Financial Modeling Best Practices

What is the financial model?

A financial model is a tool to forecast a business’s financial performance in the future. The forecast is typically based on the company’s historical performance and assumptions about the future. Besides, it requires preparing the information from an Income Statement, Balance Sheet, Cash Flow Statement, and supporting schedules.

A financial model is usually it’s built-in MS Excel. Therefore, being good at modeling means being outstanding at Excel, have a good knowledge of accounting and corporate finance.

What are the Financial model types?

The most famous and widely used financial models are:

1. DCF model (Discounted Cash Flow Analysis),
2. LBO model (Leveraged Buyout),
3. M&A Model (Mergers and Acquisitions),
4. Real Estate Model and more.

Who builds financial models? (jobs and career)

There are many different types of professionals who build financial models. For example, the most common types of career tracks are investment banking and equity research. Also, they can be within corporate development, FP&A, and accounting (due diligence, transaction advisory, valuations, etc.).

What makes a good financial model?

1. Well structured with a good layout
2. Easy to follow and understand
3. Drivers and assumptions clearly laid out
4. Simplicity over complexity

What are financial modeling best practices?

1. Excel tips and tricks

It’s very important to follow best practices in Excel when building a model. Thus, try to limit or eliminate the use of your mouse (keyboard shortcuts are much faster).

a) Incorporate a blue font for hard-codes and inputs (but formulas can stay black).

b) Keep formulas simple and break down complex calculations into steps.

c) Make use of cell comments (Shift + F2) for explanations, so the model would be easy to follow for you when you come back to it later as well as for the other users.

2. Financial Modeling logic

The best practice is to build a simple model in quadrants:

1. Derive historical information from financial statements. Then, calculate the necessary items based on that information.
2. Calculate historical value drivers based on the derived historical information.
3. Make educated assumptions for projected value drivers. The information will be based on the company’s financial statements, economy, and industry trends, etc.
4. Calculate projected line items based on the projected value drivers.
5. Add any additional calculation needed for the model.

3. Model layout and design

It’s critical to structure a financial model in a logical and easy to follow the design. Thus, the main sections to include in a financial model (from top to bottom) are:

1. Income statement
2. Balance sheet
3. Cash flow statement
4. Assumptions and drivers
5. Sensitivity analysis
6. Charts and graphs

How can you learn financial modeling?

To summarize, the best way to learn financial modeling is to practice.  It takes years of experience to become an expert at building a financial model and you really have to learn by doing.

keySkillset Financial Model gamified course gives you a hands-on experience of building a model in Excel. Moreover, you can build financial modeling knowledge and skills while having fun, collecting badges like stars and keys on the way.

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