Financial Modeling: Key Concepts
The focus of this series of posts is to teach you the fundamentals of financial modeling so that you can apply them to any number of areas. This method of financial modeling is different that many presented on the internet in that it is fully circular, meaning that updating any variable will affect all calculated values in the workbook. For instance, changing the sales growth rate will not only affect the income statement, but also the balance sheet, debt and interest schedule, and all other schedules.
This assumes that you have a moderate level of experience understanding and utilizing corporate financial statements and using Excel. If you are not familiar with financial statements, here are some useful resources. If you are using a version of Excel earlier than Excel 2007, you will need to install the Data Analysis Toolpak to have access to some of the functions used.
Constructing an effective financial model takes a blend of skills, including accounting, corporate finance, and Excel, but most importantly knowledge of the company’s operations. For existing companies, you need to rely on historical trends to develop meaningful assumptions for future financial trends. My friend Taylor Davidson, has a great list about the information you need to start a financial model and I agree:
- What is the business? What is the product / service?
- How do you target, and acquire customers?
- What are the revenue streams? (prices, sales of products or services, advertising, usage fees, etc.)
- What costs will the business create? (items and estimates, employees, hosting, SG&A; fixed costs, variable costs, etc.)
- What timeline of development and product launch and market / customer adoption are you expecting?
- What do you think are the major drivers of revenue and costs?
- What do you know about the market? (# of potential customers, $ spent currently, market trends, growth, competitors, etc.)
- What lessons, revenue / cost models and performance / operational metrics exist from studying existing competitors and complementary and substitute products?
You must also fully understand why you are constructing this model as the assumptions you develop will need to be in line with that objective. A solid financial model must be reasonable and you must be able to defend your assumptions and the projected performance. If you cannot, you may as well save the hassle and invent the numbers now.
For simplicity’s sake this model tutorial is based upon an existing public company, but once you understand the process it can easily be modified for startup businesses, joint ventures, or any other type of business. Remember, businesses may be different but finance remains the same.
It will take about six hours to read all the posts and complete the exercises. It is important that you do not skip to the end. If you are just looking for a completed financial model, the finished model is available HERE, and some other examples can be found here and here.
Items are linked as they are posted, or search for the Financial Modeling Tutorial tag:
- Excel Best Practices
- The core statements
- Working capital schedule
- Depreciation Schedule
- Amortization Schedule
- Other Long Term Item Schedules
- Completion of Income Statement Logic
- Shareholder Equity Schedule
- Shares Outstanding Schedule
- Preparing for Debt and Interest
- Debt and Interest Schedule
- Troubleshooting your model
- Explaining the finished product
- DCF Analysis
- Proofing your model
- Creating scenarios
Next: Excel Best Practices
Category: Financial Modeling
