Financial models are integral to every business. Whether you’re a startup or a running business, you will require creating a financial model in excel. It is highly relevant for you to do this to help forecast your future growth and revenue. But what type of financial model should you be going for? Well, this depends on what your requirements are. Here, you will understand ten different types of financial models and how to go about creating one.
The first question you want to address before diving into different types is what financial models are? Essentially, they help you forecast your finances and get future projections to help you run your business better. Financial models are also essential for your business plan, so you want to make sure you’re creating the right one for your business. Doing so will give you a good basis to create budgets for your business and go about allocating resources better.
Now, let’s get into the details of the ten different types of financial models you can create for your business. Each of these depends on what your business requires. So, if you’re looking to create a basic model, then the 3 statement financial model in excel is a good choice. However, if you’re planning on a merger or another business acquiring yours, you’d want to create a specific model for merger and acquisition. It’s all relevant to what your business needs.
The first one, and the most commonly used financial model in excel, is the 3 statement financial model. It is one of those financial models that almost every business creates for their budgeting and forecasting needs. It is highly relevant to the business, and as the name suggests, comprises the three basic statements made by a business throughout its course of existence. You will find the financial model in excel to have the income statement, statement of financial position, and the cash flow statement forecasted for the business.
An advanced version of the 3 statement model is the discounted cash flow financial model in excel. Here, you don’t stop at the cash flow statement. Instead, you take a step forward and create a discounted cash flow to understand the business’s present value. It is necessary when it comes to the valuation of the business. Every business needs to know what they will value after a certain period. Therefore, it is important to make the discounted cash flow statement to understand whether your business will generate a positive NPV or not.
Financial models in excel are easily tweaked to fit your requirement. No, this doesn’t mean you make changes in the data and gravitate it more towards how you want it to look. Instead, you can add relevant data to fit your business requirements. For instance, in this financial model in excel, if a business is going public, then the business owners would want to value it beforehand. It is more relevant to stock trading notions and undergoes comparable company analysis, unlike other financial models. So, you will not find this financial model used by every business as it is relevant to only those businesses seeking to go public.
Next, we have the leveraged financial buyout model in excel. So, how is this different from the others? In this, you require highly detailed and complicated modeling that isn’t required for every business. You will not find this commonly practiced, as this is mainly limited to being used in investment banking. You need to have advanced knowledge of financial modeling in excel to create this model. There are detailed debt schedules and whatnot that you come across here. The best thing to do to create this financial model is to hire a professional CFO service. Doing so will allow you to end up with an authentic LBO financial model in excel.
Let’s move on to a rather simpler model than the ones we have discussed. Budget financial models in excel are necessary for a series of things in a business. The number one reason to create this is to have sound financial planning. Doing so will allow you to understand where to place your funds over the next few years that you run your business. By knowing this beforehand, you will avoid making mistakes that will result in a higher cash burn rate. Instead, you will have modeled all the possible assumptions that will offer you a decent cash burn rate and allow you a positive cash inflow.
We would put budgeting and forecasting together, but they are very different when it comes to the application bit. You create the budget model based on the forecasting one sometimes. Other times, you compare the two to find out the variation in them. So, while they may seem to be talked about interchangeably, they have different jobs associated. In your financial forecasting model in excel, you will add all the relevant assumptions to assist financial planning. Doing this will allow you to see what you might expect from your business over the next few years that it is operational.
Another type of financial model in excel is the option pricing model. In this, you will find a variation of two methodologies that include the Black Scholes model and the binomial model. It all sounds very confusing, but you don’t have to do much for them. There are built-in formulas in excel that help you figure out the values and create your option pricing financial model. As the name suggests, this model is mainly related to the pricing of options that include call and put options.
There is a range of other financial models that you will find. All of them mainly depends on the needs of a business and its financial goals. But, how do you go about creating one from the basics? Here, you will understand what you need to create a basic financial model in excel that will help forecast and budget for your business.
One of the main things that you will have to do is get historical data of your business. In case you are a startup and do not have previous data that you can use, you will have to look at the industry data. Doing so will help you come with plausible assumptions for your business. On the other hand, as an established business, you can easily use the market data available, and all the previously made financial statements.
Once you have all your data at hand, you go into creating your assumptions. These are the inputs that you add to your financial model in excel to help you forecast it. So, what would include in them? You will need to create assumptions such as the revenue growth rate, forecast expenses, and other financial activities of your business. You will also include any potential changes that you might hope to see in your business, such as getting more investment or planning any business expansions.
After you have completed your assumptions sheet, you will move on to the financial statements to add all the relevant data. You start with the income statement and then move on to the rest of the financial statements. In the income statement, you consider every assumption relevant to revenue, expenses, financial costs, profits, and more. Moving on, you start with the balance sheet in which you incorporate all the balance sheet assumptions, and then add the retained earnings from the income statement.
Next, you get to your cash flow statement, which will be after the first two statements are made. You don’t make any assumptions for the cash flow statement. Instead, you take balance sheet differentials to create this financial statement. To ensure that your cash flow projections represent a close estimate of what your business will actually do in the next years, you will have to make use of sound assumptions for the balance sheet.
Finally, once you are done with all of the financial statements depending on your business requirements, you will have to test it out. To do this, you can conduct a series of scenarios or sensitivity analysis. Doing so will help figure out whether the financial model in excel is robust or viable enough or not. It is highly advised that you go ahead and do this to validate your assumptions and see how well your financial model in excel is linked.
So, who does all the preparation for your financial model in excel? Generally, the chief financial officer you hire will be a part of your financial plan. Therefore, they will be the ones creating the financial model for your business. Since this is such an essential part of your business plan, you want to make sure that you hire service with the right skills for the job.
We, at Oak Business Consultant, are experienced in providing consultations on such matters. Go ahead and look at how our CFO services can help you with this highly technical and critical success factor. Visit our website at Oak Business Consultant, and get a free consultation.