Introduction to Financial Modeling

A lot of people, years into their marriage, often wonder whether there could have been an effective mechanism to forecast the success of the relationship – an Excel tool where one could plug into variables related to the bride and the groom – and the model would come up with a prediction – “Hey, there is an 82% probability that you will make a great couple”

Unfortunately, such a tool doesn’t exist and we have to brace ourselves to live with our spouses as they are 

However, we are lucky that when it comes to making decisions like the ones related to intrinsic value, valuations, mergers & acquisitions, project financing etc., we have the financial model come to our rescue. 

A financial model is simply a tool that’s built in, say, MS Excel to forecast a business’ financial performance.  The forecast is typically based on the company’s historical performance, assumptions about the future, and requires preparing an income statement, balance sheet and cash flow statement. 

The corporate world is struggling to find enough professionals who can prepare financial models for complex business models and yet make them SIMPLE TO UNDERSTAND. The intellect and interest lies in making a simple, scalable and robust model.

Concept

So let’s say, you have a power plant as follows on the left side of the image but you can also build a working model of the power plant like you see on the right side of the image:

So, a model is a representation, generally in miniature, to show the construction or appearance of something.

Remember that financial models apply not only to a company but also to personal finance. We will discuss both of them in the subsequent units.