How to Build a Financial Model in Easy Steps – Beginners Guide – Techbytes

Running a successful business is not only about providing superior-high-quality products and services today. Since the business world is constantly evolving and the competition in any industry can be brutal, every business owner and their staff must pay close attention to their present and future financial position.

While there are many different ways to approach financing a successful business venture, one of the most effective and accurate involves building a financial model. A financial model is essential for a number of different reasons, including forecasting the financial future of your business.

With that being said, one of the first things that you may need to know is, what is a financial model and how to build a financial model? A financial model can be described as a model that represents the company’s past, present and future financial picture. Similar to a business plan, it is the financial representation of what is going on now and a forecast of the company's future. And, it requires using real-life financial data to create a workable plan for your company’s budget, financial planning and other related financial activities.

To build a financial model for your company or the company that you are currently representing, here are:

Basic steps to building your financial model

Step #1 - Collect historical data

The first step in building an accurate financial model involves collecting the right type of historical data. As a general rule, you need to collect at least 3 years of financial data from your company’s financial records. The type of financial data that you gather from your company’s records will depend on the type of financial model that you will be building. For instance, the data that you collect may come from the company’s income statement, balance sheet, and cash flow statement. You may also collect financial data from additional sources based on your company’s specialized needs (ie. sensitivity analysis, valuation, and etc.).

Step #2 - Calculate metrics and ratios

Once you have gathered all of the financial data that you need from the resources noted above (cash flow statement, balance sheet, and income sheet), you can use these data to calculate your company’s metrics and ratios. For example, you will be required to use three years of data to develop a financial picture in numbers. And, the numbers that you generate will be very valuable for forecasting growth margins and rates, inventory changes, and asset turnover ratios.

Step #3 - You can make informed assumptions

Once you have collected all of the historical data from your company’s accounting records, you can now use this information to build the company’s future metrics and ratio projections. For instance, if you want to know what the future projections are for changes in inventory, growth margins and ratios, and assets that may turnover, you can use this data to make appropriately informed assumptions.

Step #4 - Create a forecast

The next step in building a financial model is to utilize all of the above info and reports to forecast the company’s accounting documents(i.e. future cash flow statements, balance sheets, and income). To complete this part of the process accurately, you will need to reverse the original calculations for historic metrics and ratios. For instance, to build out the forecasted statements, you need to use the previous assumptions.

Step #5: Value the company

If you want to know the value of the company at any point in time, you can use these forecasted statements to value the company. You can do this part of the process by using the Discounted Cash Flow or DCF method.

Step #6. Financial modeling review

When you have all of the appropriate information in hand, you can use your drafted statements to determine how particular scenarios will most likely play out. This part of the process will help you to review the financial model for a wide range of things, including its overall accuracy and easy to read and understand layout.

Evaluate your model to see if it is comprehensive and effective

Now that you have followed all of the steps listed above, you need to go a little bit further in this process by evaluating the financial model that you have built. By evaluating the intricacies of your financial model, you will have a chance to see how good or effective it is. For instance, you may want to ask the following questions to see if your financial model can stand up to the test.

• Does the model have a good structure? Or, is the model structured well?
• Does the financial have a simple-to-read and understand layout?
• Is the information contained in it easy to understand?
• Is the financial model accurate?
• Does the model contain the appropriate visuals?
• Are future assumptions and forecasts clear?
• Does the financial bring to light what the fiscal officers are actually looking for?
• Are all of the elements of the financial model things that officers care about?

Whatever the answers to these questions may be, a good financial model must follow best practices and has to be detailed enough to account for a wide range of complex business circumstances. Therefore, even before you get started, you need to devise a specific plan that will guide you through the entire process.

Benefits of a good business financial model

There are many great benefits to building a financial model today. Some of the most beneficial include the following:

• You can use real numbers to devise a plan for the company’s future growth needs.
• These plans will help the business owners to create accurate budgets and will help a company to determine when they should make investments into more costly equipment that will be needed to grow the business.
• If you are looking for investors in the company at any point in time, you can show the company’s financial model to help them make informed decisions.

Conclusion

Today, building a financial model for your company is not a luxury but a necessity. This is because a financial model can help business owners make informed assumptions about the company’s budgets, financial planning, and other accounting decisions.