We frequently assert that if you comprehend the financial model, you comprehend the deal, organisation, or other entity for which the financial model is being constructed. This is so because the Financial Model contains all of the business logic. In addition to its more common applications, such as capital raising, service pricing, and revenue forecasts, a financial model may be a very powerful negotiation weapon. We shall outline the many categories of financial models in this blog article.
Table of Contents-
- What is a Financial Model?
- Uses of Financial Models
- Different types of Financial Models
What is a Financial Model?
Financial modelling is the process of using numbers to describe the operations of a business in the previous, present, and anticipated future. These models are intended to be tools for decision-making. They might be used by company leaders to project the expenses and profitability of a newly proposed project. They are used by financial analysts to explain or predict how various events, both internal and external, such as changes in economic policy or law, may impact a company’s stock price. When seeking to appraise a firm or compare it to others in the same industry, financial models are used. They are also used in strategic planning to assess possible results, generate budgets, identify project expenses, and distribute resources within the organisation. Discounted cash flow method, sensitivity analysis, and in-depth evaluation are a few examples of financial models.
Uses of Financial Models
Results from financial models are used for financial assessments and decision-making both inside and outside the organisation.
Financial Modelling executives must make decisions within the organisation regarding:
- Planning and creating a budget for the upcoming years.
- building the business organically. (For instance, breaking into new markets or launching new businesses.)
- Management of Risk.
- Assets’ or Company’s valuation.
- Budgeting for Capital
- Increasing Capital
You can always know more about the uses of financial models by going through online available financial modeling and valuation course or by reading free online blogs on finance. Now that we know the uses of the financial models, let’s learn about each of them in detail.
Different types of Financial Models
The many sorts of financial models are numerous. The top 10 models that financial modelling experts use the most frequently in corporate finance are discussed in this guide.
Below is a list of the top 10 financial model types:
Merger Model (M&A)
The most modern model is this one. The financial statement growth/dilution of an organisation and property is determined using this model. For each organisation, it is typically used with a single tab model. The merger will result in Business A + Business B becoming one company.
The most typical applications for this are in business growth and investment banking.
3 Statement Model
The simplest configuration for financial modelling is shown here. The three statements in this model—the net income, cash flow statement, and balance sheet—are all connected using EXCEL formulae. The goal is to connect all of the accounts with one another. Understanding how to link the three financial statements is crucial. A strong background in accounting, finance, and Excel skills is needed to understand the three financial statements.
Initial Public Offering (IPO) Model
Investment bankers and business development experts typically adopt this paradigm. They develop Excel IPO models to value their company. These financial models assess the company and offer judgments on the asking price that investors will offer for it.
Leveraged Buyout (LBO) Model
Of all the several kinds of financial models, it is the most intricate and difficult. In a leveraged buyout, the company’s debt serves as the main source of funding. These transactions often take place when an investment company balances its equity by borrowing as much as possible from the lenders.
Discounted Cash Flow (DCF) Model
The Three Statement Model is used in this model. This methodology aids in valuing the business using NPV (Net Present Value). The DCF Model uses the three-statement model’s cash flow and makes necessary adjustments. Does Excel’s XNPV function then discount the changes to today’s prices using the firm’s average weighted cost of capital? (WACC).
The XNPV function makes use of specific dates that correspond to each flow discounted inside the series. Secondary market research and other sections of the financial markets frequently employ these types of financial models.
This model incorporates many business divisions into a single model and covers them all. Each business system had a price as well as a total price that included all other company totals. Additionally, this model is comparable to the sum of the parts in that divisions A and B are combined to generate a new merger worksheet.
Sum Of The Parts models
This kind of model is constructed by combining different DCF models. The FP&A department occasionally finds this challenging because they must combine the data from numerous research into a single product. The model is a useful resource for figuring out the division of the business.
Option Pricing Models
Binomial Tree and Black-Scholes are two examples of option pricing models. These models’ whole foundation is based on formulas. Marketplace builders and security traders who are attempting to make money typically employ this concept.
This concept is employed by experts in financial analysis and planning (FP&A). This model’s objective is to create the budget for the upcoming years. On quarterly and monthly data, budget models are built. This model, however, places a strong emphasis on the financial statements.
Financial Valuation & Analysis also employs this style. This model’s goal is to forecast outcomes and compare them to those predicted by the budget model. The budget and projection model might be either a linked worksheet or a separate workbook.
You are now knowledgeable about the various types of financial strategies. Let’s look at how to become proficient in financial modelling.
Microsoft Excel, for example, has robust data modelling features. These tools are used by finance experts and corporate leaders to forecast financial performance and make financial choices. Financial modelling, for instance, may be used to raise money, expand into new markets, gain market share, and value a business or its assets. Financial modelling techniques rely on a fundamental set of presumptions. These presumptions rely on the goal of the financial model; for example, a model analysing sales growth will always assume rising revenue.