Financial models allow businesses to understand the performance and profitability of a given task, course of action, or product. A multidimensional financial model is a combination of financial and non-financial data that seeks to understand the overall impact of financial decisions on a business.
Using a financial model provides valuable exponential insights that can prove beneficial to the success of any business. Benefits of using a financial model are outlined below:
- Improve accuracy of decisions and forecasts
- Identify risk
- Optimize resources
- Provide visibility to evaluate solutions
The purpose of this blog post is to provide a guideline for creating a multidimensional financial model in Excel. This post will cover the steps needed to build the model, tips on how to ensure accuracy in the model, and common mistakes to avoid.
Steps for Creating a Multidimensional Financial Model in Excel
Develop Base Assumptions
The first step in creating a multidimensional financial model in Excel is to develop base assumptions. This means establishing the framework and structure of the model by setting parameters, determining assumptions, and accounting for externalities. During this stage, users may also want to identify variables that could alter the base assumptions, such as changing interest rates or tax rates. It is important to agree on basic definitions prior to starting the model so all involved in the model development process understand the language being utilized.
Develop a List of Outputs
After having established the base assumptions, the model-builder will need to determine the desired outputs of the model. It is important to have a clear list of outputs before beginning the construction of the model. This way, the model’s design can be tailored to the expected outputs so the model is not doing unnecessary calculations that are not relevant to the potential results. As outputs are determined, the model-builder will also want to identify the relevant variables needed to generate the desired results.
Source Data Points
Once the list of outputs is finalized, the user can begin sourcing the necessary data points to construct the model. This means utilizing both internal and external data sources to fill in the necessary variables and assumptions. To begin, the user can source historical data which could serve as an anchor point for the model. Additionally, the user can reference secondary data sources such as surveys, publications, and industry-specific reports to fill any remaining gaps in the data necessary to create the model.
Construct Formulas and Equations
Now that all data points necessary to construct the model have been sourced, the user can begin building the actual model by using formulas or equations. Constructing the model in Excel ensures the equations and calculations stay organized and transparent for when modifications occur down the line. By leveraging Excel’s equation builder and logic functions, the user can quickly and easily lay out the calculations and input desired data points.
Once the base model is complete and all the formulas and equations have been constructed, the user can begin running scenarios. This is the process by which a user can isolate and test the potential outcomes when a specific factor changes. This helps the user understand not just the potential outcomes but also how sensitive the model is to certain variables. By running different scenarios and understanding their outcomes, the user can develop an understanding of the inner workings of the underlying model.
The final step in creating a multidimensional financial model in Excel is to summarize the findings. After running the scenarios, the user can compile the results into an executive summary which can be used to inform potential stakeholders. This summary should include an overall assessment of the potential outcomes of the model, as well as an explanation of any key variables or assumptions that would impact the results.
Using the Three Financial Statements
In order to create a multidimensional financial model in Excel, one must understand the three primary financial statements - the balance sheet, the income statement, and the cash flow statement. With careful analysis and through creating a detailed financial model in Excel, one can merge these three statements for an all-encompassing picture of their business.
The balance sheet is a business’s statement of asset worth at a given point in time. Starting from the company’s most liquid assets such as cash and receivables, any long-term liabilities are subtracted in order to assign a tangible value to the business. The balance sheet model in Excel must also be readily adjustable to fit the unique challenges of any given business.
The income statement assesses a company’s income over a certain period of time – often a month, quarter, or year. Through assets, liabilities, expenditure, and income, one can establish a detailed financial portrait of the profitability of the business or organization. To successfully construct an income statement in Excel, one must have a detailed understanding of their business and its economic environment.
Cash Flow Statement
The cash flow statement follows the income statement in completing a business’s picture. By showing the cash used up and created by the business, the cash flow statement can give an accurate image of the company’s liquidity and predict upcoming cash flow waves. Two components of this statement can be used to base the cash flow model in Excel in order to anticipate cash flow fluctuations and make smart investments.
Benefits of Using Excel
For financial professionals, Excel is an invaluable tool for creating comprehensive financial models. Excel allows users to visualize, analyze and forecast financial data, enabling them to make informed decisions. And, compared to other software options, Excel offers a range of unique benefits that make financial modeling even easier.
Clear Visibility Into Data
Financial models are only as effective as the data that goes into them. Excel makes it easy to see exactly which data points are being used, and even allows users to easily change parameters and data sources on the fly. As a result, users can be sure that their models are always up-to-date and accurate.
Easily Customizable for User Needs
Excel’s powerful tools and functions make it easy to customize financial models however users need them. Excel allows users to take advantage of its data-centric layout and customizable inputs, allowing them to quickly input and visualize changes, estimates and assumptions. As a result, users can easily adjust models to fit their unique business needs.
Multiple Views and Features
Excel’s wide range of features and views make it easier to analyze financial models from different perspectives. Excel’s charts and graphs allow users to quickly visualize data in a range of formats. And, Excel’s comparative analysis tools allow users to quickly access different views of data to compare performance and activity.
Excel also allows users to leverage automated functions to save time and effort. Excel allows users to take advantage of powerful formulas and functions to automate data input, calculations and charting, allowing them to quickly generate the financial models they need without tedious manual work.
- Clear visibility into data
- Easily customizable for user needs
- Multiple views and features
- Automated functions
Using Common Excel Formulas for Financial Modeling
Excel is a great tool for creating financial models. The powerful calculation engine and the ability to construct compelling visuals allow financial analysts to build meaningful models with its users. Excel models can become even more powerful when aided by the use of common formulas. These formulas can help analysts make quick calculations and provide visual representations that aid in decision making. Let's look at three common Excel formulas and how they can be used in financial modeling.
The SUMIF formula allows Excel users to sum values in a range of cells based on a criteria applied. This is useful in financial models when one wants to apply a sum to a given set of values but only if certain conditions are met. The SUMIF formula helps users do this quickly and accurately. As an example, a user might need to sum the revenues from a range of products but only with sales in a certain region. The SUMIF formula helps set the criteria for the given values, ensuring that incorrect data is not included in the final sum.
The COUNTIF formula allows Excel users to count the number of cells in a given range that meet a certain criteria. This formula is useful in financial models when one needs to make quick estimates. As an example, a user might need to estimate the number of customers in a certain region. The COUNTIF formula helps provide an accurate count without manually counting each cell.
The VLOOKUP formula allows Excel users to perform a vertical lookup in a range of cells. This formula is useful in financial models when one needs to quickly lookup data associated a certain criteria. For example, a user might need to lookup a customer's order history based on their name. The VLOOKUP formula helps quickly locate the data associated with the given criteria.
Utilizing these common formulas can help financial analysts construct more powerful models in Excel. By understanding the uses of these formulas and how to apply them, users can easily create robust models that aid in business decision making.
Creating an accurate and robust financial model in Excel is no easy feat and it is likely to come with its own set of issues along the way. Therefore, it is paramount to have a good understanding of troubleshooting the errors and validating the syntax of your model.
The first step in troubleshooting errors is understanding them. Errors can range from simple typos, mathematical errors, and formula errors. By understanding the source of the error it will be easier to identify where and how to fix it.
Reviewing data types
Data types are essential for the successful operation of financial models because incorrect use can lead to missed entries, inaccurate projections, and other serious errors. It is important to double-check the data types used in each calculation because this can be the source of errors.
Finally, it is important to make sure that all calculations are written in the correct syntax. To troubleshoot potential syntax errors, it is important to review formulas systematically, double-check formulas, and cross-check formulas with references.
Creating a multidimensional financial model in Excel can be an intimidating process, but by understanding the necessary features, formulae, and formulas in Excel, even the most complex financials can be understood. By following the four-step process of preparation and data, first-level calculations, second-level calculations, and modeling in Excel, the construction of a multidimensional financial model becomes much more manageable.
Summarize the overall process of creating a multidimensional financial model
The process of creating a multidimensional financial model in Excel includes four steps. First, proper preparation and data collection must be undertaken. Next, the first-level calculations must be defined and built. The third step is to create the second-level calculations to verify the accuracy of the model. The last step is to create the model in Excel.
Highlight how Excel is a valuable resource for understanding complex financials
Excel is an extremely valuable resource when trying to understand complex financials. Using the in-depth features and formulas, a user-friendly multidimensional financial model can be created and easily referenced. With Excel, the user can determine a comfort level when it comes to understanding the financial implications of their decisions, making it the perfect tool for project evaluation and forecasting.
By following the steps outlined above, and leveraging the powerful features in Excel, a user-friendly multidimensional financial model can be built to accurately assess complex financials.