Types of Financial Models and When to Use Them

Types of Financial Models and When to Use Them? Sounds technical, right?  

But let me inform you, if you are stepping into the world of finance, this is one thing you simply cannot ignore. Why? Because everyone relies on financial models from startups to big corporations to plan, predict, and perform. Moreover, understanding which model to use in a given scenario can significantly improve the quality of your financial decisions.

In this blog, let us together explore what are financial models, the most common types of financial models and when to use them, minus the jargon.

What are Financial Models? – An Overview

A financial model is a tool built by using MS Excel. It represents a company’s financial performance using historical data, assumptions, and formulas. To forecast future outcomes such as revenues, expenses, cash flows, and valuation. 

So simply of the question, what are financial models? You can think of it as a structured spreadsheet that helps professionals make informed business decisions.

Financial models are widely used in areas like investment banking, corporate finance, equity research, and business planning. They help answer critical “what if” questions like,

• What will our profits look like next year? 
• Should we invest in this project? 
• How much is our company worth?

In simpler terms, a financial model reflects information about the real-world business scenarios into numbers. So that the decision-makers can plan better fot the business. It is not just about the numbers but about understanding the story those numbers tell.

Why Do Companies Use Financial Models?

Well, yes, companies do use financial models to make better decisions. These models help predict how a business will perform in the future. For example, they can show whether launching a new product will be profitable or not. So, it has become crucial to use financial  models to reduce risk of failures.

Additionally, financial models are also used for budgeting, forecasting, and planning future goals. They help in setting targets and tracking progress. When a company wants to raise funds, investors often ask for a model to understand the business. 

In mergers or acquisitions, financial models help figure out the value of the company. They also show how the deal might affect profits. Simply put, financial models reduce guesswork and bring clarity to business decisions.

As a result, we, at edZeb understand the importance of building industry specific models correctly. Our faculty focus on practical hands-on learning to create practical, decision-oriented models that meet real business needs.

Types of Financial Models

There are different types of financial models, each built for a specific purpose. So, choosing the right model is crucial, depending on what you want to analyze or achieve. Here are some of the most commonly used types of financial models and when to use them in brief tabular form followed by its detailed explanations,

1. Three-Statement Model

The Three-Statement Model is one of the most widely and simplest models used by companies. It connects a company’s income statement, balance sheet, and cash flow statement in one single Excel file. This Excel sheet shows how changes in one financial statement affect the others. It helps in understanding the full financial picture of a business. 

For Example:

Let’s say a company expects sales of ₹1 crore next year, and expenses of ₹70 lakhs.

• The income statement shows a profit of ₹30 lakhs.
• This profit increases the retained earnings on the balance sheet.
• The cash flow statement shows that if there’s no major investment or debt, cash also increases by ₹30 lakhs.

All three statements are linked. If you change the sales figure, all other parts of the model update automatically.

What does it include?

• The income statement shows the company’s revenues, expenses, and profits.
• The balance sheet shows what the company owns (assets), owes (liabilities), and the owner’s equity.
• The cash flow statement shows where cash is coming in and going out—very important for understanding liquidity.

Why is it important?

This Three-Statement Model is used to forecast the company’s financial performance. You can see how profits, cash, and assets will change over time by adjusting a few assumptions (like sales growth or cost margins). It’s often the first model that students learn when starting with financial modelling.

When is it used?

• For basic financial forecasting
• When building models for startups or small businesses
• As a base for more complex models like DCF or M&A

2. Discounted Cash Flow (DCF) Model

The DCF model is used to find the value of a business or an investment based on how much money it is expected to make in the future. It takes those future cash flows and brings them back to today’s value using a method called discounting. 

Not getting it, no problem. Let me simplify it for you with the help of an example.

For Example,

Suppose a company is expected to generate ₹10 lakhs in free cash flow every year for the next 5 years.

You apply a discount rate (say 10%) to reduce those values to what they are worth today. After adding all the discounted cash flows, you may find the company’s present value is ₹38 lakhs. This is what investors use to decide whether a stock or business is undervalued or overvalued.

Why is this important?

Money you receive in the future is worth less than money you have today. The DCF model helps answer the question: “How much is this business worth today based on future earnings?”

How does it work?

• First, forecast the company’s free cash flows (money left after all expenses and investments).
• Then, choose a discount rate (usually the company’s cost of capital).
• Finally, discount the future cash flows back to their present value and add them together. That gives you the company’s current value.

When is the DCF model used?

• For company valuations
• In investment banking and equity research
• By investors before buying or selling stocks or businesses

We train students to build DCF models from scratch using real-world company data so that they learn the logic and develop practical modelling skills employers look for.

3. Merger & Acquisition (M&A) Model

As the name suggests, the Merger & Acquisition model is used to check if buying another company makes financial sense. It combines the buyer’s and target’s financials and shows how the deal affects profits.

For example, if the deal increases the buyer’s earnings per share (EPS), it’s called accretive. If it reduces EPS, it’s dilutive. So, if Company A earns ₹10 per share and the EPS goes up to ₹12 after buying Company B, that’s a good sign.

It is used in investment banking and by companies especially, planning for mergers with other company. So, understanding deal assessment is necessary with hands-on training.

4. Leveraged Buyout (LBO) Model

The LBO model is also about buying a company but mostly with borrowed money. So, LBO models are used by the private equity firms to see if they can buy a company, repay the debt, and sell it later for a profit.

LBO model focuses on cash flows, debt repayment, and returns. If the deal can pay off the loan and still give high returns, it is considered successful.

LBO models are detailed but powerful. That is why, we help our students build simple-to-advanced LBO models using real private equity case studies.

5. Initial Public Offering (IPO) Model

IPO, IPO is all about going public in stock market. So, companies use the IPO model to help them plan their stock market launch. It projects how much money the company can raise, what the share price might be, and how it will impact ownership.

IPO looks at earnings, market demand, and valuation multiples to decide if the company is ready to go public. Our students learn to build IPO models using real company data and understand how startups and firms prepare for listing.

6. Budgeting & Forecasting Model

The budgeting and forecasting model is used to plan and predict a company’s financial performance. It includes estimated revenues, costs, and profits for future months or years. Companies use it to set goals, track results, and make sure they’re staying on target.

Forecasting is mostly done every quarter or month to adjust plans based on actual results. This helps businesses stay flexible and prepared for changes. For example, if a company expects ₹50 lakhs in revenue next quarter but only earns ₹40 lakhs, the model helps them find the gap and adjust spending.

We teach students how to build budgeting models that are flexible, error-free, and ready for real-time business updates.

7. Consolidation Model

The consolidation model is used when a company has multiple divisions, branches, or subsidiaries. It combines the financials of all these units into one single model to give a full view of the business.

For example, if a company has offices in Mumbai, Delhi, and Bangalore, this model merges their revenue, expenses, and profits into one report.

It helps in understanding overall company performance and making group-level decisions. Our students learn to build clean, structured consolidation models using practical multi-unit business examples.

There are different types of financial models and when to use them in business is as follows,

Startup Stage → 3-statement, Budgeting

Growth Stage → Forecasting, DCF, Consolidation

Maturity → IPO, M&A

Exit → LBO

Build Custom Financial Models with Excel-Based FP&A Software

Let us understand it in simple terms. Imagine you are running a school event like a fun fair. You need to plan how much money you will spend on food, games, and prizes, and how much you expect to earn from tickets. 

So, You will probably create a table in your notebook or Excel with expected costs and income, right? That’s the simplest form of financial modelling.

Now, imagine doing the same thing for a big company with hundreds of employees, multiple offices, and millions of rupees in sales. In that case, you need a more powerful tool to plan everything properly and that is where Excel-based FP&A software comes in. These tools help businesses:

• Plan their budgets
• Forecast their future income
• Track real-time changes
• And make smarter decisions faster

Instead of creating everything from scratch every time, FP&A software allows companies to build once and update easily. For example, if the sales team changes their revenue estimate, the model updates all related numbers like profit and cash flow automatically. Easy right?

So, we first teach our students how to build models in Excel step by step. Then, we introduce them to modern FP&A tools. That way, they are ready to work in any company whether it is a startup or a multinational business.

Examples of Financial Models

Until now, I hope you understand different types of financial models and when to use them? How different types of financial models work? How they can be built using Excel or FP&A tools? So now let us have a look at some real-world examples of financial models to see how these models are used in day-to-day business decisions.

Startup Profit Planning

A small food delivery startup wants to know if it will make a profit in the next 12 months. They create a three-statement model to plan their income from orders, delivery costs, salaries, and marketing expenses. This helps them forecast whether they will earn or lose money and when they might break even.

Company Valuation Before Sale

In case, a business owner wants to sell their company. They build a DCF model to estimate its value based on expected future profits. This helps them price their company fairly and attract buyers.

Buying Another Business

A large company is planning to buy a smaller one. They create an M&A model to see if the deal will improve their earnings. The model also shows if the merger will be profitable in the long run.

Private Equity Investment

An investor is planning to buy a business using borrowed money. They use an LBO model to check if the business can pay back the loan and still give them a good return over a few years.

Monthly Budget Tracker

A company’s finance team builds a budgeting and forecasting model to plan monthly expenses and compare them with real spending. This helps them stay on track and avoid losses.

These examples of financial models show that they are not just spreadsheets but they are important decision-making tools used at every level of business.

Conclusion

Financial models are more than just numbers in a spreadsheet. They are powerful tools that help businesses plan, grow, and make smarter decisions. From startups forecasting profits to large companies planning mergers, the right financial model can make a big difference.

Understanding the types of financial models and when to use them gives you an edge in any finance role. And whether you are just starting out or aiming to upskill, learning how to build these models the right way is essential.

At edZeb, we train students to not only understand these models but also apply them in real-world situations using hands-on practice and industry-relevant tools.

FAQ’s