A REPORT ON

FINANCIAL MODELING

SUBMITTED BY
SOURABH SINGH
PGDM - FINANCE
343/2019
Definition: -
Financial modeling is the process of creating the summary of a company’s
performance based on certain variables that helps the business forecast the future
financial performance. In other words, creating a summary of a company’s
expenses and earnings in the form of a spreadsheet that can be used to calculate the
impact of a future event or decision. This is relevant for making future decisions
like raising capital or valuing business and interpreting their impact.
Brief explanation: -
In financial modeling, we either build a model form scratch i.e., work on a new
model or work on maintaining the existing model by implementing newly available
data to it. As financial situations are of complex and volatile nature, this model
helps the user in gaining an in-depth knowledge of all the components of complex
scenario. It also helps a company sees the financial result of a decision in
quantitative terms. Knowledge of the company’s operations, accounting, corporate
finance, and excel spreadsheets are some of the key measurements and skills used
to construct this model. Such models are intended to be used as decision-making
tools.
If we take an example like in investment banking, financial modeling is used to
forecast potential future financial performance of a company by making relevant
assumptions of how a firm or company’s specific project is going to perform in the
forthcoming years. For instance, how much cash flow a project is expected to
produce within 5 years from its inception.
Excel is the main tool used by banks, corporations and institutions to perform
financial modeling. It is used because it is the most flexible and customizable tool
available.
Uses: -
Financial modeling can be used for various situations; following are some of the
areas in which financial modeling is generally used for –
 Risk Management  Valuation of a Company
 Valuation of Assets  Mergers and Acquisitions
 Options Pricing  Budgeting and Forecasting
 Capital Allocation  Raising Capital
Hence, it is used to make such decisions like whether or not to invest in a
company, asset or security; whether or not invest to invest in a project; whether or
not to do a merger or acquisition or whether or not to raise a money (e.g., do an
IPO); and other corporate finance decisions.
Used by: -
 Investment Bankers  Equity Research Analyst
 Credit Analyst  Risk Analyst
 Data Analyst  Portfolio Mangers
 Investors  Management/Entrepreneurs

Types: -
A financial model takes many mathematical representations into considerations
like- cash flow projections, debt schedules, debt services, inventory levels, rate of
inflation etc. These variables are then tested via various outputs to determine the
impact of a change in one variable or another. Although there are various financial
modelling examples, but below are some of the widely used model in the finance
industry: -
1. 3 Statement Model
This is the most standard and in-depth form of a financial model. It takes the three
financial statements (Income statement, Balance sheet, Cash flow) and linked them
together to make a dynamically linked financial model.
 2. Discounted cash flow (DCF) method
It is the most widely used method of valuation in the finance industry, which uses
the concept of time value of money. It is also build on the three-statement model
and takes the analysis further by deriving the discounting factor. Usually, weighted
average cost of capital (WACC) is used as the discounting factor to discount the
future cash flows. DCF helps to identify whether a company’s stock is undervalued
or overvalued.

3. Merger & Acquisitions model: -

This model helps to figure out the effect of merger & acquisitions on the earning
per share of the newly formed company. If the EPS increased altogether, then the
transaction is said to be “accretive”, if EPS decrease it is said to be “dilutive”.
A good model is simple enough that anyone can understand it, yet detailed enough
to handle complex situations.