FINANCIAL

MODELING
Management Services 2021 Edition
Franklin T. Agamata, MBA, HLM, IIFP, FICB, CPA

Ms. Ali-Aya May J. de los Reyes, MBA

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INTRODUCTION TO FINANCIAL
MODELING: AN OVERVIEW
Financial Modeling
Is the process of 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.
It is a numerical
representation of some or all
aspects of a company’s
operations.
A Financial model
has many uses for company
executives. Financial
analysts most often use it to
analyze and anticipate how
a company’s stock
performance might be
affected by future events or
executive decisions.
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FINANCIAL MODELING
OVERVIEW

This can be used for a wide range of purposes,

such as budgeting and forecasting, risk analysis,
investment analysis, and valuation. Financial
models can range from simple spreadsheets to
complex algorithms and simulations depending
on the complexity of the financial situation
being modelled.

Some of the key components of financial

modeling include:
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1.
DATA GATHERING
AND ANALYSIS
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Collecting and analyzing

relevant financial data, such
as income statements,
balance sheets, and cash flow
statements, to inform the
model.
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2. ASSUMPTIONS AND
VARIABLES
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Establishing the key

assumptions and variables
that will be used in the model,
such as growth rates, interest
rates and market trends.
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3. MODEL
CONSTRUCTION
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Creating a mathematical
model that incorporates the
data assumptions, and
variables, and produces
output that can be used for
analysis and
decision-making.
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4. SENSITIVITY
ANALYSIS
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Conducting sensitivity
analysis to test the model’s
robustness and evaluate the
impact of changes in
assumptions and variables on
the model output.
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5. INTERPRETATION
AND
COMMUNICATION
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Interpreting the model output

and communicating the
findings to stakeholders, such
as investors, and
management teams and
board members.
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TYPES OF
FINANCIAL
MODELS
There are many types of financial models used in
various industries. Some of the most common
types of financial models include:
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TYPES OF FINANCIAL MODELS

(DCF) Discounted (M&A) Merger and

Cash Flow Acquisitions
DCF models are used to Are used to evaluate the
estimate the value of an financial implications of a
investment based on the merger or acquisition.
expected future cash These models typically
include projections of
flows generated by the
future cash flows,
investment. This type of analysis of potential
model is often used in synergies, and estimation
equity research and of the cost of financing
investment banking. the transactions.
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TYPES OF FINANCIAL MODELS

Option Pricing Models Monte Carlo
Option pricing models Simulations
are used to value Are used to model the
financial instruments, behavior of complex
such as options and systems with many
futures contracts. These variables. This type of
models use complex model uses random
algorithms to estimate variables to simulate a
the value of the large number of scenarios
instrument based on and estimate the
various factors, such as probability of different
volatility and interest outcomes.
rates.
BEST PRACTICES
OF FINANCIAL
MODELING
To ensure the accuracy and reliability of financial
models, there are certain best practices that should
be followed. SOme of these best practices include:
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BEST PRACTICES OF FINANCIAL

MODELING

Documenting
Using Consistent Using Sensitivity Using Error
Assumptions and
Formatting Analysis Checks
Calculations
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USING CONSISTENT
FORMATTING
Consistent formatting
can make a financial
model easier to read
and understand. This
includes using
consistent font sizes,
colors, and styles, as
well as sign clear and
concise labels and
headings.
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DOCUMENTING
ASSUMPTIONS AND
CALCULATIONS
Documenting all
assumptions and
calculations used in a
financial model can help
ensure that the model is
accurate and reliable.
This includes clearly
labeling all inputs and
formulas, such as
documenting any sources
used for input data.
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USING SENSITIVITY
ANALYSIS
Conducting sensitivity
analysis can help test the
model’s robustness and
evaluate the impact of
changes in assumptions
and variables on the
model output. This can
help ensure that the
model is reliable and
accurate under different
scenarios.
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USING ERROR CHECKS:

Using error checks, such
as conditional formatting,
can help identify errors
and inconsistencies in a
financial model. This can
help ensure that the
model is accurate and
reliable.
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TOOLS AND TECHNIQUES

FOR FINANCIAL
MODELING
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SPREADSHEET SOFTWARE

Spreadsheet software, such as Microsoft

Excel, is the most commonly used tool for
financial modeling. Excel has powerful
built-in functions and is widely available,
making it accessible to users with varying
levels of experience. However, there are
limitations to what can be done with
spreadsheets, particularly with complex
models or large datasets.
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PROGRAMMING LANGUAGES

Programming languages, such as Python

or R, are increasingly being used for
financial modeling. These languages offer
more flexibility and scalability than
spreadsheets, and can handle large
datasets and complex models. However,
they require more specialized skills and
may not be as accessible to users with
limited programming experience.
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FINANCIAL MODELING SOFTWARE

There are several specialized financial

modeling software packages available,
such as MATLAB or Mathematica, that are
designed specifically for financial
modeling. These packages offer advanced
modeling capabilities and specialized
features for financial analysis and
reporting. However, they can be more
expensive than spreadsheet software and
may require specialized training.
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DATA VISUALIZATION TOOLS

Data visualization tools, such as Tableau

or Power BI, can be used to create
interactive dashboards and reports based
on financial models. These tools can help
users visualize and understand complex
financial data, and can be used to
communicate financial information to
stakeholders in a clear and engaging way.
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MACHINE LEARNING

Machine learning techniques, such as

regression analysis or clustering, can be
used for financial modeling to identify
patterns and trends in large datasets.
These techniques can be used for
forecasting, risk analysis, and other
applications. However, they require
specialized skills and may not be
necessary for all financial modeling
applications.
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CHALLENGES AND LIMITATIONS OF
FINANCIAL MODELING
UNCERTAINTY AND RISK-
Financial modeling is
inherently uncertain, as it
relies on a set of assumptions
and inputs that may not
accurately reflect the future
financial situation. Modeling
techniques, such as sensitivity
analysis and scenario analysis,
can help account for this
uncertainty, but there is always
a risk that the actual financial
situation will differ from the
model's predictions.
HUMAN ERROR- Financial
modeling is vulnerable to
human error, particularly
when models are built or
maintained manually using
spreadsheets or other
software. Even small errors
can have a significant
impact on the outputs of
the model, so it's important
to carefully check and
validate all inputs and
calculations.
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CHALLENGES AND LIMITATIONS OF
FINANCIAL MODELING
DATA QUALITY- Financial
modeling relies heavily on
the quality and accuracy of
the data used as inputs. If the
data is incomplete,
inaccurate, or outdated, the
outputs of the model may
not be reliable. Ensuring data
quality is a critical aspect of
financial modeling, and
requires careful data
collection, cleaning, and
validation.
COMPLEXITY-Financial
modeling can become very
complex, particularly for
large organizations or
complex financial
transactions. As models
become more complex,
they become more difficult
to understand and manage,
and may require
specialized skills or
software to build and
maintain.
CONCLUSION
Financial modeling is a critical tool for analyzing
and understanding financial situations, and can be
used for a wide range of applications, from valuation
analysis to risk management to decision support.
However, financial modeling is not without its
challenges and limitations, and requires careful
attention to data quality, complexity, uncertainty,
and human error. By following best practices and
using appropriate tools and techniques, financial
modeling can provide valuable insights and support
informed decision-making.
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Thanks!
Any questions?