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Enterprises actively use financial modeling to guide their financial planning and strategic decision-making. Financial models offer data-driven, quantitative analysis that tells you where your company stands and where it’s heading.
That being said, one model can’t do it all. As a finance professional, you’ll need different types of financial analysis and modeling for different situations. This post will take you through the basics of financial modeling and provide you with eleven financial modeling examples that you can use to evaluate corporate decisions from a financial perspective.
Financial modeling involves combining key accounting, finance, and business metrics to build an abstract representation, or model, of a company’s financial situation. This exercise helps a company visualize its current financial position and predict future financial performance.
Financial modeling can be quite handy in a number of situations. It can help inform investment decisions, securities pricing, and plans for corporate transactions such as mergers, acquisitions, and divestitures.
But the most common use of a financial model is for making operational business decisions and performing financial analysis. Executives typically use financial models to make decisions regarding:
This may feel like an overwhelming number of topics that require financial models; however, most established companies have taken the time to create financial modeling Excel templates that expedite the decision-making process. But this begs the question – who develops all these financial model templates?
Financial modeling is a quantitative analysis used to forecast a company’s financial performance. By combining accounting, finance, and business metrics, financial models help decision-makers predict the impact of future events or decisions. This tool is pivotal for strategic planning, investment analysis, and financial planning.
Financial modeling is instrumental for decision-making in investment banking, corporate development, equity research, and project finance. It aids in valuing businesses, making investment decisions, budgeting, and forecasting financial performance, thereby supporting strategic planning and operational efficiency.
With such a broad application, financial models are created and used by many different types of financial professionals, including but not limited to:
But in the context of the modern company, those involved in financial planning and analysis (FP&A) are the most likely to be building and using financial models that steer the direction of the company.
The FP&A team plays a crucial role within the office of the CFO. It’s in charge of the company’s financial planning. That means the FP&As are the people creating the budget and performing financial forecasting to help the CFO and other members of senior management understand the company’s financial situation.
Aside from budgeting and forecasting, the FP&A team is also tasked with decision-making support and special projects such as market research and process optimization.
In the real world, financial modeling is crucial for several key activities:
Common models, such as discounted cash flow (DCF) analyses, are widely used in investment banking and equity research to evaluate the present value of future cash flows.
Companies operating in the twenty-first century are faced with a new set of unique challenges. We now live in a global economy that’s shaped by accelerating innovations in technology. As a result, companies must be agile—poised to make quick, strategic decisions based on the latest incoming data—if they hope to succeed.
And as a financial planner and analyst, you have the opportunity to directly impact your company’s share price. Just take a look at the role of the FP&A team.
To forecast a company’s financials, you must have a deep understanding of both the company’s historical performance as well as key trends and assumptions that might impact its future performance. This also requires an understanding of business operations and accounting.
FP&As frequently visit with nearly every team within an organization, including the treasury and accounting, sales, marketing, operations, and executive management teams. In this sense, the FP&A team acts as a central hub within the company that connects and relays information between the executive and operational teams.
But to play your part—and play it well—financial modeling is absolutely essential. It’s likely the most important weapon in your arsenal. Financial modeling is what gives you the insights you need to make data-driven decisions for your company.
A robust financial model includes historical financial data, assumptions about the future, projections of the income statement, balance sheet, cash flow statement, and supporting schedules like depreciation and amortization. It may also incorporate scenario and sensitivity analyses to explore different outcomes.
Excel remains the gold standard for financial modeling due to its flexibility, widespread availability, and advanced features. However, specialized software like Tidemark can help with building financial models.
Financial modeling is used across various industries, including banking, real estate, technology, manufacturing, and healthcare. Any business engaged in financial planning, investment analysis, or seeking to evaluate strategic decisions can benefit from financial modeling.
Validating a financial model involves ensuring the accuracy of its inputs and logic. This can be done through back-testing against historical data, sensitivity analysis to understand the impact of assumptions, and peer or third-party review to identify any errors or oversights.
So how do you build a financial model? Many finance professionals choose to build their own financial models from scratch using Excel. Building a financial model this way is no simple task. You’ll need to learn some basic Excel tips and tricks, such as using keyboard shortcuts to increase efficiency. And a little bit of programming knowledge doesn’t hurt, either. Visual Basic for Applications (VBA) is the programming language typically used for Excel and other Microsoft Office programs.
But building a useful financial model takes more than plugging and chugging data and equations. You’ll also need to think about the formatting, layout, and design of your model. For example, separating input (historical data and assumptions) from output (calculations) can help you avoid input mistakes and more easily scan for errors. And a well laid-out and intuitive design will help highlight the main message and key takeaways of your model.
Financial modeling is an important tool. But one size doesn’t fit all when it comes to financial planning.
You must design your model with a specific question in mind. There are different types of models that FP&As can use depending on the problem they’re trying to solve. Let’s take a look this curated list of financial modeling examples:
The three-statement financial model integrates and forecasts a company’s three financial statements—the income statement, balance sheet, and cash-flow statement—into the future.
The three-statement model represents the real meat and potatoes when it comes to financial modeling. This model acts as a standard that gives a comprehensive overview of the company’s financial history, current standing, and future performance.
It also has predictive power. The three-statement financial model allows you to explore how your company will perform under multiple circumstances and visualize how different decisions can interact to impact the future of the company.
A Three-Statement Financial Model is a powerful financial tool that integrates three crucial financial statements of a company:
This statement reflects the company’s profitability over a specific period. It shows revenue earned, expenses incurred, and ultimately the net income (profit) or net loss.
This statement presents a snapshot of the company’s financial position at a specific point in time. It categorizes assets (what the company owns), liabilities (what the company owes), and shareholders’ equity (the company’s net worth).
This statement details the cash inflows and outflows of a company over a specific period. It categorizes these flows into operating activities (cash generated from core business), investing activities (cash used for investments), and financing activities (cash raised from debt or equity).
The merger and acquisition (M&A) model calculates the impact of a merger or acquisition on the earnings per share (EPS) of the newly formed company. This value can then be compared to the company’s current EPS. The M&A model is useful for helping a company decide whether a potential merger or acquisition will be beneficial to the company’s bottom line.
If the M&A model shows an increase in EPS, then the transaction is considered accretive, meaning it should result in growth. But if the M&A model shows a decrease in EPS, the transaction is considered dilutive, meaning it will reduce the company’s value. A sample M&A financial model for Excel can easily be found with a quick Google search.
A merger model is a complex financial tool used in the analysis of the financial viability of merging two companies. It involves the consolidation of the balance sheets, income statements, and cash flow statements of both companies into a single model. This model forecasts the financial outcomes of the merger, including synergies that may arise from cost savings or revenue enhancements. The primary goal is to assess whether the combined entity will create value for shareholders and to determine the impact on earnings per share (EPS), leverage ratios, and other key financial metrics.
The acquisition model analyzes the financial impact of merging two companies by consolidating their financial statements and forecasting the combined entity’s performance. By looking at the projected earnings per share (EPS), the model helps determine if the merger will be financially beneficial for the shareholders of the new company.
Forecasting is one of the most important tasks that the FP&A department takes care of on a regular basis. It is typically used to predict future revenues, expenses, and capital costs. Financial models used for forecasting are often compared to the actual budget to review performance in retrospect. Here are four financial model examples used for forecasting:
This is the simplest forecasting model that exists. It makes use of historical data to estimate what will happen in the future. For example, if your company has experienced a 4% annual increase in revenue for the last three years, the straight-line model would forecast a 4% annual increase for the following year.
This is another simple forecasting model that can easily be created in Excel. However, its strength lies in its ability to smooth out data. Typically, companies use the moving average model to evaluate performance on a monthly basis and makes use of three-month and five-month moving averages.
If you were to calculate a linear regression line by hand, it would take quite a bit of your time, and not be worth the effort. Luckily, Excel can do linear regression for you. This forecasting method is best used to compare the relationship between two different variables. A common example is advertising budget and revenue. If your advertising budget increases, you can expect your revenue to increase. A linear regression model will help you determine exactly how advertising and revenue correlate with each other, which can be used for forecasting.
This is probably the most complicated method of forecasting in our list. Time series modeling attempts to identify patterns in historical data and uses these patterns for forecasting. Most modern approaches to time series forecasting make use of machine learning or specialized software like Tidemark.
A financial analyst may turn to the discounted cash flow (DCF) model when they need a way of determining valuation. One of the key attributes of the DCF model is that it calculates current value while taking into account predictions for how much money something will make in the future.
The DCF model can be used to value an entire company, but you can also use this model to value:
It should be noted that while the DCF financial model can be used as a standalone tool for valuations, it can also be used in conjunction with other valuation metrics in more comprehensive models. For example, the capital budgeting model that we talk about later in this post will make use of the DCF model for some of its metrics.
The comparable company analysis (CCA) model is another way for a business to calculate its value. It’s a more basic valuation method than the DCF model.
The CCA financial model is based on the assumption that similar companies will have similar valuation multiples. It uses metrics from other businesses with similar sizes and operations in the same industry. Here is a list of the most commonly used valuation multiples:
You can also download a free CCA sample financial model for Excel here.
While this financial modeling method is able to give you a ballpark estimation for the value of your company, it is not almighty. There are often instances in which a company’s valuation cannot be extracted purely from their financial data. However, it is a very good starting place to build a base case valuation.
If you are looking for more sample financial models in Excel, insightsoftware has a large number of sample reports that you can download. Some of these will be able to help you with your CCA modeling.
Asset and liability financial models are primarily used by financial institutions (banks and insurance companies) and pension funds (corporate or public) to manage their financial objectives. For example, pension funds must be able to pay pensioners during any economic conditions, including a crisis like 2008. This is achieved through thorough risk management strategies that are continually reviewed. Most pension funds conduct a comprehensive review every three to five years. During this process, they use financial analysis and modeling to adjust their asset and liability management strategies to reduce portfolio sensitivity to economic conditions, interest rate changes, and foreign exchange rates.
ALM strategies are also employed by the FP&A departments of large corporations and conglomerates. These financial planning models are used to ensure the company remains solvent in the direst of economic situations.
The sum-of-the-parts financial model allows large conglomerate organizations with many divisions to simplify their valuation. As the name suggests, the sum-of-the-parts model values each business unit, division, or subsidiary separately and then adds them all together.
This can sometimes make it difficult for the FP&A department as they are having to gather financial data from multiple entities and compile it into a single model. This is where standardized financial modeling Excel templates or specialized reporting software really help.
In most large conglomerates, the benefits of using the sum-of-the-parts models strongly outweighs the extra effort required. This financial model is a useful tool for determining the value of a company’s divisions in the event that one is sold off or spun off into a separate company.
Every year the FP&A department is tasked with helping create the annual budget. Some people view this as being an extremely painful process due to all the fine tuning involved. However, a proper annual financial planning model that make use of quarterly figures and forecasting can greatly expedite the process. Because so many companies go through this process every year, insightsoftware has developed a budgeting software solution to streamline the process.
Most large companies will have a financial planning model in Excel or a budgeting software solution that they will use to evaluate prospective projects before they chose to pursue them. This financial analysis and modeling will vary by company but will almost always make use of the net present value (NPV), internal rate of return (IRR), and payback period calculations. These three financial performance metrics are best used when a company has several potential projects but can only pick one or two of them.
We won’t go into the details of these metrics or how they are modeled, but you ideally want the NPV to be greater than zero, IRR to be as large as possible, and the payback period to be as short as possible. If you want to learn more about these financial evaluation metrics, can check out our financial metrics post. It will provide you with the equations necessary for each calculation. You can also find a simple NPV and IRR financial model example here.
This might not be a financial model that your FP&A department needs to be familiar with, but they should be aware of its existence. Typically, investment banker on Wall Street have access to financial model templates that are built specifically for pricing IPOs.
The IPO pricing model has several different components that it incorporates. For example, it will make use of the comparable company analysis, looking at their P/E relative to industry peers. For up and coming tech. companies that have yet to turn a profit, investment bankers will look at prospective annual growth estimates. This model also takes into account previous funding round valuations, and what share price would be attractive to institutional investors that are subscribing to the IPO.
The leveraged buyout (LBO) model is used to analyze an acquisition that finances the cost mostly with debt. How much debt? Typically, a leveraged buyout is 90% debt and 10% equity. Due to this incredibly high debt-to-equity ratio, the bonds being issued are not investment grade – i.e. junk bonds. Some people consider LBOs to be an incredibly aggressive and risky move, but with great risk comes great reward.
The LBO model allows the buying company to properly evaluate the transaction so it can earn the highest possible risk-adjusted internal rate of return (IRR). As a rule of thumb, most companies will only consider an LBO when the IRR is in excess of 30% as this is the point at which the risk-to-reward becomes attractive.
Most FP&A departments won’t be looking at the option pricing model unless they are somehow involved with a company that specifically trades/holds derivatives. Option pricing models are typically used by market makers and securities traders looking to turn a profit or hedge risk. These financial models are used to assign a price (premium) for the options contract based on statistics and probability (i.e. how likely the option will be in-the-money at expiration).
There are several different financial models that can be used to price options contracts. The most commonly used models are Black-Scholes, binomial tree, and Monte-Carlo simulations. Creating financial model templates for these is not difficult if you have good understanding of mathematics, and some Excel knowledge. In fact, you can find most of these financial model examples for Excel with a quick Google search.
Now that you are familiar with the best financial models to use when making data-driven decisions, let’s take a look at the best financial modeling tools that are available.
