What is financial modeling?
Financial modeling is creating a complete program/ structure, which helps you in coming to a decision regarding investment in a project/ company. Financial models are abstract representations of a financial decision making. Now these decisions can be derived on a simple piece of paper or in tools such as Excel, MATLAB or R. Most of the financial models used for equity valuation are built on Excel, which doesnâ€™t ask for an extra effort to learn the tool itself.
Who does Financial Modeling?
Anybody dealing with any decision related to money. If you are involved in financial decision making/ planning related to large corporate, then you would definitely need financial modeling day in and day out. Financial modeling is a mandatory activity for investment bankers, bankers, project finance persons, equity research folks, PE & VCs.
Most importantly people who long to work in PE/IBs!!!
What are the steps in building a financial model?
This is where the real front end banker works. She goes to the client, collects the data like revenue, growth, investments, need for money, etc.
Back of the envelope calculations
Now most of the corporate guys are very hunky dory about their business. They usually think that their idea is one of a kind and is going to generate loads of mullah. Banker would sanitize their thoughts and try to figure out, if the business makes sense. Initially the thinking and analysis is very simple,
- Does the corporate guy look sober to me?
- How soon can I get my investment back?
- Is the revenue that he is projecting seems greater than the market size?
You usually need no industry knowledge for this. Just keep your eyes and ears open and put your thinking cap on!
Structured approach to thinking
Once the basic numbers seem reasonable (they make business sense and seem to be true as well), you have to dig deeper! This is where you need a complete financial model. And the first real step to doing that is to think of a structure of analysis. Thankfully finance has some basic theories in place and you can rely on them to proceed:
- Cash is the king â€“ The more cash is generated (from the operations of the business) the better is the business
- Money today is better than money tomorrow â€“ technically this can be called Time value of money. But it does not matter!
Practically these are the fundamental building blocks of analysis and you have to start thinking in these terms for the analysis
Stepping on the Stairway
Keeping all the above written points at the back of the mind you can put the first step on the stairway and then thereâ€™s no way backâ€¼!
Â· All the steps to the modeling heaven are simple mechanical steps which anyone can master provided one puts sincere efforts in it.
Â· Every Wednesday weâ€™ll master one step and by the end of 8th week weâ€™ll be there at the modeling heaven.