The Two Key Elements
Needed to Build Powerful
Financial Models
Introduction: Modeling is a Discipline
A financial model is a critical decision-making tool that allows users to make accurate and
informed financial decisions about a company. A financial model needs to serve as a powerful
communication tool to clearly and effectively tell the story of a company to decision makers
and to stakeholders.
A builder of financial models requires skills in accounting, finance, modeling software (such as
spreadsheets) and overall business knowledge in order to effectively forecast a company's
financial statements into the future.
1. The Key Attributes of a Model
To achieve the goals set out above, a model needs to be developed with the following attributes:
a. Dynamic: changes to assumptions properly flow through the model
b. Flexible: modular in order to facilitate easy expansion and changes to the model
c. Intuitive: layout/flow mirrors how people think about the business
d. Transparent: easy to follow with no giant formulas or hidden sections
e. Printable: in a clear and easy-to-read format on paper
f. Transferable: built by one person but usable by many
When a model achieves the criteria above, it creates tremendous credibility for the builder and
inspires confidence with the reader. A well-designed model needs to work in two ways:
1. Electronically - a model must be simple to review / audit / manipulate in a spreadsheet to
ensure it can be used as a tool in the decision-making process
2. In printed format - many senior executives and other decision makers prefer to review
financial analysis on paper or as PDF documents (rather than reviewing a spreadsheet).
©2022 Financial Modeling Institute
2. Model Planning
It is critical to properly plan and design a model before it can be built.
Whenever a model becomes filled with errors, it is often because the modeler did not
properly devise a model plan. A model built without forethought is often chaotic and
requires many additions on a weak foundation.
A model builder needs to first understand how a business operates, which requires:
Reviewing the historical financial statements of the company (including the Management
Discussion & Analysis and Notes to the Financial Statements).
Learning about the industry in which the company operates (i.e reading industry journals
and equity research reports).
Deciding on the key drivers / critical success factors for the industry / company.
Creating a list of questions to help identify and gather all the assumptions that need to be
made in the model.
Understand the purpose of the model (i.e is the model to be used for valuation?
Credit assessment? Project evaluation?)
Identify the required schedules and components to be included in the model.
Schedules should be planned for all specific calculations needed in the model, such as
revenues, costs, depreciation, working capital, etc.
Take some time to map out these components and model flow, the same way you would
when creating and outline for a presentation. Create a skeleton of your model.
©2022 Financial Modeling Institute
As part of the planning process, the model builder should also be able to answer the
following questions:
Can a reader of the model understand the operations of the company?
Have the operations been modeled correctly?
What is the right level of detail required in ther model?
Have the assumptions been challenged and vetted?
Which assumptions are key drivers to be tested as scenarios?
Is there enough historical detail to validate the required amount of forecast detail?
What is the important output that the users want to know?
What metric is used to measure results?
How many time periods should be included in the forecast? Why?
What's the appropriate periodicity for the model (e.g monthly, quarterly, annual)?
What is the most logical order to present the data?
©2022 Financial Modeling Institute
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