What is the financial model of a company?

A financial model is an abstract representation of the economic and financial state of a company that serves as a management tool and allows projecting the future results of decisions made in the present, where the conflicting party is simplified, highlighting the variables to be resolved.

To make a financial model, you need to have certain financial knowledge, which can be acquired via the Finance master that at EIA University we have for you.

  1. Objective of financial models
  2. What is the financial model for?
  3. Types of financial models
  4. What are the components of a financial model?
  5. Who does the financial modeling?
  6. Features of a financial model

Objective of financial models

The main objective of financial models is to develop a business plan or obtain the financial structure of the company, capturing the reality of the company in an abstract model to offer a transparent view of its global situation, in order to project the impact of any change in the structure of society. Furthermore, it allows the definition of scenarios with different variables which, according to their value, reflect the changes of the whole structure.

A financial model helps a company make decisions that affect its structure, as it will make the impact of any decision transparent.

What is the financial model for?

The financial model is used to evaluate companies, analyze the profitability of a company's business units, evaluate the profitability of an investment project or make investment decisions, among others.

Types of financial models

There are many types of financial models that can be used to best fit the needs of each company, among the 9 most common types of financial models we have:

  • Three-statement model: It is considered the basic setup of financial models, it allows you to create assumptions that can show changes in the model.
  • Discounted cash flow model: It is used to value the company using the net present value of the company's future cash flow.
  • Fusion model: It is most common in investment banking and business development, it evaluates the accumulation or dilution of a merger or acquisition.
  • Initial Public Offering Template: This template is ideal for when a company goes public.
  • Leveraged buyout model: it is one of the more complex and challenging types, requiring the creation of multiple tiers, cash flow cascades, and debt plans.
  • Consolidation model: add multiple business units to a single model.
  • Budget template: It is used to create a budget for the next few years.
  • Prediction model: allows financial planners to compare the forecast with the budget.
  • Options pricing model: ideal for direct calculation of binomial tree pricing models
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What are the components of a financial model?

The essential components that a solid financial model must have are:

  • Sensitivity analysis

Who does the financial modeling?

In general, the person developing the financial model is a financial analyst, however in a large company with a full finance department, it is this area that is responsible for designing and maintaining the financial model. Therefore, basic knowledge of finance is required for financial modeling.

Features of a financial model

The characteristics of a financial model are:

  • Make calculations and recommendations based on financial information.
  • Summarizes particular events directed at a particular customer or end user.
  • It helps project the earnings performance of a company.
  • Capture and evaluate all the variables of a particular event, quantify them and build formulas from them.
  • The main tool is a spreadsheet.
  • It is based on multiple inputs and assumptions.

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