuses and rewards," says Simon Blanchard, associate professor at Georgetown University's McDonough School of Business ."One way to think about this is that it's making Capital One plus Discover look a lot more like Amex than it used to."

The acquisition would also allow the two companies to combine their credit card businesses and scale banking services.

The two financial institutions notably share similar features when it comes to their bank accounts. Capital One and Discover as some of the best online banks because of features like high savings account rates, zero monthly service fees, and zero overdraft fees.

How would a Capital One/Discover merger impact customers?

The deal isn't expected to close until late 2024 or early 2025, so there likely won't be any immediate changes for customers.

The Wall Street Journal reports that Capital One is planning to switch some of its credit cards to the Discover network. Capital One may also keep the Discover brand on the cards and network, according to the Journal. 

Currently, it is uncertain whether Capital One or Discover bank accounts will have any changes.

"I don't expect the competitive deposit rates to change. I think that's part of their brand, to offer high-yield online savings . I think that's going to stay the same," says Alvin Carlos, CFA, CFP, and managing partner of District Capital Management . 

  • Are banks open today? Here's a list of US bank holidays for 2023
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Watch: Why the Chase Cards CEO is not worried about the hundreds of millions lost last quarter due to credit card rewards

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  1. Financial Modeling Defined: Overview, Best Practices & Examples

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  2. Financial Modeling

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  3. What Is Financial Modeling?

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  4. What is Financial Modeling? Definition, Types

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  5. The Financial Modeling Function for your Company Business

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  1. What is Financial Modeling? Basics & Types of Models

  2. What is Financial Modeling?

  3. What is Financial Modeling? Explanation & Setup of a Financial Model

  4. The Explainer: What is a Business Model?

  5. Basics Of Financial Modelling (2021)

  6. Financial Modeling Process- Types of financial models & how to identify best model for your company

COMMENTS

  1. What is Financial Modeling?

    The objective of financial modeling is to combine accounting, finance, and business metrics to create a forecast of a company's future results. A financial model is simply a spreadsheet which is usually built in Microsoft Excel, that forecasts a business's financial performance into the future.

  2. Financial Modeling Definition and What It's Used For

    Financial modeling is a representation in numbers of a company's operations in the past, present, and the forecasted future. Such models are intended to be used as decision-making tools. Company...

  3. Types of Financial Models

    Written by Jeff Schmidt Top 10 Types of Financial Models There are many different types of financial models. In this guide, we will outline the top ten most common models used in corporate finance by financial modeling professionals. Here is a list of the ten most common types of financial models: Three-Statement Model

  4. What is a Business Model with Types and Examples

    The term business model refers to a company's plan for making a profit. It identifies the products or services the business plans to sell, its identified target market, and any anticipated...

  5. What are the different financial models?

    Financial models once completed, display a mathematical depiction of the business events. The primary tool utilized to create the financial model is the excel spreadsheet. Investopedia definition of Financial modelling: The process by which a firm constructs a financial representation of some, or all, aspects of the firm or given security.

  6. What is a Financial Model?

    Although "financial modeling" is an umbrella term defined flexibly by different users depending on its intended uses, it is usually used in the context of corporate finance, accounting, or quantitative finance. In accounting and corporate finance, modeling usually involves forecasting the financial statements and financial analysis.

  7. Financial Modeling

    Financial modeling is the process of estimating a project or business's financial performance by considering all relevant factors, growth and risk assumptions clearly understand the impact. It enables the user to clearly understand all the variables involved in financial forecasting.

  8. Financial modeling

    This is a mathematical model designed to represent (a simplified version of) the performance of a financial asset or portfolio of a business, project, or any other investment. Typically, then, financial modeling is understood to mean an exercise in either asset pricing or corporate finance, of a quantitative nature.

  9. Financial Modeling Explained with Examples

    Financial Modeling Definition: A financial model is a spreadsheet-based abstraction of a real company that helps you estimate the company's future cash flows, financing requirements, valuation, and whether or not you should invest in the company; models are also used to assess the viability of acquisitions and the development of new assets.

  10. Components of Financial Modeling

    Financial modeling is a method of forecasting how a company may perform in the future. It combines various company data from accounting statements, such as revenue, expenses, income, and earnings.

  11. Definition of Financial Modeling

    Financial Modeling. Financial modeling is the process of building a forecast of an organization's future financial performance. A financial model considers the organization's past results, as well as current earnings and expenses, to predict the impact of their future decisions, the performance of particular assets and the overall financial ...

  12. What is Financial Modeling And How Does It Work?

    Financial modeling or data-driven analysis entails combining finance, accounting, and other vital business metrics to have a vivid and abstract model or representation of a business' financial situation. This model helps a business visualize its financial position in the market and predict financial performance in the future.

  13. Financial Modeling: Essential Concepts and Techniques

    To facilitate financial planning, budgeting, forecasting, and business decision-making. How Financial Modeling Works? Financial modeling utilizes historical financial data, assumptions, and formulas to create models simulating real-world financial scenarios.

  14. Financial Modeling Best Practices: Tips & Tricks

    Below are a series of best practices on how to build with an auditor mindset. As follows: 1. One Row, One Formula. You should have only one formula per row, meaning that whatever formula is used in the first cell of any given row should be the same formula uniformly applied across the entire row.

  15. What Is a Business Model?

    A business model is an outline that breaks down the ways that a company makes its profit. It identifies the target market, the market's need, and how the business will serve its customers. The plan also includes the costs incurred from expenses like producing and marketing the product.

  16. Financial Modeling: Definition, Models, and Uses

    Financial modeling is one of the dynamic tools of corporate finance, where it tries to forecast the performance of business units, strategies, or decisions in multiple scenarios. Like any other model, there is an expectation for financial models to match the real-world conditions to the possible extent. However, such a proper financial model is ...

  17. Financial Modeling: Definition, Types, Examples

    Financial modeling is a process of building a numerical illustration of a company's financial activity in the past, present, and forecasted future. Financial models are usually spreadsheet-based.

  18. Business Model Vs. Financial Model

    A business model is a holistic framework to describe, understand, and analyze how companies provide and capture value. The financial model is how companies generate profits, cash, and are financially sustainable. A financial model is indeed part of the overall sustainable business model and one of its core components. Aspect Business Model Financial Model Definition … Business Model Vs ...

  19. What Is a Financial Model?

    Typically, financial models examine different future economic scenarios or valuations of individual assets, whether securities, portfolios or businesses. In short, a financial model is defined as a tool built in spreadsheet programs like MS Excel for predicting future financial performance of a company or an asset, such as a company's share.

  20. Financial Forecasting Guide

    Financial forecasting is the process of estimating or predicting how a business will perform in the future. The most common type of financial forecast is an income statement; however, in a complete financial model, all three financial statements are forecasted.

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  24. Financial Forecasting vs. Financial Modeling: What's the Difference?

    Financial modeling is the process by which a company builds its financial representation. The model created is used to make business decisions. Financial models are the mathematical models made by ...

  25. Reddit Files to Go Public, in First Social Media I.P.O. in Years

    Reddit is the last of an earlier generation of social media companies to aim for the stock market, after Facebook's high-profile offering in 2012, Twitter's in 2013 and Snap's in 2017.In the ...

  26. Definition of Business Model

    Business Model. A business model is a description of how an organization creates, delivers and captures value. It has a formal structure that consists of four basic components: the value proposition, customers, a financial model and capabilities.

  27. Capital One To Buy Discover: What Will Deal Mean For Customers? (COF

    Capital One Financial Corp., the US lender backed by Warren Buffett, is set to buy Discover Financial Services in a $35 billion deal that would bring together two of the biggest credit card firms ...

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  30. Capital One Plans to Acquire Discover

    The online financial institution has entered an agreement to acquire Discover in an all-stock deal valued at $35.3 billion. Here's what you need to know about the deal and what it could mean for ...