Top Time-saving Tricks for Financial Modeling
Financial modeling is a very important financial activity and skill that every individual in finance should learn. It is the process of creating an illustration of a company’s performance, as well as a forecast of how it will likely perform in the future based on various data such as its historical figures.
Financial modeling often uses Microsoft Excel to present data, make a financial budget, predict the cost of a project, and asses a company’s value, among others.
Uses of Financial Models
Various individuals who make use of financial models and each of them uses it for a unique reason.
- Investment bankers use financial models because these are a great tool for decision-making, especially when talking about an initial public offering (IPO) price.
- Accountants use financial models especially for evaluating the return of cash flow after the purchase of a fixed asset.
- Credit analysts make use of financial models when determining the ability of a borrower to pay a debt.
- Valuation advisors use such models for valuing projects and assets.
Types of Financial Models
There are a lot of financial models and each of them is unique and solves different problems. Some of them deal more with valuation, while some others can be used to predict outcomes of specific projects, identify risks that are associated with certain financial decisions, and determine the trends in the economy. Here are some types of models.
1. Comparative Company Analysis
The model works on the precept that companies operating in similar industries are expected to demonstrate similar valuations. From the name itself, comparable company analysis uses peer group analysis that looks into the financial data of a company then comparing it to the financial details of other companies in the industry.
2. Sum-of-Parts Model
Also called the break-up analysis, the sum-of-parts model looks at the different parts of the company and bases it value on the individual parts. The valuation is done by breaking down the parts as if they were to be sold to another company.
CFI’s Advanced Financial Modeling Valuation Course shows an example of a Sum-of Parts Valuation of Amazon
3. Discounted Cash Flow (DCF) Model
The DCF model is considered as the most important that operates on the premise that the value of a company can be taken by putting together all of its expected cash flows in the future while applying the appropriate discounted rate. Simply put, it is the estimated cash flow in the future that is used to determine the value of the company at present, provided that the appropriate discount rate is applied.
4. Leveraged Buyout (LBO) Model
The LBO model deals with acquiring a company using borrowing for the sole purpose of the acquisition. After the acquisition of the business, the cash flows that it will be bringing in will be used first to cover the borrowed principal amount and the interest that comes with it.
5. Merger and Acquisition (M&A) Model
The M&A Model is used to present to the business owner the impact of acquiring a new business, specifically on its earnings per share or EPS. The accountant compares the new EPS with the current one, and if the new EPS is higher than the old one, then it is declared “accretive.” If it is the opposite, it is called “dilutive.”
How to Save Time in Financial Modeling
Business owners are busy people, and as much as they want to scrutinize and take their time reading and analyzing financial models, they just simply don’t enjoy the luxury of time. It is why financial models must be concise and easy to understand without compromising accuracy. Here are some time-saving tricks for the ideal financial model.
1. Make guidelines
The difference between making guidelines instead of rules is that flexibility is achieved with the former. Rules can be limiting, and so it doesn’t allow the accountant or business owner to make analytical insights.
2. Put the end user in mind
There are different people in the organization who will be using the financial model so the accountant should make sure that it is suitable for all types of readers or audience.
3. Be consistent
Consistency is the key to a smooth and easy-to-understand financial model. It is wise to use a template that’s provided by the company.
4. Stick to being simple
Some accountants believe in the so-called black magic of Excel, which is pretty much what its name says – black magic. Avoid using long and complex formulas, which are prone to errors.
5. Choose an intuitive structure
Financial models should represent figures, not confuse end users. Excel calculations should be easy to read and follow one pattern, whether it is top to bottom or right to left.
6. Use a neat model
It should be remembered that financial models are to be read and analyzed so the template should be ideal and suitable to the amount of information presented. Accountants should start with small templates, gradually adding more features and sections as he moves along.
Financial modeling is a tricky endeavor. However, with time and experience, it is a skill that is learned, which is helpful to the growth of the business.
CFI is the official provider of the global Financial Modeling & Valuation Analyst (FMVA)™ certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional resources below will be useful: