Financial modelling is a tool used by businesses to make recommendations based on information gathering and calculations. Financial modellers construct representations of the financial aspects of the company, or a specific security, with the goal of making accurate predictions about future performance. Othman Louanjli uses financial modelling in his role at Julius Baer, where he works as a private banker in Abu Dhabi. There are various types of financial modelling, the most widely used of which are outlined in the embedded infographic.
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A financial model is in essence an interactive calculator. Analysts input historical data into a spreadsheet and use this to capture variables and create formulas. The information gathered acts as a foundation for making forecasts based on past performance as well as current trends and market conditions. Spreadsheet language facilitates reconstructions of virtually any revenue stream or cash flow. Forecast and valuation theories can be tested within the financial model, which provides a mathematical depiction of the company as a whole, or of a certain business event.
What Is it Used For?
Financial models are used in various situations within a business, wherever key decisions need to be made regarding finances. Executives may use financial modelling before attempting to raise capital for the business, as one example. It can also be used to make decisions about acquisitions, be they of other companies or of new assets. When a business is considering organic growth, such as entering a new market or opening new physical or online stores, financial modelling can help predict the outcome of these ventures with a certain degree of accuracy. Forecasting is one of the primary goals of financial modelling, so it is a useful tool in budgeting for the years ahead. It can also be used to value a business or determine areas of capital allocation. The short video attachment explores some of the most common reasons businesses will use financial modelling.
Who Builds Financial Models?
There are various roles within the finance and business industries where knowledge of financial modelling is a useful or necessary skill. Analysts and associates at investment banks or within private equity or equity research may be required to use financial modelling at various intervals. Financial planning analysts and mangers and credit analysts will also need to be aware of financial modelling techniques, as will corporate development managers and analysts.
How to Learn Financial Modelling
It takes many years of practice and experience to become adept at creating accurate financial models. The only way to learn is by doing it, so those who want to develop their financial modelling skills need to practice. This practice can take the form of looking at historical data for any mature company and building future flat-line models to calculate the present net value of each share. Looking at equity research reports is also a good way to practice.
There are financial modelling training courses which can be accessed by those who need to develop their skills professionally. In the PDF attachment, you can find a step-by-step guide to help you get started. When formatting, be sure to differentiate between inputs and outputs, also referred to as assumptions and calculations. This can be done in various ways, such as using opposing font colours or through adding shading or borders. The structure of a good financial model will be logical and easy to follow, using one spreadsheet for the whole model and then grouping within this model for various sections.