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A Beginner’s Guide to Understanding Financial Models

65% of businesses fail during the first 10 years of operation. If you want your business to stand the test of time, you need to plan well and make use of all the data that you have available. 

Financial modeling is a process that helps businesses forecast future performance and make better decisions about finances. Making use of financial modeling can help your business plan its next steps and avoid making critical errors.

In this beginner’s guide, we’ll tell you what you need to know about understanding financial models.

What Is Financial Modeling?

Financial modeling is a process that’s used to forecast and analyze the financial performance of a company. A financial model will usually be based on a company’s history. Past data will be used to make future performance predictions.

A financial model will consist of a simple spreadsheet that was built in Microsoft Excel but could be created in another type of software instead.

Types of Financial Models

The Three-Statement Model serves as a foundation for other types of financial models. This type of financial model will include three main sections which include an income statement, a balance sheet, and a cash flow statement.

Other types of financial models include a Discounted Cash Flow (DCF) Model, a Merger (M&A) Model, an Initial Public Offering (IPO) Model, and a Leveraged Buyout (LBO) Model.

Why Use Financial Modeling?

Financial models are used for many different purposes. Primarily, they help leaders of an organization to make better financial decisions and set better goals for the future.

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Some of the main decisions that a financial model may help with include the following:

  • Raising capital
  • Acquisitions
  • Business growth and entering new markets
  • Budgeting and forecasting
  • Business valuation
  • Credit analysis

Having solid financial data and future predictions can help a business get funding. It can also serve as a guide when making big changes such as entering a new market or opening new locations.

Which Software Is Used for Financial Models?

In most cases, a business will choose to use Microsoft Excel for financial modeling. Excel provides a lot of flexibility and can be customized for the specific needs of each business.

Many accountants and financial professionals are familiar with Excel, so it serves as a good choice for those who create financial models. They’ll be able to input and visualize business data easily.

There are other software options available for creating financial models as well, but generally speaking, most businesses will be happy to use Excel since it does a great job of meeting the needs of financial model creation.

Who Is Financial Modeling For?

Many different types of professionals build and use financial models.

Financial modeling is especially common in industries in the finance sector. This includes investment banking, business development, accounting, financial planning and analysis (FP&A), private equity, and valuation.

Financial models can do a great job of informing any company that wants a clear view of what could happen in the future. All types of companies should consider using them as part of their operations.

If you’re interested in the benefits of financial models, you may want to use professional financial modeling services. 

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Understanding Financial Models

If you want to plan for the future of your business and make informed decisions, financial models can help. Financial modeling will use past data to forecast future performance and can help you get funding, enter new markets, and better understand your business.

Searching for more helpful business tips? Browse our blog now to find more financial guides.

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