Financial modeling estimates the future financial performance of a business. It combines accounting, finance, and business metrics that come together to form the estimate. Relevant factors, such as growth and risk assumption, as well as their impact, allow business owners to gain valuable knowledge of all financial forecasting variables.
Financial models are, essentially, a long series of interdependent calculations, so adding new information can have a chain reaction, affecting multiple areas at once. It gives you a solid picture of what to expect over a set time frame. Financial situations that are volatile or complex require a business owner to use a model to gain insight into the scenario’s components. A financial model can show you how much cash flow could be potentially generated from a certain project or which areas require more capital.
In this article, TPI Group explains how to make a financial model and why they are essential for financial planning.
What Are Financial Models Used for?
Because financial models are a type of financial analysis, business owners and executives can use them for decision-making in all areas of their business, such as:
- Budgeting and Forecasting
- Organic Business Growth
- Raising Capital
- Company Valuations
- Acquiring New Assets/Businesses
- Prioritizing Projects
From pitching investors to securing loans, financial models are the easiest way to assess company performance, risk levels, and projected outcomes.
Financial Modeling Examples
The basic financial model, also called a three-statement model, has the core statements linked together in a dynamically connected financial model: the income statement, balance sheet, and cash flow statement.
The three-statement model provides a good foundation for advanced financial models, such as discounted cash flow (DCF) models, leverage buyout (LBO) models, and other variations.
The Elements of a Three-Statement Financial Model
Now that we’ve answered the big question: “What is financial modeling?” we’ll provide the elements you need to create a basic model yourself. You will need your company’s:
- Historical Performance
- Driving Factors (e.g., revenue growth, margins, capital expenditures, etc.)
- Revenue Details (e.g., gross profit, expenses, total expenses, etc.)
- Capital Assets (e.g., property, plant, and equipment (PP&E), etc.)
Along with the information above, you will also need to build a debt schedule. It will allow you to calculate interest expenses.
With all of the available data entered into your spreadsheet, you can move on to the forecasting part of the process. In order to complete the three-statement model and determine your company’s forecasted performance, you will need to link the items that have been previously calculated, making sure to cover these main sections:
- Cash from Operations
- Cash from Investing
- Cash from Financing
As you can see, financial modeling is an involved process. If your company doesn’t have the internal resources to create an effective financial model, the experts at TPI Group can provide guidance and analysis to help you succeed now and in the future.
Who Uses a Financial Model?
Financial models help a wide variety of decision makers—including owners, directors and managers—guide their decision making processes.
Creating financial models and leveraging the insights they provide is a complex undertaking, which is why so many business owners decide to consult with financial professionals. Someone who has experience in accounting, financial planning, investment banking, and corporate finance would be able to answer your questions and devise financial models relevant to your company. TPI Group has the financial expertise you need.
Keep Your Financial Model and Financial Statements in Order
For over 20 years, TPI Group has helped high-income individuals and various businesses with their taxes, financial planning, accounting, and much more. We have a thorough understanding of the vast financial landscape and can help you create financial models that lead you toward success.
Contact us today to get started!