A fully functional financial model needs to be modular so you can later adapt it to more detailed schedules if necessary. For example, we will initially project revenue by making a percentage growth assumption, however in the future you can (or arguably should) make a detailed revenue schedule based on they key factors (macroeconomic, microeconomic or both) that drive revenue growth. Many of the To accomplish this, you need:

1. Consistency – Is the value in thousands, millions, or ..? What does this color mean?
2. Clarity – Where is this cell getting its data? What does this cell do?
3. Repetition – Only enter any assumption once, and then reference it from other parts of the model.

Color Conversions

• Blue – These are assumptions you enter
• Green – These are direct references to one or more sheets
• Black – These are calculations that occur on the active page or references within the active page

Turn Iterations ON – The circular model will not calculate if iterations are turned off

1. Press ALT, T, O (in sequence, not at the same time)
2. Click on the tab titled Formulas (in Excel 2007 and later only) or Calculation (in Excel 2003 and prior)
3. Check the box for Enable Iterative Calculations (Excel 2007 and later only) or Iteration (in Excel 2003 and prior)
4. Set the “Maximum Iterations” field to 100 and the “Minimum Change” to 0.001 (both of these are the default values)

Don’t hard code values into formulas – always reference the inputs you entered.

• 
  For example, in cell B3 (shown above) you reference the 8% growth rate in cell B1 rather than entering 8% directly into the formula
• This ensures that you model remains accurate when you update these values later

Adjust page formatting at the beginning of this process to ensure it is duplicated consistently.

• I recommend:
  • Page
    • Landscape orientation
    • Fit to 1 page by 1 page (for short projections) or 50% normal size for longer projections
      
  • Margins
    • Top Margin: 1 inch
    • Bottom Margin: 0.5”
    • Left and Right Margins: 0.5”
    • Center Horizontally on Page
      
  • Header/Footer
    • No Header
    • Footer containing the file path and name, time and date
      
    • Footer contents should be in 9 point font and not be scaled with page
      

Some final tips:

• Use “Center Across Selection” instead of “Merge Cells” when formatting
• Never “Hide” cells. If you don’t want them displayed, group them by pressing CTRL + Shift + Right Arrow, or Shift + F2)
• Make extensive use of Cell Comments (right click on cell and “Insert Comment”) to note where the input or formula came from. This prevents “What was I thinking syndrome” the day after.
• Utilize Custom Number Types for the type of number that will be in the cell. This format ensures that the numbers and percents will all line up nicely:
  • For numbers: #,##0.0_);(#,##0.0)
  • For percents: 0.0%_);(0.0%)
    
  • In Excel 2007 and later, you may want to define this as a custom style and also include the color, so you would have:
    • Input – Number
    • Input – Percent
    • Referenced – Number
    • Referenced – Percent
    • Calculated – Number
    • Calculated – Percent
      – Select New Style:
  • When you need to hide a calculation for presentation purposes, use the custom number format ;;;
    • Don’t forget to leave a comment, so you don’t accidentally delete the cell in the future
    • This is better than setting the font color to be white because, when printed, white colored fonts print as black

I cannot urge you enough to keep up with the above recommendations. The time it will save you in the long run is incalculable.

Next: The Core Statements [not yet completed] (or go back to the beginning)

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