The guide to developing a financial model

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A financial model is a digital presentation of how any business or company operates. Businesses use a well-designed financial model for decision making, forecasting business financial performance, and setting the proper direction for a growing business.

A personalized financial model is like an engine that runs on fuel. We provide our financial model with tight assumptions such as salaries, cost of goods, expenses, and a customer acquisition cost that runs like fuel. As a result, we get the output such as planned income statement, balance sheet and cash statements.

Research-based assumptions are key for any financial model to provide accurate projections. And using these assumptions, companies use financial analysis and modeling as a powerful decision-making and forecasting tool.

This article will provide a comprehensive guide on building Financial Models and some tips for success, as many beginners find it difficult to develop a Financial Model in Excel due to its complexity. But before we jump into some tips and resources on developing financial models for investors and a startup idea, it’s important to understand the basics.

Types of financial models

A tool that helps analyze and improve the dynamics of a company’s finances is a financial model . Its main purpose is to predict financial results in the future. A company hires different professionals to create such financial analysis models and update them.

Here are the main types of financial models companies use:

Three-stage model
Discounted Cash Flow Model
Merge model
Consolidation model
Budget model
Forecast model
Options pricing model

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And when it comes to choosing the type of model, it only depends on the needs of the business and the interpretation of business financing. It is simply because the main objective is to analyze the finances of the company correctly. For better understanding, below is the main screen of a well-designed financial model.

The guide to developing a financial model

What makes a good financial model?

Although your company’s financial model model, you should care about some parameters. These settings help you build a nice, smooth, and easy-to-use financial model.

Some of these settings are listed below:

Realistic assumptions

The main objective of an effective and efficient financial model is to help the company anticipate its performance in various scenarios. To this end, to be successful, the selection of assumptions must be realistic and appropriate.

All financial modeling and analysis is based on assumptions, and the selection of assumptions is reflected in the production of the financial model. Thus, the assumptions should be close to reality and trustworthy so that the model remains true, reasonable and represents reality. An example of realistic assumptions is given below.

Flexibility

Flexibility is another vital key to effective and efficient financial modeling. As a financial model needs to run various scenarios with a period extended by different analysts, so it needs to be flexible enough to plug in multiple data Cash flow projections, amortization schedules, inventory level, debt repayments and level management of inventory.

Due to the flexibility, a financial model can adjust and manipulate any field to produce the projections for long periods such as one year, two years or even five years. Below is an example of a flexible financial model gloving the major financiers with simplicity.

Easy to use and understand

A financial model is maintained by financial analysts and business owners. The results are presented to lenders or bankers for funding, so it should be easy to use and understandable by ordinary people. In fact, a well-designed financial model makes the complex simple to use and understand.

Below is an example of an easy-to-read and understandable production of an effective financial model.

Charts and graphs

Clear communication of results is another key to effective and efficient financial modeling. The most effective way to present the results of the financial model is through charts and graphs. Charts and graphs present the numbers in a vivid and clear form that are easy to grasp and understand by most of the executive who doesn’t have enough time to read the numbers and go in depth for the results.

Below is an example of presenting complex data in easy and stable form of graphs.

Which software to use to create a financial model?

You can use any software or programming language such as VBA to build a financial model to ensure quality and standard at the highest level. However, Excel is by far the most common and trusted platform for creating financial models. Apart from its affordability, it has many other qualities listed below that make it the number one choice for most financial model builders for their startups.

Completely flexible and dynamic.
Frequently used by ordinary people.
Extremely affordable.
Requires no training to use even for beginners.
Transparent and easy to audit.
Easily editable.
Customizable according to your needs.
Easily integrate with other finance software.

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Best practices for building a financial model

When dealing with finances, simply relying on personal thought or instinct seems like the wrong choice. Instead, the best thing is to test situations, interpret financial results, and make better choices based on financial model best practices . Consequently, the financial modeling industry is moving towards near perfection in creating reliable and profitable models. Investing in financial modeling is one of the high priorities over the next two years (26%), according to information from Statista.

Below are some strategies for building a perfect financial model.

Use an Excel spreadsheet

Excel is the software of choice, which almost all companies and financial institutions use due to its versatile and customizable nature. Moreover, special techniques in Excel can be used to make the work easy and presentable to the daily user.

Here are some of the tips to use the best potential of Excel.

Use various keyboard shortcuts
Minimize or eliminate mouse use
Use simple calculations and formulas
Using the group feature to unify sections
To locate complicated formulas, use F5
Add grid lines to graphs to align points
Use index matching instead of VLookup
Use date functions to make a date more dynamic

Proper formatting

Financial Model Building best practice is to clearly distinguish inputs and outputs. You can achieve this clear formatting by using colors such as yellow for inputs and gray colors for calculated results or projections.

Below is an example of clear inputs and outputs.

Layout and design

Apart from better than average Excel skills, professional financial model developers also focus more on Excel spreadsheet organization. Structuring is important for businesses, which helps them locate the essential parts of the model. The structure of the financial model should be logical and easy to follow design. You can achieve an easy design by building the whole model on a spreadsheet and use grouping to create different sections. It helps to get the information quickly without searching all the worksheets.

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Below is an example of a well-grouped financial model.

How to build a financial model for a startup?

For a structured and well-designed financial model , you have to design each part separately, and in the end, you link these parts together to build the complete financial model.

Below is the step-by-step breakdown of each model, where to start from, and how to tie all these models together to develop a fully functional financial model.

Prepare hypotheses

Any financial forecasting model depends on the assumptions unique to each company. These assumptions include relevant business topics such as revenue, cost of goods, capital, salaries and expenses. Due to high significance, assumptions should be considered serious and reasonable and require proper research and critical thinking.

For a new startup, assumptions should be based on the actual needs of the model rather than a hard-to-use list. These assumptions drive the entire financial model and are commonly referred to as the drivers of many businesses. Below is an example of well-documented and close assumptions used as input to the financial model .

Prepare the income statement

The revenue statement reflects the revenues and costs of a business which decides the profit and loss and leads to well documented assumptions. A well-designed income statement consists of revenue, COG, gross margins, EBITDA, EBIT, and net profit. Each of these headers contains numerous sub-level entries to accommodate every cash transaction in the enterprise.

Below is a visual example of a revenue statement that sketches a complete picture of the transaction all arbito within a specified time frame.

Prepare the balance sheet

The balance sheet is a complete picture of your business, reflecting assets, actions and liabilities. It is an indicator of the financial health of your business. You can easily generate the balance sheet after building the income statement and put the assumption in place.

Below is an illustration of a Sample Balance Sheet that is generated based on assumptions and derived from the income statement.

Build a Cash Flow Statement

A cash flow account is an important document in any business financial modeling that reflects the cash flows in your business for a specific period. Besides business needs, investors want to see what a startup is doing with its money. It assures investors that their payment is being used appropriately and that the company can repay debts and loans.

Below you can see a cash flow account that was made with the help of the other two statements.

Make your sheet of excellent professional

In conclusion, note that financial modeling is necessary for financial services and the tips above can improve their functionality. The basic concept of financial modeling practice is to reduce the loss. Also, provide financial forecasts using top-down, bottom-up, or regression analysis, followed by related statements using some basic calculations. And finally, represent all the calculations using graphs or simple graphs to have effective results.

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What if you don’t have enough time to build a financial model in Excel or you don’t have a pretty knowledge of Excel spreadsheets? Don’t worry; FinModelslab is there to help you with its well-designed and practical financial models. And out of these, one will best suit your business needs.

Here is an example of one of the financial models designed and prepared by FinModelslab To present you with a well-documented and easy-to-use financial model.

These financial models are designed to provide you with efficiency and accuracy with little effort. You need to enter all your assumptions into the dashboard once, and you get the five-year projections right on your screen in real time. You don’t need to wait for your model to perform complex calculations and you get the result of your hypothesis both in absolute figures and in colorful graphical charts.

Once you enter your desired scenario, you can get an income statement, cash flow statement, and balance sheet in one click that looks like the one shown below.

These aren’t the only results you get from FinModelsLab’s financial model; Instead, you get many financial production reports like Top Revenue, Top Expense, Breakeven Analysis, Valuation, Fin Charts, Operational Charts, KPIs, Chart Sources and Uses, Cash Flow Statement with indirect method and much more.

FinModelslab has designed a variety of financial models to meet the needs of every business. Below are some of the header categories which contains dozens of financial templates to suit your needs.

Agriculture
Beauty and sports
Care and education
Cleaning, repair and services
E-commerce
Entertainment and leisure
Finance and professional services
food and drinks
Health care
Hospitality
Manufacturing
Marketing and consulting agency
Market
Real estate
Retail
Software as a service
subscription box

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Don’t waste your time with complex Excel formulas if you are not an expert on them. Instead, visit FinModelslab and start using your financial model shortly after selecting one.

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