What is Financial Modeling and How it is Useful?

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If you are involved in financial markets or business decisions at any level, you will likely have come across the term “Financial Modeling”.  Throughout the course of these experiences, you may have come to wonder what exactly financial modeling is, and how it is used within business.

Financial modeling is essentially a tool or process, run through, and displayed as a spreadsheet (most likely excel) which summarizes the financial position of a business, and can also detail the impact of future decisions or fiscal events in relation to the current financial position of a business.

What is Financial Modeling Used For?

Financial modeling is a key tool for many sectors with a business. It charts the overall financial position of a company and every aspect of how this is broken down. Top level executives may use financial modeling to chart the impact of any major decisions or changes upcoming within the company. The outcome of this process and how it affects the model can make or break the decision in many cases.

From a macroeconomic perspective, financial modeling may also be used to gain insight into how changes in government fiscal policy or other external issues could have on a company.

Mergers and acquisitions may also live or die depending upon the outcome of certain financial models relating to profitability and the overall impact on competitiveness and the bottom line.

Ultimately, financial modeling is one of the most utilized mechanisms to analyze the financial position of a company at any given time and is used both internally, and externally.

How Financial Modeling be Beneficial

There are various types of financial model in use during regular business practice; the likelihood is you have encountered many of these such as discounted cash flow analysis. Although these models are executed as spreadsheets, it does not mean they are simple or basic in any way. Modeling can be very useful thanks to some of the following characteristics:

Relationships within the Model

Any financial model is not just a stand-alone calculation. There are ongoing dependencies and assumptions within every financial model. These are the things which allow it to function in such a dynamic fashion, and produce accurate results when changes are made. This can save both time and money for businesses where one or two financial models can accurately predict the outcome of a given decision.

Ability to Test Situations

Implementing the correct financial model which is well-designed and executed, can allow businesses to test out potential strategies and how they may impact the company. This can all be done via the model. Making these projections without having to take live risk can be a very valuable tool for any business.

Forecasting Future Needs

As well as a firm’s current position, financial modeling can help to forecast the future position of a company based on the data inputs. This can allow directors or anyone else concerned to anticipate potential problems which may arise. These kinds of forecasts can be used to particularly good effect when trying to gauge value and the share price within a company. Supply chain managers and logistics may also benefit from certain types of financial model forecasts.

Final Thoughts

More than just a spreadsheet. This is the tag line which should be attached to financial modeling. These models perform a clear and integral function within everyday business decisions. Used by businesses around the world, they are the lifeblood of success for many. This is worth considering  if you are starting a business or thinking of introducing the use of financial modeling on an level.