The process of combining historical and projected financial information to make business decisions
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What is Financial Modeling?
Financial modelingis one of the most highly valued, but thinly understood, skills in financial analysis. The objective of financial modeling is to combine accounting, finance, and business metrics to create a forecast of a company’s future results.
A financial model is simply a spreadsheet which is usually built in Microsoft Excel, that forecasts a business’s financial performance into the future. The forecast is typically based on the company’s historical performance and assumptions about the future, and requires preparing an income statement, balance sheet, cash flow statement, and supporting schedules (known as a three-statement model).
From there, more advancedtypes of modelscan be built such as discounted cash flow analysis (DCF model), leveraged buyout (LBO), mergers and acquisitions (M&A), and sensitivity analysis. Below is an example of financial modeling in Excel:
Image: CFI’s Financial Modeling Courses.
Key Highlights
- Financial modeling combines accounting, finance, and business metrics to create a forecast of a company’s future results.
- The main goal of financial modeling is to accurately project a company’s future financial performance.
- Modeling can be useful for valuing companies, determining whether a company should raise capital or grow the business organically or through acquisitions.
What is a Financial Model Used For?
There are manytypes of financial modelswith a wide range of uses. The output of a financial model is used fordecision-making and performing financial analysis, whether inside or outside of the company. Financial models are used to make decisions about:
- Raising capital (debt and/or equity)
- Making acquisitions (businesses and/orassets)
- Growing the business organically (e.g., opening new stores, entering new markets, etc.)
- Selling or divesting assets and business units
- Budgetingand forecasting (planning for the years ahead)
- Capital allocation (priority of which projects to invest in)
- Valuing a business
- Financial statement analysis/ratio analysis
- Management accounting
What Software is Best for Financial Modeling?
Forecasting a company’s operations into the future can be very complex. Each business is unique and requires a very specific set of assumptions and calculations.Excel is usedbecause it is the most flexible and customizable spreadsheet tool available. Other software programs may be too rigid and specialized, whereas Excel knowledge is generally more universal.
Who Builds Financial Models?
There are many different types of professionals who build financial models. The most common types of career tracks are investment banking, equity research, corporate development, FP&A, and accounting (due diligence, transaction advisory, valuations, etc).
How Can You Learn Financial Modeling?
The best way to learn financial modeling is to practice. It takes years of experience to become an expert atbuilding financial models,and you really have to learn by doing. Reading equity research reports can be helpful, as they give you something to compare your results to. One of the best ways to practice is to take a mature company’s historical financials, build a model into the future, calculate the net present value per share, and compare your projections to current share prices or the target prices in equity research reports.
Taking a professionalfinancialmodeling training coursealso offers a solid base understanding of the relevant concepts and skills. In the meantime, you may be interested in exploring CFI’s free Financial Modeling Guidelines or having a go at building your own financial models.
Image: CFI’s Financial Modeling Courses.
How Much Accounting Knowledge is Required for Financial Modeling?
In order to build a financial model, you need a solid understanding of accountingfundamentals. You have to know what all the various accounts mean, how to calculate them, and how they’re connected. We recommend having at least a few accounting courses under your belt.
Additional Resources
Free Financial Modeling Guidelines
Three Financial Statements
Stock Valuation
Financial Modeling Test
See all financial modeling resources
FAQs
What Is Financial Modeling? Financial modeling is the process of creating a summary of a company's expenses and earnings in the form of a spreadsheet that can be used to calculate the impact of a future event or decision. A financial model has many uses for company executives.
Is financial Modelling easy? ›
It requires technical and mathematical skills, as well as problem-solving and decision-making abilities. Financial modeling is more challenging to learn than accounting and investing.
What is the difference between financial analysis and financial modeling? ›
Financial analysis is typically carried out using ratio and trend analysis of relevant information taken from financial statements and other reports.” “Financial modeling, on the other hand, is essentially the task of building a model that represents a real world financial situation.
What are the basics of financial modeling? ›
The key steps involved in building financial models include gathering data, calculating ratios and metrics, making informed assumptions, creating a business forecast, assessing the value of the company, reviewing your model.
How much do financial modelers make? ›
By Years of Experience. Entry-level financial modeling analysts with 0-2 years of experience typically earn around $55,000-65,000 per year. With 2-4 years of experience building financial models, analysts can expect average salaries closer to $70,000-80,000.
Can I learn financial modeling on my own? ›
It is possible to learn financial modeling without any mentor but there are higher chances that you might end up getting lost in the process if finance is completely a new area to you.
Which is better CFA or financial modelling? ›
While CFA offers prestige, Financial Modeling provides accessible practical skills. Proficiency in financial modeling enhances CFA pursuits. In simple terms, mastering both is pivotal for a successful finance career. CFA imparts theoretical knowledge, while Financial Modeling equips you with practical skills.
Is financial modelling the same as forecasting? ›
Financial forecasting is the process by which a company thinks about and prepares for the future. Forecasting involves determining the expectations of future results. On the other hand, financial modeling is the act of taking a forecast's assumptions and calculating the numbers using a company's financial statements.
Do financial analysts do financial modeling? ›
While younger analysts tend to do a lot of data gathering, financial modeling, and spreadsheet maintenance, more senior analysts tend to spend time on developing investment theses, speaking with company management teams and other investors, and marketing ideas (if they are on the sell-side).
What is financial modeling in a nutshell? ›
In a nutshell, financial modeling is a numerical scenario of a real world financial situation used to ascertain the future financial performance by making projections. The objective is to combine accounting, finance and business metrics to create a representation of a business, forecasted into the future.
Therefore, a solid first step in building a model is to fully analyze a set of historical financial data and link projections to the historical data as a base for the model.
How do I learn financial modeling skills? ›
The best way to learn financial modeling is to practice. It takes years of experience to become an expert at building financial models, and you really have to learn by doing. Reading equity research reports can be helpful, as they give you something to compare your results to.
What is a financial modeling job? ›
Financial modeling is the process of organizing and analyzing raw data to create forecasts, insights, and recommendations. While financial modeling has always had a place in finance, the number of jobs, both in and out of finance, that require financial modeling skills continues to grow.
What is financial modelling or CFA? ›
While CFA offers prestige, Financial Modeling provides accessible practical skills. Proficiency in financial modeling enhances CFA pursuits. In simple terms, mastering both is pivotal for a successful finance career. CFA imparts theoretical knowledge, while Financial Modeling equips you with practical skills.
What is the difference between accounting and financial modeling? ›
Accounting involves recording, organizing, and summarizing financial transactions and data to create financial statements. Financial modeling then uses these statements and other data to create projections and analyze various financial scenarios.
