If you want to start a career in Investment Banking or looking
for profiles like Fundamental Analyst or any related profile in other financial
institutions like hedge fund, investment
advisory firms,etc., financial modelling
will give you a kick start to take off your career. In this blog we’ll try to
answer some related questions like what is financial modelling, why do we learn
it and where it is applicable?
What is Financial Modelling?
The
main purpose of creating a financial model is to basically forecast the future
performance of a firm by estimating its financial numbers based on its
historical performance. It is nothing but constructing a financial representation
of a firm either partially or completely, through a mathematical model
generally prepared on spreadsheets with the help of various Excel formulae.
Financial
modelling is one of the common tools which analysts used to check the financial
health of the company or a firm and also how it is going to perform in future
by forecasting some of the key line items from its financial statements likeRevenue, EBITDA, EBIT, etc.
Why do we need to learn Financial Modelling?
The financial
model helps the analyst to answer various questions which are critical to any
business. Working in any of the domains of finance like Equity Research,
Investment Banks, Credit Research, building a model gives a clear picture of the company’s performance, which areas it
should monitor more closely to remain in the competition. It also enables the
analyst to understand, how a business will react to different financial
situations or market conditions. Which are the important areas where thecompany should make investments for better
returns?
It
could be a simple or complex financial model, but it will be considered as a good model only if it can be easily
understood by its users, another important aspect of a good model is that it should
clearly convey assumptions and conclusions. As most of the financial models
work on garbage in garbage out method, hence the objective behind
creating it should be very clear from the scratch.
Where are Financial
Modelsapplicable?
The
main objective of financial modelling is to create a model which will help the
companies and investors to take better financial decisions keeping its future
growth and investment returns in mind. Some of the factors which affect the
financial decisions are Sales or Revenue,
cash flow projections or debt structure. Areas where financial models
generally used are:
·
In
projecting the company’s or its stock’s future performance
·
In
project finance
·
In
investment banking
·
In
equity or industry research
·
In
company’s past performance analysis
·
In
capital budgeting which includes allocation of resources for major expenditure
and investments etc.
·
In
deciding the cost of capital, means that financial models tell the company
about the right mix of equity and debt structure to increase the investment
returns.
There
are various financial models available like: Discounted Cash Flow Model, Comparative Analysis Model, SOTP Model, LBO
Model, M&A Model, Industry Specific Model to name a few and as a
financial analyst one should know which type of financial model is applicable
to industry, company or the financial instrument which he or she is covering.
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