Introduction to

Financial
Modeling
 What is Financial Modeling?
Financial modeling is the construction of spreadsheet
models that illustrate a company's likely financial results in
quantitative terms.

Financial modeling is the process by which a firm

constructs a financial representation of some, or all,
aspects of the firm or given security.
 Financial Models

A financial model is a mathematical representation of the

financial operations and financial statements of a company. It is
used to forecast the future financial performance of the company
by making relevant assumptions of how the company would fare
in the coming financial years.

Financial models can simulate the effect of specific variables so

that the company can plan a course of action should they occur.
 Financial Models

It is also a risk management tool for analyzing various financial and

economic scenarios and also provided valuations of assets

These models involve calculations, analyzing them, and then provide

recommendations based on the information gathered.

A financial model generally includes projecting the financial statements

such as the income statement, balance sheet, and cash flow statement
with the help of building schedules such as the depreciation schedule,
amortization schedule, working capital management, debt schedule, etc. It
encompasses the company’s policies and restrictions imposed by lenders
that would impact the financial position.
 Summary
Financial modeling- the process by which a firm constructs a
financial representation of some, or all, aspects of the firm or
given security. The model is usually characterized by
performing calculations and makes recommendations based
on that information. The model may also summarize particular
events for the end-user and provide direction regarding
possible actions or alternatives.
TYPES OF FINANCIAL
MODELS
There are various kinds of financial models that are used according
to the purpose and need of doing it. Different financial models solve
different problems. While the majority of the financial models
concentrate on valuation, some are created to calculate and
predict risk, the performance of a portfolio, or economic trends
within an industry or a region.
THREE STATEMENT MODEL:

An integrated 3-statement financial model is a type of model that forecasts

a company’s income statement, balance sheet, and cash flow statement.

While accounting enables us to understand a company’s historical financial

statements, forecasting those financial statements enables us to explore how
a company will perform under a variety of different assumptions and visualize
how a company’s operating decisions (i.e. “let’s reduce prices”), investing
decisions (i.e. “let’s buy an additional machine”) and financing decisions (i.e.
“let’s borrow a bit more”) all interact to impact the bottom line in the future.
A well-built 3-statement financial model helps insiders (corporate
development professionals, FP&A professionals) and outsiders
(institutional investors, sell-side equity research, investment
bankers, and private equity) see how the various activities of a firm
work together, making it easier to see how decisions impact the
overall performance of a business.
DISCOUNTED CASH FLOW MODEL:

Among the different types of Financial models, DCF Model is the most
important. It is based upon the theory that the value of a business is the
sum of its expected future free cash flows, discounted at an appropriate
rate. In simple words, this is a valuation method that uses projected free
cash flow and discounts them to arrive at a present value which helps in
evaluating the potential of an investment. Investors particularly use this
method in order to estimate the absolute value of a company.
SUM-OF-THE-PARTS MODEL:

It is also referred to as the break-up analysis. This modeling involves the

valuation of a company by determining the value of its divisions if they
were broken down and spun off or they were acquired by another
company.
LEVERAGED BUY-OUT (LBO) MODEL:

It involves acquiring another company using a significant amount of

borrowed funds to meet the acquisition cost. This kind of model is being
used majorly in leveraged finance at bulge-bracket investment banks and
sponsors like the Private Equity firms who want to acquire companies with
an objective of selling them in the future at a profit.

Hence, it helps in determining if the sponsor can afford to shell out the
huge chunk of money and still get back an adequate return on its
investment.
MERGER & ACQUISITION (M&A) MODEL:

Merger & Acquisitions type of financial model includes the

accretion and dilution analysis. The entire objective of merger
modeling is to show clients the impact of the acquisition on the
acquirer’s EPS and how the new EPS compares with the status quo.

In simple words, we could say that in the scenario of the new EPS
being higher, the transaction will be called “accretive” while the
opposite would be called “dilutive.
OPTION PRICING MODEL:

On, to buy or sell the underlying instrument at a specified price on or

before a specified future date”. Options traders tend to utilize different
option price models to set a current theoretical value.

Option Price Models use certain fixed knowns in the present (factors
such as underlying price, strike, and days till expiration) and also
forecasts (or assumptions) for factors like implied volatility, to compute
the theoretical value for a specific option at a certain point in time.
Variables will fluctuate over the life of the option, and the option
position’s theoretical value will adapt to reflect these changes.
 Source
https://www.iare.ac.in/sites/default/files/lecture_notes/IARE_FM_NOTES.pdf