Creating a basic financial model in Excel can be a powerful and useful tool for businesses and individuals alike. This model can be used for budgeting and forecasting, among other tasks. Its purpose is to provide a representation of how financial performance could change over time and how the decisions made could affect it. Financial modeling is an important part of the financial decision-making process, as it allows users to understand their financial situation and map out their desired future financial position.
There are numerous benefits to creating a basic financial model in Excel. It allows businesses and individuals to better understand their financial situation, as well as understand the effects of certain decisions on their finances. It also allows for easy comparison of various financial scenarios, as well as for easier budgeting and forecasting. Furthermore, it can be used to measure the success of certain strategies and tactics adopted. Finally, it can help identify areas for improvement and cost savings, which can be significant for businesses.
For a beginner financial analyst, Microsoft Excel is the best software to create a basic financial model. With its user-friendly interface, powerful tables and calculations that can be done quickly and efficiently, the software is capable of delivering the most complex financial models.
Apart from Microsoft Excel, there are many other software packages which are able to do the same job. The best among these include OpenOffice, LibreOffice, and Google Sheets, which are all free to download. These could be great alternatives if Excel is not available.
Creating a basic financial model in Excel requires some knowledge of data entry, the ability to recognize trends and patterns, and the basic capability to build an Excel spreadsheet. Here is a step-by-step guide on creating a basic financial model in Excel.
In order to create a financial model in Excel, you need to make sure to collect data from reliable sources. Data sources such as company financials, SEC filings, analyst research, and other industry sources can provide valuable data for making decisions and forecasting outcomes. Once you've gathered the data, it’s important to make sure the data is up-to-date and accurate.
Following the gathering of the data, it’s important to organize the data into meaningful inputs. An organized matrix of companies, products, markets, and other characteristics will help inform your model. Once the inputs have been defined, it’s essential that you also create input-level labels and descriptions to make sure that users understand the assumptions behind the model.
Once you've organized the inputs, it's important to develop and define assumptions. Assumptions are best described as estimates and forecasts. Such assumptions should take into account historical data, current trends, and whatever other detailed information you may be able to find. An appropriate set of assumptions should be sufficient to generate meaningful outputs.
The final step in creating a financial model is building the model logic. This involves creating formulas and equations to calculate outputs based on the inputs and assumptions that you have defined earlier. Excel’s functions and functions such as SUMIF, IF, VLOOKUP, and INDEX-MATCH can be used to build these formulas. After you have built the model logic, it’s important to run various tests to ensure that the model is sound and accurate.
Visualizing the Model
The careful analysis of numbers and calculations within a financial model can quickly become burdensome. Therefore, it is useful to find a way to represent the information visually so that users can quickly catch insights and key items. Here are a couple of ways to make your financial model outputs graphically appealing.
Making the Outputs Graphically Appealing
By starting with a good layout and design, users will be more engaged with the content. A financial model should be organized in such a way as to allow a user to easily understand the inputs, calculations, and outputs. Being mindful of the colors and amount of text used can go a long way in making the environment more user friendly. For example, integers could be green while strings could be blue. This provides the user with a sense of organization that would otherwise be lacking.
Different Types of Visual Representations
Depending on the data being represented, there are numerous ways to make the information visually easier to understand. Here is a few of the most popular methods:
- Bar Graphs: used to represent discrete information such as monthly expenses.
- Pie Charts: used to represent how a whole is broken down into smaller parts.
- Line Graphs: used to represent changes over time.
- Scatter Plots: used to show the relationship between two different variables.
- Venn Diagrams: used to show the overlapping relationships between two groups.
Visualizing the data in a financial model can make it easier for stakeholders to understand the information. Choosing the best type of graphical representation involves having an understanding of the data, the audience, and the purpose of the representation.
After populating your financial model with data and formulas, you will need to calculate the results. There are two approaches: using in-software formulas, or using macros if needed.
Using In-Software Formulas
Forbuilt-in functions in Microsoft Excel, you can easily calculate averages, counts, sums and other calculations. Great for simple models that require few calculations. For example, use the function =SUM to add up numbers.
Using Macros if Needed
If your model is complex and needs to perform cross-column or cross-row calculations, you can use macros to create the desired outcome. Being able to program the macro will allow you to calculate the values you need quickly and efficiently. You can also use a macro to automate data-extraction and display the results in a user-friendly format.
Macros provide more accuracy than using in-software formulas and can be used to streamline large models. If your model is extensive, it is best to consult a professional programmer to create the macro.
Once a financial model is complete, rigorous testing is required to ensure the model is functioning correctly. The two techniques commonly used in this process are reviewing formulas and spot-checking outputs.
Reviewing formulas is an important process that should be utilized each time a model is built or modified. Depending on the size and complexity of the model, this might sometimes be a trivial process and other times might involve a significant amount of time. Regardless, it is of utmost importance to review all formulas to ensure the model is calculating all the necessary values correctly.
This review process can be done in a variety of ways, but all of them involve going through each of the formulas cell by cell and determining if the formulas match the expected calculations. For example, if a cell looks like it should be calculating a subtotal, the user should look in the formula and verify that it is indeed a subtotal formula. If the cell is not performing the expected calculation the user should adjust the formula until it is working correctly.
Spot-checking outputs is the second common method used in debugging a financial model. In this process, the user scans key output areas of the model, typically summary tables and charts, and compares the values to external sources or assumptions to ensure the model is producing accurate results.
Any discrepancies should be investigated further with the aim of determining the source of the mistake and correcting for it. In some cases, it could be that the assumptions used in the model are not reflecting the desired reality, in which case the assumptions might need to be adjusted. If a formula is producing inaccurate results, then the formula should be reviewed and corrected, if needed.
Debugging a financial model is an important process that should not be overlooked. Taking the time to properly review formulas and spot-check outputs is crucial to maximizing the accuracy of the model.
A financial model is a powerful tool to understand the financial performance of a business. By following the steps outlined in this article, you have gained the knowledge to create a basic financial model in Excel. To recap:
- Create a spreadsheet that displays the financial inputs and outputs of your model.
- Include financial formulas in the model to calculate things like depreciation, amortization, and interest payments.
- Use Excel functions and features to create tables and charts that display the financial data.
- Identify key drivers of your financial model, such as sales volume and cost of goods sold.
- Troubleshoot problems with the design, such as verifying that the data is entered correctly and that the formulas are calculating correctly.
A financial model offers many benefits. It can help you to make informed business decisions, identify opportunities for growth, and assess the financial impact of potential changes. Additionally, a financial model can help you to create detailed projections to develop a long-term financial plan. Keeping all of this in mind, a basic financial model can be a great starting point for any business looking to understand their financial performance.