FINANCIAL MODELING
WHAT IS FINANCIAL MODELING?
A financial model is a quantitative representation of financial information, from, e.g., a business, organization or branch of a government. A financial model is used by the financial analyst and may be constructed for many purposes, including: valuation of a security, forecasting future raw materials needs for a corporation, or determining the benefits of a hostile takeover or merger. The focus here will be on financial modeling as it relates to Wall Street jobs and, more generally, careers in the finance industry. However, financial modeling with other applications has many of the same characteristics as financial modeling for Wall Street.
ARE THERE DIFFERENT TYPES OF FINANCIAL MODELS USED ON WALL STREET?
There are many kinds of financial models used on Wall Street. While most financial models focus on valuation, some are meant to quantify and predict risk, portfolio performance, or general economic trends within and industry or region. There are several different methods employed for valuation in financial modeling. Discounted cash flow models (DCF models) and capital asset pricing models (CAPM) are used to assess the value of a security. However, while the discounted cash flow model is used by financial analysts to estimate the fair price of a security with respect to identifying undervalued securities, the capital asset pricing model focuses on valuation of a security within the context of its volatility, or risk.
THE BASICS OF FINANCIAL MODEL CONSTRUCTION
Most financial models are built by first gathering pertinent data from a company’s financial statements. This portion of financial model construction is called financial statement analysis. A financial model may require additional information, such as comparative data from the financial statements of other companies, in a case where a comparative company analysis is being conducted. A financial model may entail further sophistication, e.g., the incorporation of sensitivities, which enable a model to track potential scenarios in the future that are not represented in extant data, e.g., from the modeled company’s financial statements. Two examples of highly sophisticated financial models used on Wall Street are the leveraged buyout model (LBO) and the merger and acquisition model (M&A model), both of which are most commonly employed in investment banking and closely related areas, such as private equity and venture capital.
WHAT SKILLS ARE NEEDED TO BUILD FINANCIAL MODELS?
To succeed on Wall Street, whether in an investment banking career or working elsewhere in a financial services job, one must have quantitative—mathematical—and qualitative—business management—skills to construct an accurate and comprehensive financial model. The most common tool used on and off Wall Street to build financial models is Microsoft Excel, with which the financial analyst’s job also requires significant acquaintance. For a career as a financial analyst, normally one possesses an undergraduate degree in business. There are alternative degrees that are well suited to Wall Street careers involving financial modeling, such as mathematics and economics. However, knowledge of business structure and functioning is ultimately required for full involvement in the design and implementation of most financial models. An exception is financial modeling of a purely stochastic nature, such as technical analysis and some applications in risk analysis, in which no attention is paid to the nature of the businesses underlying the securities in an analysis. Those with management positions in investment banks and similar financial institutions normally possess the MBA.
However, an MBA alone does not guarantee adequate training and experience to be able to construct and adapt financial models to the myriad unique and complex situations encountered in an investment banking career. The Investment Banking Institute offers a course, the Investment Banking Bootcamp, which, as the name implies, provides comprehensive financial modeling training along with a maximum of opportunity to practice building real financial models precisely of the sort one would need to construct as an investment banker, venture capitalist or in a private equity career. The Investment Banking Institute’s training course is not only useful for these elite Wall Street careers; the knowledge and skills, inculcated though hands-on training and intense practice during the Investment Banking Bootcamp, provide a potent advantage to anyone who is interested in or has already embarked on a financial services career. The Investment Banking Institute’s training provides the skills of quantitative analysis, for undertaking the technical aspects of financial model building, and the knowledge of qualitative analysis, such as understanding corporate structure and finance. These skills combined are necessary to design and utilize a financial model so that it is a comprehensive and accurate tool for evaluating relevant aspects of the underlying business or businesses.
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