How Financial Modeling Differs from Financial Forecasting

I have observed often that students (and even professionals) get confused with Financial Modelling and Financial Forecasting. These two terms are often used interchangeably as well (mostly in a wrong context). These are neither exactly the same thing nor they are two disjoint sets. Let’s try to understand these concepts with the help of an example.

Imagine that you are working as a Credit Risk Officer in a bank. The Rolling Motors, a car manufacturing company, is one of the bank’s existing corporate clients. The company already has taken two loan facilities from the bank with which they have set-up two car manufacturing units, one in Pune and another one in Chennai. Now the company wants to set-up another car manufacturing unit in Thane, Mumbai and has approached the bank for a third loan facility. You, as the credit officer, will have to evaluate this proposal and take a decision if the bank wants to extend the third loan facility to the company.

Basically, there would be two parts you would have to evaluate. In the first part [part-1], you would like to understand how well the Rolling Motors Company has been performing till now and their conduct of the existing two loan accounts. In the second part [part-2], you would try to assess if the proposed third plant would make sense for the company to set-up and if it would make sense for the bank to extend the third loan facility.

Historical Financial Modelling:

For part-1, you need to take their historical financial numbers and put in a spreadsheet in a structured format. You would like to understand the company’s sales growth YoY, improvement in gross profit margin over last few years, the major cost heads such as raw material, labour cost, plant maintenance cost and if these cost items as a percentage of revenue have remain within an acceptable level for last few years, EBITDA margin, net cash flow, current ratio movement, working-capital requirement, debt servicing etc. This part is known as the Historical Financial Modelling which is used to assess a company’s current state of affairs and how it has performed over last few years.

Financial Forecasting:

As regard to part-2, you’ll have to understand the future benefit to the company by setting-up the third manufacturing plant. To assess the future benefit, we first need to start with forecasting car demand in the market for next few years to see if there would be consumer appetite in future to buy the type of cars that the Rolling Motors would manufacture from the third plant. Based on this demand forecast, you can estimate the sales the third plant can possibly generate for the company. There would be other things to consider here as well – such as the projected market share of Rolling Motors, the future selling price of a car, any regulatory change that can impact the car sales (eg. BS-IV emission standard) etc. When you have a realistic estimate of the revenue, you can gradually forecast the other line items such as raw material cost, labour cost etc. This would help you to prepare the estimated cash-flow that the third plant can generate in next few years and if that would be sufficient to meet the debt repayment obligation for the third loan facility. This part is known as the Financial Forecasting Modelling.

Together we have Financial Modelling:

In this context, Financial Modelling primarily comprises of two parts – historical performance analysis and future performance prediction i.e. Forecasting. Therefore, Financial Modelling and Financial Forecasting are not exactly two different things, rather Financial Forecasting is a subset of the holistic Financial Modelling exercise.

Different forecasting methods:

Depending on situations, there could be different types of parameters that one need to forecast in the context of financial modelling, such as demand forecasting, sales forecasting, unit price forecasting, raw material price forecasting etc. We can employ qualitative or quantitative or a combination of both methods as deemed suitable for a case.

Qualitative forecasting methods employs surveys and depends heavily on viewpoints of experts in a particular field. This method is particularly useful to predict the short-and-medium trends, but has limitations of biasness over quantitative method of forecasting.

  • Delphi Method – Opinion survey with the domain experts and then compiling them to forecast;
  • Consumer Survey to understand the shift in consumer choice before launching a new product or service;

Quantitative forecasting methods uses data from the past, evaluate causal relationships among parameters to predict the future numbers.

  • Time series method uses the historical trend in a parameter and weigh that with the recent available data to forecast for future;
  • Econometric modelling involves robust mathematical and statistical calculations. This type of forecasting modelling is primarily used in the academic field or a situation that involves a large set of interdependent parameters such as in case of economic policy formulation;

Each of these methods requires separate discussion for detail understanding. I’ll take up each of these methods in my future articles.

Why Every Project Managers must do Financial Modeling

As a project management professional, you need to work with several individuals in many different roles. As a project manager, you’re inferred to be a leader, and know how to read body language, negotiate, and other infinite skills. Project Managers can be able to build, review or analyze project finance models at all levels. Practice Finance Modelling will give you the tools you need to build and analyze robust and transparent cash flow based financial models and significantly increase your Excel efficiency as well.

Skills required for Project Managers:

As the project manager, you are responsible for planning, budgeting, and document all aspects of the specific project you are working on. Project managers need to work closely with management team to make sure that the scope and direction of each project are on schedule or not. From education perspective project managers require various skills depending upon the field of work you do. Skills that must have in you is leadership skill, time management skill, Budgeting skill and analytical skill. The roles and duties of project managers are as follows.

  • Coordinating employees with the third parties/vendors for the immaculate execution of projects and  ensuring all projects are delivered on-time and within budget
  • Measure project performance using appropriate system tools and techniques
  • To be a successful project manager you must have the solid technical background or hands-on experience in software development and web technologies
  • Project Managers distributes budgeted money equally to all the parts of the project to run the project’s activities flawlessly.
  • As a project manager, you make recommendations on what insurance policies to take for a project and prepare a risk management reports when an insured event occurs.
  • You are liable to use a spreadsheet application and know how to handle with the data and numbers.
  • You must have to work smarter with keyboard shortcuts, create complex financial models, mine data like an expert and display your findings beautifully.
  • You need to prepare spreadsheets to help budget calculations, sum adjustments. Basically which means you must have a strong knowledge of financial modeling.

Although financial modeling skill set have a beneficial impact on making better business decision, but it is not taught us in any finance or accounting courses. Financial modeling helps to reach at optimal business solutions by analyzing various parameters.

What is Financial Modeling?

Financial Modeling is used for future planning of company’s long term goals according to different situations that may arise. The output of a financial model is used for decision making and performing financial analysis. Most of the financial analysts have to work with large amount of data as well as numbers. Almost each one of them uses MS Excel to create financial models to analyze and plan financial statements. A supremacy over financial modeling will give all the financial analysts an edge over others as they can do their work faster and accurately.

What will you learn in Financial Modeling?

The purpose of Financial Modeling is to build financial model which can enable you to take better financial and budgeting decision. Financial Modeling helps reach at optimal business solutions by analyzing various parameters such as operations, investment, financing and valuation. Financial modeling usually relates with corporate and quantitative finance applications. In financial modeling you will learn various aspects of business such as

How financial modeling helps to Project Managers?

Whether you work in information technology, healthcare, manufacturing, e-commerce, energy, construction or business services – all of these industries are in need of project management talent. 

Project managers takes initiatives to remain market competitive that positively impact on company’s business plans and business goals. If you are looking for more growth in your career, financial modeling skill set will definitely help you. After getting trained in financial modeling, Project managers can understand the business knowledge correctly and deliver value and benefits to the organization, the client and the employees. 

Not only the better career opportunities but also a huge salary hike you will get after completing the financial modeling training from a reputed institute. Average salary of 10 lakhs per annum a project manager will have after getting the financial modeling certification.

Project managers require to handle business projects in order to accomplish such varied goals as leading teams, satisfying clients, balancing budgets, meeting deadlines. This type of skills are developed only when you take part in a structured training of financial modeling.

If you have finalized your goal of attaining the Financial Modeling Certification, the next step is to enroll in a good institution that provides training for Financial Modelling and you don’t need too far to search for it. EduPristine provides training for the Financial Modelling Course that will help you to get a kick start in your career.

The Core Skill for Every Finance Analyst – Financial Modeling

Why financial analyst requires financial modeling skill sets:

It is the essential task of a financial analyst to evaluate the financial health of the prospective company. A financial analyst able to track the financial report to ensure smooth running of the business. This involves preparing budgets, analyzing trends, and creating MIS reports etc. To execute these tasks you must have the skill of preparing financial statements, financial forecasting as well as financial modeling.

Skills required for financial analyst:

As there are different roles and responsibilities in the finance sector, important skills are vary a lot. Financial analyst can clarify and explain the company’s finances with their analytical and interpersonal skills. Beside the written and verbal skills as a financial analyst you are responsible for various skills such as;

  • Collating, preparing and elaborating reports, budgets, accounts, and financial statements
  • Review company’s financial reports and find ways to reduce costs
  • Monitor financial details to ensure that legal requirements are met
  • Controlling income, cash flow and expenditure
  • Undertaking research into pricing and factors affecting performance
  • An analytical and logical approach to problem solving
  • Developing and managing financial models with basic knowledge about Finance buzzwords
  • Advanced knowledge of financial theory and the practical experience of working with MS – Excel

Although financial modeling skill set have a beneficial impact on making better business decision, but it is not taught us in any finance or accounting courses. Financial modeling helps to reach at optimal business solutions by analyzing various parameters.

What is financial modeling?

Financial modeling is a skill which is built in Excel to forecast the financial performance of any business. The output of a financial model is used for decision making and performing financial analysis. Most of the financial analysts have to work with large amount of data as well as numbers. Almost each one of them uses MS Excel to create financial models to analyze and plan financial statements. A supremacy over financial modeling will give all the financial analysts an edge over others as they can do their work faster and accurately.

What will you learn in Financial Modeling?

Whether it is service industry or the manufacturing industry, all businesses are focusing to reduce the human effort to improve efficiency and output. Financial Modeling helps reach at optimal business solutions by analyzing various parameters such as operations, investment, financing and valuation. Financial modeling usually relates with corporate and quantitative finance applications. In financial modeling you will learn various aspects of business for

When you learn to make a model correctly, and then understand how to use that model for various purposes of business.

How financial modeling helps to financial analyst?

A variety of financial jobs out there, financial analyst, financial manager, financial advisor and many more. Selecting finance as your profession, you can work in different positions within an organization. If you are looking for more growth in your career, financial modeling skill set will definitely help you.

Financial models are typically used to anatomize and analyze a company’s performance and make predictions about the company’s future. Due to having such knowledge in building a financial model, it will open up a wide variety of career choices for you in finance.

Not only the better career opportunities but also a huge salary hike you will get after completing the financial modeling training from a reputed institute. Average salary of 7 lakhs per annum you will get after getting the financial modeling certification.  

Financial analyst make decisions to improve company’s financial performance. The major decisions including scheduling operations, preparing a budget, approving a capital investment, etc. This type of financial skills are developed only when you take part in a structured training of financial modeling.

If you have finalized your goal of attaining the Financial Modeling Course Certification, the next step is to enroll in a good institution that provides training for Financial Modelling and you don’t need too far to search for it. EduPristine provides training for the Financial Modelling Course that will help you to get a kick start in your career.

Different types of Financial Models for Financial Modelling

Financial models are used to evaluate a company’s past or historical performance, to benchmark a company with respect to its peers/ competitors or to estimate/ forecast how the company is going to perform in future. In finance parlance, these are known as Credit Analysis, Ratio Analysis, Equity Research, and Investment Banking etc. In this article, I have covered the major types of financial modelling.

Three Statement Model:

Three basic statements to understand a company’s financial performance are

  1. Income Statement
  2. Balance Sheet
  3. Cashflow statement.

Given an audited financial statement, we need to prepare a financial model by linking all these three statements. Different companies have different styles and approaches to represent their cost-revenue and balance sheet items. While developing this kind of models we need to appropriately classify them under different sections to normalize the company’s biasness to inflate or deflate revenue, profit, cash flow etc.

When to use – Banks and other financial institutions use this model to evaluate the historical financial performance of their corporate borrowers.

Credit Rating Model:

This model is built upon the three statement models, which is extended further to do three-to-five years of projections, and incorporate other parameters such as future demand growth in the industry, strength & quality of management, quality of collaterals, conduct of the existing loan accounts etc. A credit score is calculated which is a weighted average of financial risk score, management risk score, business risk score, and industry risk score.

When to use – When a company applies for loans, the bank uses this model to evaluate the company’s legitimate borrowing potential and the applicable interest rate.

Comparable Company Analysis (CCA) and/ or Ratio Analysis:

Based on a company’s business profile (such as the geography its operating in, product & service category, target customers etc) and financial profile (size of the company, top and bottom line etc), an analyst need to determine a set of comparable companies. Different types of financial ratios that can be used across this set of companies are PE Multiple, EV/ EBITDA, P/B ratio (Price-to-Book value) etc.

When to use – At times we might not have sufficient data available for a company to be analysed, or we want to understand where a company stands with respect to its peer companies, we need to use CCA or Ratio analysis methods.

Discounted Cash Flow (DCF) Model:

It is valuation analysis model that is based on projected future cash flow to assess a company’s worth or value. Future cashflows are to be discounted with an appropriate discount rate (which is dependent of the company’s capital structure and cost of capital) and then sum them up to calculate the valuation.

When to use – Investors use this model to understand the true value of a startup before putting their money and calculate the stake to be bought. Stock market investors use this for fundamental analysis to see if a company is trading higher or lower vis-à-vis its actual worth.

Leveraged Buyout (LBO) Model:

It is also a valuation analysis model but its difference with the DCF model is that LBO takes into account a significant debt financing. The purpose here are three folds – balance sheet adjustment for debt-heavy capital structure, to come up with an acceptable IRR (internal rate of return) and an exit value based on EV/EBITDA multiple.

When to use – When an acquirer company (most of the cases bi bracket Private Equity firms) uses a significant amount of debt to finance the cost of acquisition, we need to use this model to determine the fair valuation and exit-return of the company being acquired which may be private or public.

Merger and Acquisition (M&A) Model:

We need to consider the M&A financing options (eg. Cash, Stock, Debt and Hybrid), share swap ratio, control premium, expected synergy post M&A etc.

When to use – When two companies decide to merge for possible synergy, higher market share, diversification etc or a company decided to acquire another company (eg. Microsoft acquiring LinkedIn), an Investment Banking analyst would this type of models to determine the accretion / dilution.

Option Pricing Model:

These are very complex statistical models and are used by professional option traders. These models take into account few parameters whose values are knowns at present (eg. underlying price, strike price and days to expire of an option) along with forecasts or assumptions on other parameters including implied volatility, to compute the theoretical value for specific options at a given time. Generally, two types of models are used here – Binomial model and Black-Scholes model. Both these models are computation heady and use complex statistical methods.

When to use – Option traders use these models before taking positions on large options and keep on recalibrating the value of the underlying options to understand the value of their options.

Depending on the purpose, requirement and end-use, we can create different types of financial models as discussed above. From situation to situation the complexity of the financial model would also vary. We’ll try to elaborate on each of these models in our subsequent articles.

If you have finalized your goal of attaining the Financial Modelling Certification, the next step is to enroll in a good institution that provides training for Financial Modelling and you don’t need too far to search for it. EduPristine provides training for the Financial Modelling Course that will help you to get a kick start in your career.

How Financial Modeling kick start your career after MBA

Why MBA Graduates require Financial Modeling skills?

If you are an MBA graduate having the knowledge of finance and management then it’s obvious you have the advanced knowledge in Excel as well. After completing MBA, you will get plenty of job opportunity in various sector like financial analysis, equity research etc. You may face numerous challenges on how the different aspects of business are interacting with each other. If these interactions are organized in a structured manner and processed in a simplified way, it leads to faster decisions in business. To make decision faster we are suggesting you to go through a structured training in Financial Modeling.

What are the skills required for MBA Graduates?

As an MBA graduate, you must know the concepts of corporate finance and other theoretical aspects of the financial services industry. It’s a fact that a fresh MBA graduate is not completely ready for a corporate job. Spreadsheet modeling is one of the most important skill that you are required to have while applying for corporate jobs.

Basic and essential skills required as an MBA graduate:

  • Leadership
  • Teamwork
  • Problem solving and analytical skills
  • Interpersonal and communication skills
  • Strategic thinking and planning abilities
  • Time management and project management skills

To get high salary package and good opportunity in a financial sector, it is required to have necessary function-specific skills such as

  • Basic understanding of accounting and financial management principles
  • Ability to interpret numbers and draw conclusions from results of various financial strategy changes
  • Solid business judgment and desire to tackle complex business problems
  • Ability to synthesize large amounts of data into small manageable chunks and then communicate these chunks both written and verbally
  • Ability to recognize key factors in extensive data
  • Having strong analytical and quantitative skills, number crunching and basic knowledge about Finance buzzwords
  • Advanced knowledge of financial theory and the practical experience of working with MS – Excel

As an MBA graduate if you need to make business decision faster, you should have the knowledge of excel. Not just basics of Excel, you need to have advanced knowledge of MS – Excel, including financial modeling.

What is financial modeling?

Most of the finance professionals work with large amount of data as well as numbers. Almost each one of them uses MS Excel to create financial models to analyze and plan financial statements. A strong understanding of financial modeling will give you an edge over others as you’ll be able to do the work faster and accurately.

What will you learn in Financial Modeling?

Financial Modeling helps reach at optimal business solutions by analyzing various parameters such as operations, investment, financing and valuation. Financial modeling usually relates with corporate and quantitative finance applications. In financial modeling, you will learn various aspects of business for

How financial modeling is beneficial for MBA graduates

As an MBA graduate there are various benefits you get, including the chance of a higher salary, better career opportunities and access to ideal financial environments. After getting the advance knowledge in financial modeling post MBA, you will get the opportunity to develop your financial skills that are needed to succeed in senior management.

Financial models are typically used to anatomize and analyze a company’s performance and make predictions about the company’s future. By having knowledge in building a financial model, you will open yourself up to a wide variety of career choices in Investment Banking, Equity Research, Fixed Income Research, Credit Rating and Risk Management.

A financial modeling course after MBA will not provide better career opportunities but also a salary hike you. Average salary of 7 lakhs per annum you will get after getting the financial modeling certification.

The table below shows the average salary corresponding to Financial Modeling plus a degree.

Pursuing Financial Modeling can give you an edge over the other MBA professionals. Financial Model plays an important role in long-term planning, business planning, expansion, development, cost planning etc. If you are an MBA graduate or a MBA student, we suggest you to go through the structured training in financial modeling which will improve your career growth instantly.

If you have finalized your goal of attaining the Financial Modeling Certification, the next step is to enroll in a good institution that provides training for Financial Modelling and you don’t need too far to search for it. EduPristine provides training for the Financial Modelling Course along with a certificate from BSE institute that will help you kick start your career.

Top 10 Books on Financial Modeling

There are plenty of ways to learn financial modeling. People usually depend on top institutes which provide financial modeling training. During the training, many of them need to visit online learning portals to clear their doubts as well.

Financial Modeling Books

Books are the one of the most helpful ways to learn Financial Modeling. There are a lot of books available which can provide you the required knowledge. It’s not an easy task to pick the most appropriate book. So here, we’re listing some of the top rated books:  

Based on the requirement, we categorize the Financial Modeling Books in the following levels:

Beginners Level:

Financial Modeling: by Simon Benninga

Financial Modeling Books

This book explains the implementation of financial models in Excel. Major topic areas are

  • Corporate finance
  • Portfolio management
  • Excel Spreadsheets

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Foundations of Real Estate Financial Modelling:  by Roger Staiger

Financial Modeling Books

This book is designed to provide an overview of financial modeling for real estate projects. Chapters include:

  • Information on Amortization
  • Equity Bifurcation
  • Accounting statements
  • Additional asset classes etc

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Financial Modelling: by Joerg Kienitz and Daniel Wetterau

Financial Modeling Books

The book enables the reader to model, design and implement a wide range of financial models for derivatives pricing and asset allocation, simulation techniques, and calibration even for exotic options etc. This Financial Modelling book comprises with facts about:

  • Risk neutral densities, implied volatility surfaces, option pricing and typical paths for a variety of models including SABR, Heston, and Bates
  • Fourier transforms, and detailing the implementation of the COS 
  • Usage of MATLAB and its basic functions applied for financial engineering

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Intermediate Level:

Financial Modelling in practice:  by Michael Rees

Financial Modeling Books

This book gives a brief idea on the intermediate and advanced level of Financial Modeling. It comprises with the principles of designing, structuring and building accurate models in Excel. Major topic areas are

  • Modelling of financial statements
  • Cash flow valuation
  • Risk analysis
  • options and real options

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Financial Modeling and Valuation: by Paul Pignataro

Financial Modeling Books

This book guides you in the fundamental tools for properly assessing the stock investment. Major focus areas of this book are

  • Step-by-step financial modeling – taught using downloadable Wall Street models
  • In-depth coverage of valuation techniques like calculating LTM data, smoothing EBITDA and Net Income
  • Chapter end questions, practice models, additional case studies and common interview questions

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Advanced Level:

The Handbook of Post Crisis Financial Modelling:by Emmanuel Haven and Philip Molyneux

This Handbook represents original research on the key issues affecting financial modeling in the areas of banking, mathematics, and law. This book tells you about the topics which are used for modeling in Excel. The topics are

  • Role of central banks, governments,
  • Policy making,
  • Economic and financial variables

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Professional Level:

Financial Forecasting, Analysis and Modelling: by Michael Samonas

Financial Modeling Books

This book provides a complete structure of long-term financial forecasts, helping financial professionals in their planning and budgeting process. This book guides readers by

  • Developing long-term projection plans
  • Sensitivity analysis
  • Monte Carlo Simulation and more

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Building Financial Models (McGraw-Hill Finance and Investing): by John S. Tjia

Financial Modeling Books

This book provides guidance to designing, building, and implementing valuation projection models to keep accounting and finance professionals competitive in today’s marketplace. Major topic areas of Building Financial Modeling are

  • Discounted Cash Flow modeling
  • Mechanics of projection models
  • Cash sweep and more

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Financial Modelling and Asset Valuation with Excel: by Morten Helbaek

This book gives you straight into the knowledge about financial theory with Excel; providing you with the skills you need to build financial models for private or professional use. Subjective areas of this Financial Modelling and Asset Valuation book are

  • Net present value
  • Internal rate of return
  • Risk, Portfolio theory
  • CAPM, Project Valuation Simulation,
  • Sensitivity Analysis and many more using with Excel

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Financial Modeling for Business Owners and Entrepreneurs:by Tom Y. Sawyer

This book guides you with a step-by-step methodology for planning and modeling for a company and helps in solving specific business problems. The chapters that are included in this book are as following

  • High level discussion of business principles and practical suggestions for the business entrepreneurs
  • Development of organizational concepts and the forecasting of staffing and related costs
  • Assess the life cycle cost of the sales and marketing function, modeling the fixed and variable costs associated with the company’s product and services

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There is a lot of information you can get from these books which will helps you in preparing Financial Models . So which one you are planning to read first?

EduPristine provides online as well as classroom training on Financial Modeling. So along with the theoretical knowledge if you are looking for practical training then check out the Financial Modeling Course provided by EduPristine