What is Financial Modelling? - Introduction #financialmodeling course

Introduction

This tutorial introduces financial modeling, explaining its significance and guiding you through the essential steps to create effective financial models using Excel. Financial modeling is crucial for preparing future financial statements and helps in making informed business decisions.

Step 1: Understanding Financial Modeling

• Financial modeling is the process of creating a representation of a company's financial performance in the future.
• A financial model consists of interconnected financial statements, including the income statement, balance sheet, and cash flow statement.
• Key features of a good financial model:
  • Flexibility: Models should adapt to changes in input data without breaking calculations.
  • Accuracy: Ensure all formulas are correct and linked correctly.
  • Clarity: The model should be easy to understand for users.

Step 2: Setting Up Your Excel Workbook

• Start by creating a new Excel workbook.
• Organize the workbook with separate sheets for:
  • Assumptions: Input variables that drive the model (e.g., revenue growth rates, expenses).
  • Income Statement: Projected revenues, costs, and net income.
  • Balance Sheet: Assets, liabilities, and equity projections.
  • Cash Flow Statement: Cash inflows and outflows.

Step 3: Linking the Sheets

• Use cell references to link data between sheets:
  • For example, to link revenue from the Assumptions sheet to the Income Statement sheet, use the formula:

    =Assumptions!B2
    

• Ensure that changes in the Assumptions sheet automatically update the relevant cells in the Income Statement, Balance Sheet, and Cash Flow Statement.

Step 4: Input Assumptions

• Identify key assumptions that will impact your financial model:
  • Revenue growth rate
  • Operating expenses
  • Tax rates
• Input these assumptions in the Assumptions sheet for easy adjustments.

Step 5: Building Financial Statements

• Income Statement:

  • Start with revenue and subtract cost of goods sold (COGS) to find gross profit.
  • Deduct operating expenses and add other income/expenses to arrive at net income.

• Balance Sheet:

  • List assets (current and long-term).
  • List liabilities (current and long-term).
  • Calculate equity by subtracting total liabilities from total assets.

• Cash Flow Statement:

  • Use the indirect method starting with net income.
  • Adjust for non-cash items and changes in working capital.

Step 6: Testing the Model

• Test the model by changing input assumptions to see how they affect the financial statements.
• Ensure that all links are functioning correctly and calculations are accurate.

Conclusion

Creating a financial model involves understanding its components, setting up an organized Excel workbook, linking sheets for dynamic updates, and inputting assumptions to drive projections. By following these steps, you can build a robust financial model that assists in strategic decision-making. For a deeper dive into financial modeling techniques, consider enrolling in specialized courses or utilizing additional resources.