Prerequisites to Learning

Financial Modeling
Building a Financial model will only be fruitful when it is giving out
results that are accurate and dependable. To achieve efficiency in
preparing a model, one should have a required set of necessary
skills. Let’s see what those skills are:

#1 Understanding of Accounting Concepts:

Building it is a pure financial document that uses financial numbers
from a company or market. There are specific accounting rules and
concepts that are constant in the financial industry worldwide, e.g.,
US GAAP,  IFRS (International Financial Reporting Standards), etc.
These rules help in maintaining the consistency of the presentation
of financial facts and events. Understanding these rules and
concepts are of extreme importance to maintain accuracy and
quality while preparing to build a model in excel.
Our primary focus in Accounting is also to identify and predict the
accounting malpractices by companies. 
#2 Excel Skills:
The primary financial Modeling in excel where is where a model is
prepared is an application like MS Excel.  It involves a wide range of
complex calculations spread over multiple tabs interlinked to show
their relationships with each other. Having an in-depth working
knowledge of excel like formulas, keyboard shortcuts, presentation
varieties, VBA Macros, etc. are a must while preparing a model.
Keeping knowledge of these skills gives the analyst an edge in his
working skills over others.
#3 Interlinking of Financial Model Statements:
A 3 statement financial modeling needs to be interlinked
together. The interlinking allows vital numbers in the Model to flow
from one statement to the other, thus completing the inter-
relationship between them and showing us the complete picture of
the financial situation of the company. Example of interlinking: 1)
Net change in cash (from Cash Flow Statement) must be linked to
Cash in Balance Sheet. 2) Net Income from Income statement
should be linked to Retained Earnings in Statement of Stock
Holder’s Equity.
#4 Forecast
The skill of forecasting financial Modeling is important because
usually, the purpose of it is to arrive at an understanding of the
future scenario of any financial situation. Forecasting is both an art
and a science. Using reasonable assumptions while predicting the
numbers will give an analyst a close enough idea of how attractive
the investment or company will be in the coming period. Good
forecasting skills increase the dependability of a model.

#5 Presentation:
Financial Modeling is full of minute details, numbers, and complex
formulas. Different groups use it like operational managers,
management, clients. These people will not decipher any meaning
from the Model if the Model is looking messy and hard to
understand. Hence, keeping the Model simple in presentation and
at the same time rich in detail is of great importance.
 How do you build a Financial
Model?
Financial Modeling is easy, as well as complicated. If you look at the
Model, you will find it involved; however, it has smaller and simple
modules. The key here is to prepare each smaller modules and
interconnect each other to train the final financial model.

You can refer to this step by step guide on Financial Modeling in

Excel for detailed learning.

You can see below various Schedules / Modules –

 Please note the following –

 The core modules are the Income Statement, Balance Sheet, and
Cash Flows.
 The additional modules are the depreciation schedule, working
capital schedule, intangibles schedule, shareholder’s equity
schedule, other long-term items schedule, debt schedule, etc.
 The different schedules are linked to the core statements upon their
completion.

Full-Scale Modeling is a lengthy and complicated process and

hence disastrous to go wrong. It is advisable to follow a planned
path while working on a financial model to maintain accuracy and
avoid getting confused and lost. Following are the logical steps to
follow:

 A quick review of Company Financial Statements: A short review

of the company financial statements (10K, 10Q, Annual reports, etc.)
will give the analyst an overview of the company, as in, the industry
of the company, segments, history of the company, revenue drivers,
capital structure, etc. This helps plan the layout of financial
Modeling by setting a guide path, which can be referred to from
time to time as we progress.
  Historical Numbers: Once a fair idea is generated about the
company and the types of financial models to be prepared, it is
advisable to start with inputting Historical data. Past Financial
Statements of the company can be found on the company
website. Data from as long as the conception of the company is
available. Usually, the past three years data is added to the historical
side, called actual numbers. Color code the cells so that historical
and formulas can be quickly identified separately.
 Ratios and Growth rates: Once the historical numbers are added,
the analyst can calculate the required Financial ratios (Gross Profit
Ratio, Net Profit Ratio, etc.) and growth rates (YoY, QoQ, etc.).
These ratios help in identifying a trend for high level strategizing
and also forecasting.
 Forecasting: The next step after historical and ratios is
implementing projections and forecasting. It is usually done for 3 to
5 years. Line items like Revenue are generally projected on Growth
rates. Whereas cost items like COGS, R&D, Selling General & Admin
exp. Etc. are projected on the base of revenue margin (% of sales).
The analyst should be careful while making the assumptions and
should consider the trends of the market.
 Interlinking of Statements: For the Model to reflect the flow from
one statement to another, they must be linked together dynamically
and accurately. If done correctly, the Model should balance out all
the words, thus giving it a finalized outlook.