Financial Modeling Examples & Best Practice Tips

Financial modeling techniques are a sneak peak into the future. Given the many types of financial modeling examples and unknown variables that can impact what can happen, the models have no way of always being entirely accurate.

That being said, they give a clear and closely accurate view of what you can expect tomorrow so that you have what you need to make the right decisions today.

We’re going to dive into how a financial model template can be of service and review some tools that can be of great aid.

Coming Up

What Is Financial Modeling?

Who Builds Financial Models?

What are the Objectives of Financial Modeling?

What are the Financial Modeling Categories?

What are the Top 10 Types of Financial Models?

How to Start Financial Modeling?

What are Best Practices and Tips for Financial Modeling?

Closing Words

What Is Financial Modeling?

Financial modeling combines and applies knowledge from business, finance, and accounting to represent a company’s financial status and situation through metrics.

With an understanding of the business’ current and prospective financial decisions, business leaders, stakeholders, and executives have the answers they need to charge forward with great confidence.

Financial modeling takes into account risk factors, growth opportunities, and interprets the impact of potential scenarios. Just like you wouldn’t apply a geometry formula to an algebraic problem, each financial model fits its desired use case and reason for application.

That’s why it’s so important to understand the types of financial modeling, so you can know which to apply. We’ll share these details shortly!

Who Builds Financial Models?

Given the expansive use and financial modeling examples available, there are different people responsible for building and using them. In most cases, financial models are built by accountants, investment bankers, corporate analysts, and equity research analysts, to name a few.

Financial planning and analysis (FP&A) teams and CFOs tend to oversee and make use of financial models. However, with so much on their plate, they can’t be bogged down by the intricacies of all that’s involved.

That’s why so many of these teams are relying on finance automation software to automate complex financial processes, combine and cleanse financial data, perform analysis and provide forecasts to reap the benefits of having insights from data available.

What are the Objectives of Financial Modeling?

Financial modeling examples are leveraged for a variety of purposes. They are so valuable because they are used to:

• Raise capital
• Grow the business and expand into new markets
• Budget and forecast
• Sell or diversify business assets
• Allocate capital
• Ascertain a business’ valuation
• Analyze financial statements

In addition, businesses use financial modeling to determine whether or not they can extend credit to increase sales. Since the extension of credit comes along with its fair share of risk, financial modeling can be applied to figure out whether or not extending credit is worth it. And, if so, how much to extend.

These are just a few examples and objectives of financial modeling; the use cases and reasons are extensive.

What are the Financial Modeling Categories?

With all these objectives that financial modeling can be used to achieve, it makes sense to categorize the variety of financial modeling for better understanding. The categories are all divided to solve specific business problems or provide answers to questions.

Here’s a look at the common categories:

1. Project Finance Models

If there’s an upcoming project, you’ll need to deduce its feasibility before starting. Project finance models determine the structure and capital necessary.

2. Pricing Models

To establish how much a product or service should cost, you can deploy pricing models. Pricing greatly impacts the marketing and sales of products, so it’s an important step when hitting the market. The basic equation is that Units X Price = Revenue and Revenue - Expenses= Profit.

3. Reporting Models

Reporting models make use of historical data such as revenue, financial statements, and expenses from the income statement, cash flow statement, and balance sheet.

What are the Top 10 Types of Financial Models?

Given the various uses of financial models, it’s only valid that there are so many financial modeling examples to choose from when you’re searching for answers of your own.

Take a look at 10 of the most popular types of financial models to have an overview in mind:

1. Three-Statement Model

The three-statement model is one of the most basic examples of a financial model. It leverages the income statement, balance sheet, and cash flow. The idea is to see how a single variable will create change across the three statements if made by linking them together. It’s performed using Excel.

2. Discounted Cash Flow (DCF) Model

Based on the three-statement model, the discounted cash flow (DCF) model uses a company’s Net Present Value (NPV) of its future cash flow to obtain its value. It’s a useful model for equity research and in capital markets.

3. Merger Model (M&A)

In corporate development and investment banking, the complex merger model (M&A) is conducted to deduce a company’s accretion or dilution in a merger or acquisition.

4. Initial Public Offering (IPO) Model

Also used in corporate development and investment banking, the initial public offering (IPO) model is for when a business is planning to go public. Through the model and Excel formulas, the IPO model values a business and includes an IPO discount to make sure that the stock trades in the secondary market.

5. Leveraged Buyout (LBO) Model

Known as one of the most challenging models, the leveraged buyout (LBO) model is found in investment banking and private equity. The intention is to calculate the multiple or annualized rate of return expected by investing in a company or choosing to sell or hold your stake.

6. Sum of the Parts Model

The sum of parts model combines multiple DCF models together. To arrive at the net asset value of the company, the sum of parts model does what its name suggests, combines multiple pieces together, such as the value of the businesses and its investments, minus its liabilities.

7. Consolidation Model

The consolidation model combines several business units into one model. It’s very similar to the sum of the parts model in that multiple parts are combined to create a new worksheet.

8. Budget Model

Budget models make use of the company’s income statement monthly or quarterly to budget wisely for an upcoming time frame.

9. Forecasting Model

A forecasting model may be combined with the budget model, but if not, it can also stand on its own. It’s another model that’s useful in financial planning and analysis (FP&A) to forecast what’s yet to happen and make decisions accordingly.

10. Option Pricing Model

Option pricing models are straightforward because they are based on mathematical formulas. The three most popular option pricing models are the Black-Scholes Model, the Binomial Option Pricing Model and the Monte-Carlo Simulation. They are used to determine the theoretical value of an options contract.

How to Start Financial Modeling?

However you choose to start financial modeling, the most important primary ingredient is to have correct data. The accuracy of financial statements and information will of course impact your models and affect their outcomes.

As such, it’s crucial to leverage finance automation to help consolidate, cleanse, centralize, and update your financial data. This way, you always have access to the most up-to-date and correct raw data to leverage in your models.

Additionally, you can leverage technology to help execute your financial analysis, with the use of best financial modeling software. Don’t forget about finance automation software, which can provide you with advanced analytics that are automated, without the need for an IT team.

With these dashboards and reports, you gain deep insights to help with decision-making.

What are Best Practices and Tips for Financial Modeling?

During the execution of any of the financial modeling examples listed above, keep in mind these tips and tricks to get the most from your efforts:

• Flexible: Make sure that your models are scalable and adaptable. It should be designed such that any adjustment can be easy to implement.
  
  
• Structured: Integrity should be the primary focus of any financial model and integrity in financial models is based on sound logic.
  
  
• Understandable: Transparency within your models ensures that anyone who wants to use it can understand what’s going on. This is true for both experienced modelers and novice modelers.
  
  
• Automation: Even if you’d rather not automate your entire financial modeling process itself, you can use finance automation software to pull the financial data that you need to apply within your model. By using automation software, you save a lot of time and benefit from updated and accurate data without the risk of human error.

Closing Words

As you already knew, the many financial modeling examples each serve their own value and purpose. Depending on what you’re trying to accomplish or provide, you can use a financial model that is relevant.

That being said, the use of technology and automation software is very beneficial during the financial modeling process because the sheer amount of data and demand for accuracy can otherwise cause overwhelm.

With automation in your corner, you can streamline financial modeling and access the insights you need to make informed business decisions.