Introduction to Excel Financial Modeling What is a Financial Model and how to build one

Post on: 24 Июль, 2015 No Comment

This is a guest post written by Paramdeep from Pristine. Chandoo.org is partnering with Pristine to bring an excel financial modeling online training program for you.

This is Part 1 of 6 on Financial Modeling using Excel

In this and next 5 posts, we are going to learn how to build a financial model to do project evaluation using Excel. The 6 parts of this tutorial are,

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. Now this could be on a simple piece of paper or in excel. The advantage with excel is that, even if you have calculation speed and accuracy like me (this is one place where I am like Einstien!), then also you would be able to come to the right conclusion!

Who does Financial Modeling?

Anybody dealing with any decision related to money (wish there was somebody who did not require that!). If you are involved in financial decision making/ planning related to large corporate, then you would definitely need financial modelling day in and day out. Financial modeling is a mandatory activity for investment bankers, bankers, project finance persons, equity research folks, PE & VCs.

What are the steps in building a financial model?

Data collection – 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 seem 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 – The more cash is generated (from the operations of the business) the better is the business

Money today is better than money tomorrow – 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

Deciding on a Layout – Now when you start to put this plan in excel, the starting point is deciding on a layout for your financial model. Usually the following questions need to be answered:

How much information/ data would your model have? If its going to be large, then it might make sense to break the model in multiple sheets

What kind of assumptions would your model make? For better readability, we would try to keep assumptions in a different heading than the calculations and the final conclusion

Different fonts/ formatting for assumptions and other parts might enhance readability as well

Create logical modules for your model

Keep your P&L, Balance Sheet, cash flow statement, etc. separate

Even in P&L, keep the revenue generation separate from costs

One Advice for Aspiring Financial Modelers

Speed is the Key. Finally when you are dealing with tons of information, you can easily get bored. If you remember a bunch of keyboard shortcuts, then it would be very beneficial! Here are some resources to get you started:

An Example Financial Modeling Case

Now to make your life easy, we have done the first two parts for you! There is a case (In the attached PDF file) that lists a situation and some of the data you might need to organize your thoughts. The decision is simple, would you advice Mr. Samar to invest in design Y?

Download the case pdf from here [pdf].

Once you have read the case and analyzed the numbers try creating a model for evaluation. Remember to make the layout of your model in such a way that navigation becomes easier.

What Next?

In the next installment of this tutorial, learn how to create a layout / template for our project evaluation model . We also discuss about some of the best practices to follow when building models in excel.

Join our Financial Modeling Classes

We are glad to inform that our new financial modeling & project finance modeling online class is ready for your consideration.

Share your Experience:

Do you build financial models? What is your experience like? What process do you follow and how do you plan the model? Do share your ideas and methods thru comments.

Added by Chandoo:

Thank you Paramdeep & Pristine:

Many thanks to Paramdeep and Pristine for making this happen. I am really enjoying this series and learning a lot of valuable tricks about financial modeling.

If you like this series, say thanks to Paramdeep. I am sure he can take any amount of appreciation without choking.

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This article is written by Pristine. The author can be contacted on paramdeep@edupristine.com .

Pristine is an awesome training institute for CFA, PRIMA, GARP etc. They have trained folks at HSBC, BoA etc. Chandoo.org is partnering with Pristine to bring an excel financial modeling online training program for you.