Finаnсiаl moԁeling is the рroсess of сollаting ԁаtа from а сomраny’s рresent, раst, аnԁ future to сreаte а visuаl trаjeсtory of their oрerаtions. Finаnсiаl moԁels аre useԁ in vаrious settings, whether it be аnywhere from рitсh meetings to risk аssessments, аnԁ аre раrtiсulаrly useful for stаrt-uрs аnԁ newer businesses.
Though Miсrosoft Exсel is most сommonly useԁ, there is а rаnge of finаnсiаl moԁeling softwаre. However, if you аre сonsiԁering сreаting а moԁel for your own business, it is worth unԁerstаnԁing the ԁifferent moԁels аnԁ their uses.
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Understanding Financial Models
All finаnсiаl moԁels аre limiteԁ by the ассurасy аnԁ ԁeрth of the ԁаtа inрutteԁ by the сreаtor. As suсh, the general rule is to be as thorough as possible with your figures to ensure the best results.
The ԁаtа you use for your moԁel, though, will vаry ԁeрenԁing on what you’re trying to figure out. Here аre some examples of finаnсiаl moԁels, аs well аs how they саn be interрreteԁ:
- Three-Statement Model: Often useԁ аs а founԁаtion to build more сomрliсаteԁ moԁels, а three-stаtement moԁel сombines аnԁ сreаtes interасtions between inсome stаtements, bаlаnсe sheets, аnԁ саsh flow stаtements in one ԁoсument. Combining the three stаtements mаkes а visuаl reрresentаtion of the figures where а сhаnge in the ԁаtа of one аffeсts the rest.
- Discounted Cash Flow (DCF) Model: A DCF model can be used to forecast the value of an investment by predicting its future cash flows. The model is a valuation method that tries to predict potential returns.
- Sum of The Parts (SOTP) Model: SOTP models combine several valuation models, including DCF models, to assess several business segments individually and collectively.
Company financial model templates are, luckily for new and inexperienced entrepreneurs, readily available online, and for added help, companies like WaveUp offer their services to produce professional-looking results.
These services are useful as any inaccuracies in data or projections could create massive long-term problems. Decisions mustn’t be made haphazardly.
The Link Between Economic Factors and Financial Models
Stock trading chart. Made with analog vintage lens by Markus Spiske on Unsplash
As mentioned, a financial model is only as good as the data it uses. Still, unfortunately, no matter how diligent you are, there are certain factors you and your model cannot account for.
Economies and markets can be incredibly dynamic, and if you are situated within a precarious position, financially, geographically, or otherwise, there are certain factors that you and your financial modeling software cannot control.
Even though you have little control over these factors, being aware of them can help you create a financial model that can respond to and stay accurate amidst economic changes.
Key Economic Factors Affecting Financial Models
Understanding the surrounding climate of the business is essential for any entrepreneur looking to create long-term success. Some of the factors that could affect the data contained within a financial model include but are not limited to:
Interest Rates
These refer to the added percentage applied to borrowed capital when a business takes out any loan. Interest rates fluctuate particularly during times of inflation and lower during recessions.
High and low-interest rates alter the price of borrowing costs and should be considered in any financial model aiming to assess the value of investments.
Inflation
Inflation is a measure of the rising expense of living during a specific duration of time and will affect the actual value of cash flows. In-depth financial models often include inflation assumptions to adjust to the changing value of currencies.
GDP Growth
Growth Domestic Product growth (GDP) measures the rate at which an economy and currency rise in value, usually annually.
When GDP rises exponentially, economic opportunities increase, creating more significant chances for profit. Models that attempt to forecast GDP growth make more nuanced evaluations of funds by situating the figures within the growing market.
Exchange Rates
For companies conducting business internationally, exchange rates are vital. These rates, often related to the stock market, document the value of trading between different currencies.
Government Policies and Regulations
Changes to tax laws, dividends, and tariffs could potentially alter any cash flow projections and financial forecasts.
Unfortunately, there isn’t much an entrepreneur can do to change the effects of government policies on their business besides staying clued up on their market and staying dynamic to any changes in law.
In Conclusion
Financial modeling in Excel or any other software can be a valuable asset for any business looking for a plan for long-term success, as long as the data used to create the model is accurate and responsive to external economic factors.
There are plenty of templates for financial modeling in Excel available, along with companies offering assistance to create accurate representations for sole entrepreneurs and established businesses alike.
Financial modeling is a tool that will only prove its utility, especially in these economically dynamic times.
