What is financial modeling?

Simply put, Financial modeling is a excel based application that is developed to forecast a companies future financial performance. The projection built is usually based on the company’s historical performance and entails creating financial statements; specifically an income statement, balance sheet, cash flow statement and other at times, other schedules. This is typically referred to as a 3-statement model. Once this has been established more sophisticated financial models can be built. Examples include discounted cash flow models (“DCF”), leveraged buyout models (“LBO”), and merger and acquisition (“M&A”) models.

When is Financial Modeling used?

Financial models are an invaluable tool in the corporate world and are the basis for determining the risk associated with critical business decisions. While this is not an exhaustive list, a company will use financial modeling for the following purposes:

  • Making acquisitions (businesses and/or assets)
  • Raising capital – debt or equity
  • Green fielding and growing a business organically – new industry verticals or geographic locations
  • Making strategic acquisitions of an asset or business
  • Divesting or selling a majority or minority interest in a business
  • Valuing a business – for sale, estate and tax planning
  • Forecasting and budgeting
  • Capital expenditure – where to allocate resources

The most common types of financial models.

  1. Three Statement Model
  2. Discounted Cash Flow (DCF) Model
  3. Merger Model (M&A)
  4. Initial Public Offering (IPO) Model
  5. Leveraged Buyout (LBO) Model
  6. Sum of the Parts Model
  7. Consolidation Model
  8. Budget Model
  9. Forecasting Model
  10. Option Pricing Model

Best ways to learn financial modeling?

Repetition is the key to mastering the art of financial modeling. As the old adage goes, practice does make perfect, and it take a lot of it to gain the proficiency required to merit that of an expert. Here are some tips to get you started.

1. Developing and building a valuation from scratch is the best practice. This allows you to get a better understanding about how everything is connected and eventually you will be able to optimize how to format and work with complicated spreadsheets. For starters, download and review 3-5 years of historical annual data, latest quarterly fillings, and industry research pieces in order to forecast growth. Best to focus on an industry sector that you are passionate about, that will keep things a little more interesting.

2. There are a number of freeware templates floating around on-line, do a search to find some examples.

3. Take a Financial Modeling class. Developing and reviewing the basic principles of accounting, finance and valuation coupled with developing models step by step under the watchful eye of a seasoned banker will undoubtedly expedite the learning curve.


A few things to keep in mind while working on your model. Continually review if the model makes sense and Focus on the weaknesses and strengths of your model. What happens when you change the inputs? What is your model suggesting? Based on the comparable transactions are the outputs in your model realistic?

The excel modeling is the easy part, it’s the underlying fundamentals that is vastly more difficult and critical with respect to the model. Are you working with an early stage or mature company? Is the year over year growth rates realistic or do they suggest an indefensible increase based on historical performance? Is the company in a highly regulated industry? Is the management team experienced in the sector? Has there been any recent acquisitions or divestitures that may impact future performance? How is the quality of earnings? Is there risk from an exchange rate perspective?

These are the types of considerations, and there are many more, that make modeling an art rather than a science and will produce the most realistic and viable model from which to base strategic decisions.

Financial Modeling is frequently used in the following fields:

  • Investment Banks
  • Hedge Funds
  • Private Equity
  • Credit Rating Agencies
  • Equity Research
  • Corporate Finance
  • Asset Wealth Management
  • Business Development
  • Corporate Finance
  • Strategy Consulting