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Financial Modeling

4 Best Practices You Should Follow for Financial Modeling

Financial Model is an essential finance toolkit that deals with historical data of a given company and forecast its future performance to evaluate its risks and returns profile.

Income Statement, balance sheet, and cash flow statement these are the main three pillars of this modeling.  These help a corporation in strategic planning and decision making. This is the reason why most companies rely on it.

This article will simply guide you through to build your financial model step-by-step. If you are novice finance professional you will get a clear picture of what you need to do without wasting your time going through all the jargons.

An unplanned way can be time-consuming as structural changes may occur in the midway through a modeling process. So, laying out the blueprint at first solves most of the modeling problem as you will have the clear picture what you need to do step by step.

1.The Goal of the Modeling

Blueprint as we mentioned above is the key here, laying out it at first gives clarity and it helps to avoid painful corrections down the road. Clearly defined purpose helps to breakdown layout, structure and end-outputs.

2. Total Time-Taken

Understanding the timeline is also important input to determine the approach of financial modeling exercise. Long-duration models are mainly custom built and need to include too much operation details. On the other-hand shorter duration models uses prefabricated templates which helps to maximize the speed of construction and minimize the errors.

3. Model’s structuring

At this point you might opened your excel and thinking about the structuring. Before taking any step, keep in mind that model should be and always divided into three sections:

  • Input
  • Calculations
  • Outputs

You can take a look at the below approach almost every model is built in this manner. This approach is always found to be practical and useful.

Cover page:  It leaves the first impression. So if you do it well then it clearly explains other things. Simple instructional Cover pages typically includes: Project name, description the author’s information and any applicable disclaimers.

Inputs and Assumptions: Immediate after the cover page must come driver’s tab. You should make it clear, concise and very easy to understand.

Detailed calculations and operating tab: This tab is model tab and it is the heart of the model where all information from the drivers tabs work together to project a company’s financial outlook into the future years.

Output tab: Most financial model shows three output tabs such as financial output tab, Executive summary tab and Specific output tab. This tab is most frequently used by the operators.

So, the construction phase of the modeling process is now officially complete. Now we can move towards the formatting aspect of the modeling.

4. Formatting your Financial Modeling

Each individual company follows their own preferences or internal practices while formatting. But I can say the best practices in formatting are to use consistent and identifiable color schemes.

The more you become familiar with the applications and the process, the better you will find that it is productive and powerful way to describe a company.

So, a financial modeling will become a new storytelling tool for you. There are certain companies that provide help in regards with planning this model. So, if you are unable to do it on your own, it’s better to take the expert’s help. 

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