Financial modeling is a critical skill used by people in a range of analytical and planning roles, and plays a key role in the decision making process, especially in almost every financial career path.
So let’s explore what makes it so important, and see how it is used to help professionals make informed decisions. We’ll take a quick look at some of the types of financial models you’re likely to encounter, and review how financial modeling is used within various roles.
We’ll also highlight some of the best financial modeling courses and qualifications available to help you boost your skills, so that you can develop and use financial models like a pro.
At its core, financial modeling involves creating a mathematical representation of a company’s financial performance.
Financial models can range in complexity from simple models that project future revenues and expenses to complex models that factor in a range of variables, such as macroeconomic trends, industry-specific metrics, and market dynamics. Typically, these financial models are built with spreadsheet software such as Microsoft Excel.
Modeling is an important tool for finance professionals, as it allows them to evaluate the financial health of a company, guide investment decisions, and develop strategic plans.
The key to creating effective financial models is to use accurate data, thoughtful assumptions, and sound modeling techniques that take into account the various risks and uncertainties that can impact an organization’s financial performance.
Financial models are used for a variety of purposes within any industry, such as:
Understanding the various types of financial models; their applications, and the key components of each, is crucial for generating the data and insights needed to make the right strategic decisions. Here are some financial model examples:
The 3 statement model is used to analyze a company’s financial performance by creating projections for its income statement, balance sheet, and cash flow statement, which are all dynamically linked from a set of input assumptions.
It is based on the principle that a company’s financial performance is driven by its ability to generate revenue, manage expenses, and generate free cash flow.
This type of financial modeling is particularly relevant in equity research, investment banking, and corporate finance. It’s mostly used to evaluate a company’s financial health, identify areas for improvement or for business plan development.
The budget model is used to plan and control a company’s financial resources over a specific period, typically a year. It involves detailed, line-by-line projections of the company’s revenues and expenses, and comparing them to existing financial goals and targets.
It’s an important tool companies use to manage their financial resources effectively, and allocate them efficiently to achieve their strategic objectives.
This type of model is widely used in Financial Planning & Analysis (FP&A) and corporate finance teams, particularly in the planning and budgeting process. It is also used in the nonprofit sector to plan and control resources, and by governments to allocate financial resources.
A forecasting model is used to predict a company’s future financial performance based on historical data, trends and market condition assumptions.
Forecasting models are widely used in financial planning and analysis (FP&A) to help companies make informed decisions about resource allocation, investment, debt, and risk management.
A forecasting model is in some ways similar to a budget model, and are quite often combined as they are complementary yet distinct: a budget is usually a firm’s target profit and loss (P&L) for a specific time period, whereas a forecasts is an estimate of where the actual performance of a firm will be. So both models are often used together to compare forecast vs the budget set out initially for performance management.
An option pricing model is used to determine the fair value of options contracts. It involves estimating the probability distribution of future stock prices, along with other factors such as the option’s strike price, stock price volatility, time to expiration, and risk-free interest rate.
As option pricing formula is purely mathematical, there is less customization involved and more straightforward to input the formula in a spreadsheet for calculations.
Investors, traders, and financial analysts use this type of model to evaluate the price of options contracts and determine their trading strategies.
More affectionately known as the ‘merger model’, this model is used to evaluate the pro forma financial impact of a potential merger or acquisition.
This model takes into account factors such as the purchase price, financing costs, tax implications, and integration costs to estimate the potential financial impact on the combined organization.
This model also evaluates potential synergies and cost savings that may result from the M&A, as well as the financial accretion/dilution for the buying firm in the deal to determine the potential return on investment.
The merger model is widely used by equity research, investment banks, corporate development and private equity firms to evaluate potential merger and acquisition opportunities.
The IPO (Initial Public Offering) model is used to evaluate the potential financial impact of an initial public offering of a company’s shares.
It involves doing a comparables company analysis (“comps”) to obtain a comparable set of financial ratios to estimate the valuation of the company to determine the IPO pricing range based on various factors such as the company’s financial performance, market conditions, and investor sentiment.
Investment bankers in the equity capital markets team and underwriters use IPO models to evaluate the feasibility and potential success of an IPO. Based on this analysis, leaders can make informed decisions about the timing, pricing, and structure of the IPO.
The LBO (leveraged buyout) model is used to evaluate the financial feasibility of acquiring a company using a significant amount of debt financing.
It involves analyzing the financial statements of the target company and projecting its potential future financial performance under the new ownership structure. The LBO model is widely used by private equity firms and investment banks to evaluate potential acquisition targets.
It’s a more advanced model which requires in-depth knowledge of capital structure, with detailed debt schedules and cash flow waterfalls to evaluate the feasibility of such acquisition and how much debt financing to use.
The SOTP (sum of the parts) model is used to evaluate the valuation of a company by breaking down its various business segments or assets and valuing them separately.
It involves analyzing the financial statements of the company and separating its business units or assets, then valuing each segment based on its unique characteristics and financial performance.
SOTP modeling is often used in equity research and investment banking to evaluate the value of a conglomerate or a company with diverse business operations. It is a critical tool for investors and analysts to evaluate the valuation of a company with diverse business operations.
The consolidation model is used to combine the financial statements of multiple companies into a single set of financial statements. It involves analyzing the financial statements of each company to assess their individual profitability, whilst providing a comprehensive view of the financial performance of the group as a whole.
Consolidation modeling is often used in corporate finance to analyze the financial performance of subsidiaries and joint ventures.
For example, a holding company with multiple subsidiaries may use a consolidation model to analyze the financial performance of the group as a whole after eliminating any inter-company transactions.
Financial modeling is incredibly important not just in finance, but in all industry sectors and even the government. It provides a framework for a range of essential activities like decision-making, risk management, and financial analysis.
Financial models are some of the most important tools used by finance professionals to understand the potential impact of various financial decisions, and to make informed choices based on quantitative analysis. Accurate models are therefore essential for firms to be able to function properly.
Good financial models provide detailed and useful insights into the financial performance of a company or investment opportunity. By building and refining robust models, companies and institutions are able to make data-driven decisions that achieves their objectives.
It is an essential skill to possess in a range of financial careers, and can greatly enhance your ability to succeed in your chosen field.
While building a financial model might seem like a daunting task, the process can usually be broken down into a few key steps.
Further on, we will look at specific financial modeling courses that will equip you with the skills and knowledge to build and use financial models at an advanced level, but for now, here’s a basic overview of what’s involved:
The first step is to clearly define the purpose of the model. What problem are you trying to solve? What are the key questions that need to be answered?
Defining the purpose of the model will guide all subsequent steps in the modeling process.
Once you’ve identified the purpose of the model, you’ll need to gather relevant data. This might include historical financial statements, industry reports, economic data, and other relevant information.
The more data you have, the more accurate and useful your model will likely be.
Before you start building the model, it’s important to outline the structure of the model. This means identifying the key variables, assumptions, and calculations that will be included in the model.
This will help you to organize your data and ensure that the model is logical and easy to understand.
With the structure of the model in place, you can start building the model. This will involve using spreadsheet software (such as Microsoft Excel) to input the data and create formulas to calculate the results.
It’s important to double-check all formulas and calculations to ensure accuracy and whether it all makes sense.
Once the model is built, it’s important to test it and refine it as necessary.
This might involve running sensitivity analyses to see how the model performs under different scenarios, or comparing the model’s results to actual data to ensure accuracy.
Finally, you’ll need to present the model to stakeholders in a clear and concise way.
This might involve creating charts and graphs to illustrate the results, or creating a presentation that summarizes the key findings of the model.
Financial modeling is used by individuals in any industry dealing with a company’s performance. Let’s review some of the career paths where finance modeling is valued.
A financial analyst is a professional who specializes in building financial models to support decision-making in a variety of industries. Their primary responsibility is to develop complex models that provide insights into the financial performance and future prospects of a business or investment opportunity.
Financial analysts are typically employed by companies like investment banks, private equity firms, hedge funds, and other financial institutions. They also work in industries such as healthcare, real estate, or technology, where financial modeling is necessary for strategic decision-making.
The role of a Financial Modeling Analyst requires strong analytical skills, attention to detail, and the ability to work with large amounts of data. Advanced proficiency in financial modeling software, such as Microsoft Excel, is a must. Analysts also need to be able to effectively communicate complex financial information to both financial and non-financial stakeholders.
Investment banking is a sector that heavily relies on financial modeling. The type of financial modeling typically used in investment banking includes discounted cash flow (DCF) models, leveraged buyout (LBO) models, merger and acquisition (M&A) models, and initial public offering (IPO) models.
The financial models used in investment banking are mainly for valuation, capital raising, financial analysis, and strategic decision-making.
M&A models are used to analyze the financial implications of potential mergers or acquisitions, and IPO models are used to evaluate the financial prospects of a company before it goes public.
Investment bankers use financial modeling to help their clients make informed decisions about M&A opportunities, how best to finance it to maximize returns. They must be able to build complex financial models quickly and accurately, often under tight deadlines and with limited information.
In the field of corporate finance, financial modeling is a critical tool used for quite a wide range of purposes. These include things like budgeting, forecasting and valuation, as well as running risk and scenario analysis models to see how well a company is likely to perform in relation to certain influences or stresses.
For example, financial statement forecasting models are used to project future financial positions, such as income and balance sheets, while cash flow forecasting models are used to identify a company’s most likely levels of future liquidity and solvency.
Capital budgeting models are used to evaluate investment opportunities and determine whether they are financially viable.
These models typically use DCF (discounted cash flow) analysis to estimate the net present value of an investment, taking into account factors such as initial investment, expected cash flows, and the required rate of return.
Scenario analysis models are used to assess the potential impact of different scenarios on a company’s financial performance.
This could mean building models to evaluate the impact of changes in interest rates, exchange rates, or commodity prices on their business to make sure planned strategies can handle these variations.
Financial modeling is used in accounting to analyze and interpret financial data to support decision-making, budgeting, forecasting, and financial reporting.
If you’re planning to get into a career in accounting, it’s more than likely that you’ll use financial models for things like cash flow forecasting, budgeting, financial statement analysis, and variance analysis.
An accountant would use cash flow forecasting models, for example, to determine a company’s ability to meet its financial obligations. These models combine historical data with assumptions about what will happen in the future, to forecast inflows and outflows of cash.
Budgeting models are used to create a financial plan for a company; setting goals and allocating resources to meet those goals. They would usually take into account various factors such as revenue growth, expenses, and capital expenditures which are handled by an accounting team.
Variance analysis uses financial models to identify and explain variation between actual financial performance and budgeted or projected financial performance.
These models help companies to identify areas where actual performance deviates from expected performance, so that they can make adjustments to their plans as necessary.
Wealth management involves managing the finances of high-net-worth individuals (HNWIs) and ultra-high-net-worth individuals (UHNWIs) through investment advisory services, financial planning, and other related services.
In this sector, financial modeling is typically used to provide investment recommendations and create financial plans for clients.
There is some quite specific modeling that you might use as a wealth manager, such as portfolio optimization models, risk analysis models, and retirement planning models.
Financial modeling enables wealth managers to provide personalized and highly bespoke investment advice and financial planning services to their clients. This helps to ensure that their recommendations align with their clients’ investment objectives, risk tolerance, and overall financial goals.
Financial modeling is typically used in commercial banking by people such as credit analysts, loan officers, and others to evaluate the creditworthiness of a business or corporation seeking a loan or other banking services.
This allows decisions to be made based on things like credit risk models, cash flow models, and sensitivity analysis models:
Equity research analysts use financial modeling extensively in their work to value companies and make investment recommendations to clients. They use financial models to project a company’s future financial performance, assess the company’s risk profile, and estimate its intrinsic value.
Modeling is typically used to build discounted cash flow (DCF) models, which estimate a company’s intrinsic value based on its projected cash flows. Analysts also use other types of financial models, such as relative valuation models, to compare a company’s valuation to that of its peers.
Financial modeling is crucial for most research analysts as it helps them make informed investment recommendations. A well-built financial model can provide a detailed insight into a company’s financial health, helping analysts to identify potential risks and opportunities.
In the world of real estate, financial models are commonly used to estimate the future cash flows of properties, assess their potential profitability, and determine their value.
In addition to property valuation models, real estate analysts might use financial modeling to create pro forma financial statements, which estimate the future financial performance of a property.
Financial models are also valuable tools to help analyze the financial feasibility of development projects, or to assess the impact of changes in market conditions on the value of property portfolios.
If you want to learn more about financial modeling, there are a huge range of certifications available, but it can be difficult to know where to start.
Let’s take a look at some of the top financial modeling courses to help you find the right type of certification for your career.
If you’re looking for a taster session in financial modeling or just to learn the 3 statement model, check out Gridlines’ free modeling course on this.
If you’re looking for something approachable and introductory to start off with, try out Schweser’s financial modeling course at $199.
This course was developed in partnership with The Marquee Group, a leading company in financial modeling and training. In fact, it is now part of Training the Street group (see next point).
We find that it is a good starting point to dip your toes in the world of financial modeling before you decide to invest further.
Established way back in 1999, I was trained by TTS myself as a graduate, as still kept my training books until today!
TTS has a lot of experience training the graduates of the financial services industries, and has finally translated its top class training for the online audience.
TTS have quite a few online courses offered, but we particularly like the Essentials 10 Course Bundle for Valuation, Modeling and Origination for comprehensive training, which we think is fantastic value for money for $500 (discounted from $1,175).
The FMVA certification is a globally recognized qualification offered by Corporate Finance Institute (CFI). It’s designed to provide a comprehensive understanding of financial modeling and valuation skills to professionals who want to excel in the field of finance.
The FMVA program covers a wide range of topics, including financial statement analysis, business valuation, corporate finance, Excel and VBA for finance, financial modeling best practices, sensitivity analysis, and scenario analysis, among others.
The FMVA program is delivered through online video-based tutorials, interactive exercises, case studies, and assessments. It takes around 120-200 hours to complete and costs $497, but you can get another 10% off here using the code ‘MYFMVA10’ →
To earn the FMVA certification, candidates need to complete all the required courses and pass the final exam. This is a 3-hour online exam that tests the candidate’s understanding of financial modeling and valuation concepts, as well as their ability to build complex financial models from scratch.
The project of building a financial model is a key component of the certification as it allows candidates to demonstrate their real-world proficiency in financial modeling.
Wall Street Prep (WSP) has a lot of experience training the financial services industry. Perhaps more US-centric in its reputation, but the training course is thorough, practical and focused for investment banking, private equity, corporate finance and equity research analysts.
WSP’s financial modelling premium package costs $499, but you can get another 15% off any self-study program using the code “WEBPROMO“ upon check out.
The CBCA program from the Corporate Finance Institute (CFI) is an online certification program designed to teach individuals the necessary skills and knowledge in commercial lending roles.
The program includes courses on financial modeling, financial analysis, credit structuring, and other key topics that are relevant to credit analysis and loan underwriting.
The CBCA program is delivered through online video-based tutorials, interactive exercises, case studies, and assessments. It costs $497, but you can get another 10% off here using the code ‘MYCBCA10’ →
If you’re looking for the best financial modeling courses, there are a few key factors to think about.
It’s important to look for courses and certifications that provide a comprehensive overview of financial modeling concepts and techniques, and that cover a range of different types of financial models.
This will ensure that you have a solid foundation of knowledge and skills that you can apply to a variety of different financial modeling situations.
It’s also important to look for courses that provide plenty of practical exercises and examples, as well as opportunities to build your own financial models from scratch. This will give you the chance to put your new skills into practice and gain confidence in your abilities.
Like all the best financial certifications, look for courses that are taught by experienced instructors, or that are delivered by respected professional bodies. This will help to ensure that you learn skills that are consistent with where the industry is at, and that you achieve certification that’s likely to be recognized and valued by recruiters.
Something else to consider is the cost and time commitment required for the course. If you’re already a busy professional, maybe with a family, then it’s important to plan how you’ll fit your study time into your schedule.
There are several financial modeling software options available on the market, and the best software for you may depend on your specific needs and preferences. Some popular options include:
If we had to pick one piece of software to master for financial modeling, it would be Excel.
It’s the most commonly used program for financial modeling due to its flexibility and widespread availability. It offers a range of financial modeling functions and formulas, and can be easily customized to suit your specific modeling needs.
Learning how to use Excel to an advanced level is fundamental to financial modeling, and is essential in most careers within the financial sector.
Five reasons why Excel is perhaps the best, and certainly the software most people should learn first for financial modeling are:
Python is a popular programming language that has gained traction in the finance industry due to its flexibility, versatility, and wide range of libraries and tools available for data analysis and modeling.
In recent years, Python has become an increasingly popular choice for financial modeling due to its ability to handle large amounts of data, perform complex statistical analysis, and automate repetitive tasks.
One of the key advantages of using Python for financial modeling is its ability to handle big data. Python is able to process large datasets and perform complex calculations more efficiently than spreadsheet-based tools like Excel.
Its open-source nature and vast community of developers means that there are plenty of resources and tools available for financial modeling, such as pre-built templates and packages for specific financial modeling tasks.
However, while Python has many advantages for financial modeling, it does require a higher level of technical skill than Excel.
Users need to be familiar with programming concepts and syntax, which can be a steep learning curve for those without a background in computer science.
Although if you’re planning to move into finance from software engineering, for example, then you might already have a great head start.
While Python is becoming more widely adopted in finance, Excel remains the industry standard for financial modeling, and many employers still require proficiency in Excel as a prerequisite for financial modeling roles.
This software offers advanced financial modeling capabilities, particularly in the areas of budgeting, forecasting, and financial consolidation.
Adaptive Insights is a cloud-based financial modeling software that offers features such as financial planning, forecasting, and analysis, as well as real-time data consolidation and reporting.
While not specifically designed for financial modeling, Tableau is a powerful data visualization tool that can be useful for creating interactive financial models and dashboards.
Databox is another cloud-based data analytics and dashboard tool that can be used for financial modeling and analysis.
Financial modeling can be challenging, but with practice and proper training, it can become easier. Practice with real-world scenarios, use templates, and learn new modeling techniques to improve.
Practice is key to getting better at financial modeling. Use real-world scenarios, build models from scratch, and use templates to continously improve your skills. Consider taking a financial modeling course or study and work through the models others have built at work.
Financial modeling can be a lucrative and rewarding career path. Financial modelers are in high demand in a variety of industries, including finance, real estate, and consulting.
Financial models are typically built by financial analysts, investment bankers, equity researchers, corporate finance professionals, and other finance professionals.
The length of time it takes to learn financial modeling varies depending on the individual and their level of commitment. Some may learn the basics in a few weeks, while others may take months or even years to master advanced techniques.
Yes, in a recent announcement by CFA Institute in March 2023, the CFA Program will start to include some Practical Skills Modules (PSMs) – of which financial modeling is one choice – for Level 1 candidates from 2024.
That said, this is one option of the PSMs that Level 1 candidates can choose which requires 10-15 study hours and at a beginner/introductory level as it only covers 3 statement models used in valuation, and therefore not that extensive.
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