What is Financial Modeling?
Financial modeling is one of the most highly valued, but thinly understood, skills in financial analysis. The objective of financial modeling is to combine accounting, finance, and business metrics to create an abstract representation of a company in Excel, forecasted into the future. This guide to financial modeling for beginners and “dummies” will teach you all the basics a beginner needs to know!
There are many types of financial models, with a wide range of uses, including making business decisions at a company, making investments in a private or public company, pricing securities, or undergoing a corporate transaction such as a merger, acquisition, divestiture, or capital raise. This financial modeling guide is designed to teach you the basics.
Image from CFI’s financial modeling courses.
Why do you use Excel?
Forecasting a company’s operations into the future can be very complex. Each business is unique and requires a very specific set of assumptions and calculations. Excel is used because it is the most flexible and customizable tool available. Software, as an alternative, can be too rigid and doesn’t let you understand each line of a business’ operations the way that Excel does.
What are the steps for building a financial model?
In this financial modeling for beginners and “dummies” guide, we have laid out the basic steps of how to build a financial model.
- Historical data – input at least 3 years of historical financial information for the business.
- Ratios & metrics – calculate the historical ratios/metrics for the business, such as margins, growth rates, asset turnover ratio, inventory changes, etc.
- Assumptions – continue building the ratios and metrics into the future by making assumptions about what future margins, growth rates, asset turnover, and inventory changes will be going forward.
- Forecast – forecast the income statement, balance sheet, and cash flow statement into the future by reversing all the calculations you used to calculate historical ratios & metrics. In other words, use the assumptions that you made to fill in the financial statements.
- Valuation – after the forecast is built, the company can be valued using the Discounted Cash Flow (DCF) analysis method. Learn more about DCF models and valuation.
Image from CFI’s financial modeling courses.
Who builds financial models?
There are many professions and career paths that require financial modeling. Here are some of the most common ones:
- Investment Banking Analysts & Associates
- Equity Research Analysts & Associates
- Private Equity Analysts & Associates
- Credit Analysts
- FP&A Analysts & Managers
- Corporate Development Analysts & Managers
How much accounting knowledge is required?
In order to build a financial model, you need a solid understanding of accounting fundamentals. You have to know what all the various accounts mean, how to calculate them, and how they’re connected. We recommend having at least a few accounting courses under your belt. Since accounting is a prerequisite for financial modeling, we offer our accounting crash courses for free!
Which Excel skills are required?
There are many Excel formulas and functions required to build a financial model. Here are a few of the most common ones:
- SUM Function adds up a set of numbers.
- AVERAGE Function calculates the average of a set of numbers.
- COUNT Function counts the number of cells that contain numbers
- MIN and MAX Function calculate the minimum and maximum of a set of values.
- SUMPRODUCT Function multiplies two sets of arrays and adds the totals.
- IF Function is a logic-based formula that can make your model more dynamic.
- Charts & Graphs are an important part of financial modeling.
- Formatting skills can help separate great from good models.
More Excel resources:
What are the hallmarks of a good financial model?
When building a model, it’s important to follow best practices, which we outline in our courses. A good model is simple enough that anyone can understand it, yet detailed enough to handle complex situations.
Here is a list of general best practices for building models in Excel:
- Well-structured, with a good layout
- Easy to follow and understand
- Drivers and assumptions clearly laid out
- Simplicity over complexity
- Focus on important issues
- Visual outputs
Thanks for reading our guide to financial modeling for beginners (and “dummies”). For more advanced instruction, please see CFI’s financial modeling courses.
How to get a job in financial modeling?
There is a wide range of corporate finance jobs that require financial modeling skills. If you’re interested in financial planning & analysis (FP&A), equity research, investment banking, private equity, or corporate development, explore CFI’s Career Map to find the best career path for you.
More resources beyond financial modeling for beginners…
At CFI, we spend a lot of time building Excel models. Therefore, we have a lot of valuable free resources to share with you. Here are some of our most helpful resources, in addition to this “dummies guide” to financial modeling: