Financial modeling is a quantitative analysis of the financial assets and performance of a firm. It helps to hypothesize likely financial outcomes with the help of mathematical representations and improve predictions by estimating the market functions.
Based on the assumptions, calculations are made, and using different types of financial models, the results are then analyzed. The structure of the model is usually dynamic, which means that there is inherent flexibility and sensitivity to the numbers used.
The main components of financial modeling are the income statement, balance sheet, cash flow statement, and debt schedule.
The income statement reflects the summary of the company’s expenditure, revenues, profits, and losses during the accounting period. It is also known as profit and loss statement, statement of operation, and statement of financial performance.
The balance sheet shows the details of the company’s liabilities and assets at a point in time and is used in business evaluation. It is also referred to as the “statement of financial position” as it demonstrates the company’s financial position.
Cash flow statement
The cash flow statement reflects the changes in cash and its equivalents due to changes in the income statement and balance sheet. It is useful for generating cash forecasts by breaking down the operating, investing, and financing activities to determine the company’s performance.
A debt schedule is a cash flow projection and tracks the debt, interest, payment schedules of the company. It is a crucial part of financial analysis and includes details like the opening balance, interest expense, repayments, and closing balance.
The role of financial models in financial analysis
Financial models help summarize the results of various financial practices and help provide directions towards desirable outcomes. They give a detailed view of the financial portfolio, investments, and other financial assets of a company. The forecasted data proves useful in formulating policies, assessing investment options, reviewing existing financial functions, and raising capital.
Think of financial models as simulations created to understand income statements, balance sheets, depreciation schedules, project costs, economic trends, and their impact on the company’s financial operations.
Depending on the type of problems that need to be solved, different types of financial models need to be used. These models usually are part of one of the following categories - pricing models, reporting models, integrated financial statement models, and project finance models.
The different types of models include discounted cash flow model, comparative company analysis model, sum-of-the-parts-model, leveraged buy-out (LBO) model, merger and acquisition model, and option pricing model.
A good financial model should give you information about the company’s financial position, an overview of the different components and their relationship, a detailed summary of the costs, and predictions about future performance.
The role of Excel in financial modeling
Excel is an indispensable tool for financial modeling. It is a spreadsheet program used to record, analyze and represent data in a tabular format.
An in-depth understanding of Excel is essential for an investment banking or financial analyst and an investment banking certification course that covers the basics of Excel can provide a good foundation for learning financial modeling.
Excel can prove to be an extremely useful tool when dealing with large amounts of financial data, recording entries, and calculating financial outcomes. It features existing formulas that help you to calculate payments, yields, rates of interest, and depreciation.
It offers templates that help you to create budgets, cash-flow statements, and create custom financial reports. The data can be stored and organized in a flexible manner to be reused at any point in time. Excel integrates with various software applications so that you can import data from various sources and represent it in various forms.
Gaining proficiency in Excel can be extremely beneficial for your investment banking career. Once you are familiar with using Excel you can start building basic financial statements using historical data.
There are financial modeling certifications available in the market but choosing the right certification program can yield long-term benefits for you.
Not all financial modeling certifications teach you how to use Excel to its full potential. While choosing the right program, keep in mind that the course covers all Excel functions and tools.
Building a career as a financial analyst or an investment banking professional can be extremely rewarding. You can explore online courses and resources that can help you along the way. Once you’re familiar with the basics, you can opt for professional investment banking certifications that will help you to polish your skills and get practical experience in the financial industry.