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Financial Modelling explained16 June 2017

Financial Modelling explained

What is financial modelling?

Financial modelling is a tool that is built into Microsoft Excel to forecast business performance into the future. The forecast is based on the company’s previous background and requires the balance sheet, cash flow statement and income statement.

What is a financial model used for?

The financial model has been mostly used for making and performing financial analysis. Within a company its executives use financial models to:

  • Selling or divesting assets and business units.
  • Valuing a business.
  • Making acquisitions
  • Growing the business
  • Budgeting and forecasting
  • Capital allocation

How financial Modelling helps your business?

  • Financial Modelling in excel helps you understand the reality of your business, it is a cause and effect machine. In business there is no absolute right or wrong prediction that can be made of your business as many people in the industry will tell you. A model will help you understand your business and how it works. This will provide an analytical framework to see the realities of your business.
  • Financial models are used to test hypothesis about companies. If you test your hypothesis in a financial modelling excel this will be much cheaper and easier to do so than trial and error. You can test this through scenarios and the results that you attain can be used for a wider discussion about the company. The model will prompt you to ask questions such as what happens if the invoices are not paid or what impact will low sales have on the business?
  • The model can create a road map for the business, it lays out a programme which the company can adhere to. You can soon lay out plans of what to expect in the future and when certain actions will take place. This can help in setting goals for internal staff and looking after the expectations of the stakeholders of the business.
  • The financial model will help you to build contingency plans and help you learn from various scenarios. It is very important to use the model for learning but it shouldn’t be solely depended upon. 

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