How to Make a Financial Model: Complete Guide

Learning how to make a financial model is an essential skill for anyone in finance or business.

In case you have to evaluate a startup’s potential for investment. It will become hard without a financial model to see if it will succeed or fail. A financial model helps predict revenue, expenses, and cash flows, giving you a clear picture. 

This guide will walk you through how to make a financial model, its uses, types, steps to build one, tools, and tips for beginners.

What Is Financial Modelling?

We all know what is financial modelling. It is the process of creating a structured representation of a business in numbers. It is usually built in Excel or similar software. The model shows how money flows in and out of a company. It connects revenue, expenses, assets, and cash.

The main goal is to predict financial performance in the future. It helps in making decisions about investments, budgeting, and growth. A financial model is like a map that guides business planning, so it is important to know how to create a financial model.

Practical Uses of Financial Models in Business

Financial models are powerful tools. They guide both our daily and long-term decisions. These models simplify complex numbers and present them in a way that supports planning, strategy, and investments. So, businesses of every size benefit from using them. Below are some of the key practical uses of financial models in business.

• Budgeting and Forecasting

The financial Models help estimate future income and expenses. They allow companies to plan how much money will be needed for operations, expansion, or savings. This makes financial planning more reliable. So, you must be aware of creating financial models in Excel or using other tools.

• Fundraising and Investments

Every financial institution, be it Banks, venture capitalists, or private investors, relies on financial models before committing funds. A strong model builds confidence and proves that the business can deliver returns. So, it becomes important for a finance aspirant to know how to create a financial model.

• Business Valuation

When a company plans to sell equity, raise capital, or merge with another firm, business valuation becomes critical to calculate a fair value. It is done by analysing revenue, profits, and future growth potential. That is why you should know how to create a financial model in Excel.

• Risk Analysis and Scenario Planning

Businesses can face uncertainty at any stage. So, the financial models test different outcomes, such as sales dropping or costs rising. Scenario analysis shows how the business will perform in both best and worst cases. So, creating financial models in Excel or other tools is crucial.

• Strategic Decision-Making

Business expansion into new markets, launching new products, or cost-cutting plans need a financial base. Models provide the numbers to support or reject these strategies. So, create a financial model in Excel or use any other platform, as decisions depend on modelling.

Financial models are more than spreadsheets. They are decision-making guides that reduce uncertainty and improve confidence. With them, businesses can prepare for challenges and seize opportunities. Therefore, there is a necessity to learn how to create a financial model.

Types of Financial Models

There are different types of financial models. Each type serves a different purpose. Some are simple, while others are highly detailed. Knowing the main types helps in choosing the right one for a business need. Creating financial models in Excel is common, and some of the following types use Excel while others do not.

• Three-Statement Model

This three-statement financial model in Excel is the most common model. It links the income statement, balance sheet, and cash flow statement. It gives a complete view of financial performance and is the base for many other models.

• Discounted Cash Flow (DCF) Model

The discounted cash flow model values a company based on future cash flows. It discounts them back to today’s value. Investors use it to judge if a company is worth investing in.

• Mergers and Acquisitions (M&A) Model

Various companies use this financial model in Excel to analyse whether the deal will create value before merging with or buying another firm. It also shows how the financials will look after the merger.

• Initial Public Offering (IPO) Model

The IPO model is used when a company plans to go public. It projects how investors will value the company’s shares and sets the right share price for listing.

• Leveraged Buyout (LBO) Model

Most of the private equity firms use the LBO model. It shows how much debt can be used to buy a company and also measures returns from the investment after repayment of debt.

• Consolidation Model

This consolidated financial model in Excel combines the finances of multiple business units into one so that large companies with many divisions can get an overall picture.

• Budget Model

Businesses use a budget model for internal planning as it is focused on income and expenses for short periods, like a year or a quarter.

Each type of the above-mentioned financial models serves a unique role. Together, they help in valuation, planning, and decision-making across industries. So, you, being a finance aspirant, should learn how to make a financial model. Many are still used to creating financial models in Excel, while others have adopted new tools and software for the same purpose.

How to Make a Financial Model: Step-by-Step Guide

Building a financial model may look difficult at first. But if you follow a clear process, it becomes much easier. Every model is built in steps, and each step has a purpose. Here is a simple guide that students can follow.

Define the Purpose

The first thing to do is to decide why you are making the model. It could be for different purposes like valuation, fundraising, budgeting, or risk analysis. The goal will decide how detailed your model needs to be.

Choose a Time Frame

The next thing is to select the time period of the model. You can create models on a monthly, quarterly, or yearly basis. Most business models cover three to five years.

Collect Historical Data

After that, gather the company’s past financial statements, including the income statement, balance sheet, and cash flow statement. Also, collect business data like sales volume, pricing, or costs.

Create Assumptions

Then, make a list of assumptions that will drive the forecast. For example, include revenue growth rate, cost margins, tax rates, and interest rates as these numbers form the base of your model.

Build the Revenue Forecast

Now you can start by projecting sales using simple drivers like price multiplied by units sold. You should link these to your assumptions and create a logical structure for revenue.

Add Costs and Expenses

You can separate fixed and variable costs and project them based on past data and expected changes to show the operating profit of the business.

Create Capital Expenditure and Depreciation Schedules

Businesses invest in assets like machinery, buildings, or technology. So, add these costs to your model and then calculate depreciation to spread the cost of assets over time.

Work on Working Capital

If you work on working capital, then include receivables, payables, and inventory and forecast them using past patterns as they affect cash flow.

Build the Debt and Interest Schedule

If the business has loans, record repayments and interest costs. Link these to the income statement and balance sheet.

Prepare the Three Statements

• Now connect everything into one system:
• The Income Statement shows profit.
• The Balance Sheet shows assets and liabilities.
• The Cash Flow Statement shows the movement of cash and ensures all three statements are linked correctly.
  

Add Scenarios and Sensitivity Analysis

When you test how the business will perform in different cases. For example, if sales drop or if costs rise, sensitivity analysis will show you which assumptions matter the most.

Do Valuation and KPI Calculations

If your goal is valuation, then apply the Discounted Cash Flow (DCF) method and calculate important ratios like margins, return on equity, and debt-to-equity ratio.

Build the Output Sheet or Dashboard

Now you have to create a simple summary using charts, graphs, and key numbers that highlight results that others can quickly understand your model.

Review and Test the Model

At last, check your formulas and make sure the balance sheet balances. Also, review your assumptions to see if they are realistic and keep in mind to always test for errors before sharing.

So, now you know how to create a financial model in these easy steps. However, you should also know how to make a financial model using other tools as well. A good financial model is not just about numbers. It is about telling the story of a business in a clear, structured way. For students, learning this skill opens doors to careers in investment banking, equity research, consulting, and corporate finance.

Tools & Software for Building Financial Models: Alternatives to Excel

Excel is considered one of the major tools for the job. Many other financial modelling software exist that assist in simplifying and making the procedure more accurate and time-saving. 

A few alternatives to Excel that professionals might find useful with complex models or large datasets are listed below.

Google Sheets

Google Sheets is the first and most effective alternative to Excel. It is a spreadsheet tool that is on the cloud and works similarly to Excel. The collaboration feature of this tool offers a very powerful way to allow multiple users to simultaneously work on the same model. Though it has some limitations against extremely complicated numerical calculations, as might be the case in Excel, it remains very handy for teams working on projects in real time.

Microsoft Power BI

Microsoft Power BI is originally targeted as a business analytics tool; it is increasingly being used for financial modelling. Data visualisation, interactive dashboards, and the interaction with multiple data sources are its paramount features. Mostly, professionals turn to it for extracting insights and visualising trends, hence mustering greater interpretability for the models.

Tableau

Tableau is yet one of the Excel alternatives providing a data visualisation service to augment the financial models. It connects databases and spreadsheets to produce dynamic dashboards. Analysts use it for forecasting, scenario planning, and communicating findings to stakeholders.

Python with Financial Libraries

Python, with libraries including Pandas, NumPy, and Matplotlib, is becoming generally recognised for use in financial modelling. It allows one to automate repeated tasks, handle very large datasets, and conduct advanced statistical analyses. Those in investment banking, equity research, and fintech often use Python for predictive applications.

R Programming

R is also a statistical programming language used for advanced financial analysis. It is very much used in risk modelling, forecasting, and regression analysis. It can accomplish mathematical calculations that Excel may not be able to do or can do but very slowly.

Quantrix Modeller

Quantrix is a niche financial modelling tool. It offers multidimensional models, scenario analyses, and flexible formula structuring. It is suitable for use in corporate finance teams, strategic planning, and budgeting processes where manual spreadsheets can become cumbersome.

Adaptive Insights

You can also use Adaptive Insights. It is a cloud-based planning tool that allows for budgeting, forecasting, and financial reporting. Using this allows for templates and automation that reduce manual errors and save time. It is also used by companies for collaborative financial planning.

Anaplan

Anaplan is an enterprise-grade planning software used in large-scale financial modelling. It has provisions for multi-dimensional analysis, scenario planning, and ERP systems integration. It finds its application for professional forecasting, financial consolidation, and performance tracking of more complex projects.

The tools you pick would depend on your financial model’s complexity, the size of your data, and whether or not collaboration or advanced analytics need to be involved. Even though Excel is considered the easiest, most financial experts also list Python, Power BI, and Quantrix as options that can help you gain more efficiency and insight. Learning any of these will definitely enhance your capabilities, preparing you for a job in corporate finance or investment banking in equity research.

Conclusion

The ability of financial modelling should be in the list of must-have skills for any person. Especially the ones who want to pursue a career in finance, investment banking, corporate strategy, or business analysis. By knowing what it is and how to make a financial model within the business setting, one is empowered to make the best forecast performance and evaluate risk. 

Various types provide you options to select particular approaches to different scenarios, while a step-by-step methodology ensures that modelling is done correctly and unleashes your truncated thinking into a strong, structured set of assumptions and calculations. 

Setting up a process of what tools to use, along with competencies beyond Excel, equips you with the most modern, efficient way of dealing with complex data and working collaboratively. Just entering the world of the modeller enriches your analytical thinking and thereby shortens the distance between you and the higher echelon of the professional world. Strong financial modelling skills will open up rewarding career opportunities for you and give you confidence in making sound business decisions, whether you are a student or a working professional.

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