Introduction
Financial models are an invaluable tool for making elements of the complex global economy comprehensible. Enterprises need to build models that accurately and efficiently demonstrate the economic flows of capital and other resources through the organization. Excel is a popular tool for such modeling due to its widespread use and its widespread availability. This blog post will explain the benefits of using financial models, provide an overview of how to use Excel to model financial flows and show how create network diagrams with Excel to visualize financial models.
Types of Financial Models
When it comes to modeling financial flows, there are two main types of models: cash flow models and financial reports & ratios models. Let us explore each of them in more detail.
Cash Flow Models
A cash flow model is a representation of expected cash flows over a period of time. These models use input variables such as current assets, current liabilities, and expected capital expenditures to project expected cash flows in a given period of time. Cash flow models are typically used to understand the financial position of a company at any given point in time or to project future cash flows.
Financial Reports & Ratios Models
Financial reports & ratios models are a type of financial model used to create financial reports and compare financial analyses of a company across time. These models use data from balance sheets, income statements, and other financial documents to generate financial ratios, such as the debt-to-equity ratio, current ratio, and return on investment. These ratios are then used to understand the financial health of a company and to compare the performance of similar companies.
In summary, there are two main types of models used for modeling financial flows: cash flow models and financial reports & ratios models. Cash flow models are used to project future cash flows, while financial reports & ratios models are used to generate financial ratios and compare financial analyses of a company.
Setting Up Network Diagrams in Excel
Network diagrams are useful for modeling financial flows and can be easily created in Excel. With the ability to view critical data points, such as total cash flow, and how different elements of the system are connected, Excel can be highly effective at projecting financial models.
Steps to Create Network Diagrams
Setting up network diagrams in Excel only takes a few simple steps:
- Select the Array data series option
- Determine the length of the data series
- Enter the formula of the data series
- Create an array graph
- Adjust the graph data series
Formatting Features of Diagrams
Once the network diagrams have been setup, there are a variety of formatting options available. Features such as data point highlighting, viewing of individual elements and items, as well as displaying of aggregate summary data can all be adjusted.
For example, the color of each data point can be customized, enabling users to quickly identify different components and patterns. This can be especially helpful when mapping out complex financial models with multiple components.
Modeling Depreciation
Creating network diagrams in Excel for modeling financial flows requires an understanding of the different forms of depreciation. Depreciation is the decrease in an asset's value over its expected useful life, often due to wear and tear, aging, or obsolescence. By modeling depreciation, companies can make better investments in assets, improve the accuracy of their financial statements, and ensure their books are compliant with Generally Accepted Accounting Principles (GAAP).
Depreciation Methods
The most common depreciation methods used in accounting are straight line, accelerated, double declining balance, and sum-of-the-years'-digits.
- Straight-line: A company divides the cost of an asset by its expected useful life and then deducts that amount evenly from its profit and loss statement each year.
- Accelerated: This method is similar to the straight-line method, with the difference being that a larger amount of depreciation is taken each year at the start of the asset's life and then a lesser amount of depreciation is taken in the later years.
- Double-declining balance: The double-declining balance method takes twice the amount of the straight-line depreciation rate. This means that a larger portion of the asset's cost will be deducted from the company's profit and loss statement in the early years of the asset's life.
- Sum-of-the-years'-digits: This depreciation method allocates more deductions to the early years of the asset's life. It is based on the sum of the digits in the asset's useful life, meaning that the amount of depreciation taken in each year decreases as the asset ages.
Leveraging Depreciation Entries in Models
Depreciation entries can be a useful tool when modeling financial flows. For example, a company may want to estimate the cost savings associated with upgrading its existing fleet of vehicles. By leveraging depreciation entries, the company can calculate and compare the total cost for purchasing and operating the new vehicles to the total cost for operating its current vehicles. This can be a helpful tool for making informed decisions about asset purchases.
Another way to leverage depreciation entries in models is to estimate the future value of a company's assets. Depreciation entries can help with forecasting future cash flows, which can be useful for predicting the company's future profitability and creditworthiness.
Depreciation entries can also be used to estimate the impacts of taxation and other government policies. Companies can calculate their depreciation deductions, as well as their associated tax credits or rebates, to assess how government regulations can affect their bottom line.
5. Modeling Cross-Functional Accounts
Creating a network diagram for financial flows which include cross-functional accounts can be a time consuming and difficult task. It involves distinguishing between accounts and automating processes to account for entries.
A. Differentiating between accounts
In a network diagram for modeling financial flows that involve cross-functional accounts, it is important to differentiate between all accounts involved. This allow users to clearly identify a financial flow from one account to another and track all related information. When drawing the diagram, users should include a legend to refer to each account.
B. Automating processes to account for entries
Once all accounts have been identified, users should then automate processes to account for entries in the network diagram. By automating processes, users can quickly and accurately add information to the diagram, such as transaction dates and amounts. This will make it easier to track financial flows and make changes to the network diagram when needed.
Additionally, automating processes can help in generating reports and visualizations of the financial flows. This can provide a detailed overview of all transactions between accounts, as well as trends and anomalies, which can be used to identify areas of improvement.
Increasing Accessibility of Models
Being able to quickly create network diagrams in Excel for modeling financial flows is a useful tool for project managers, financial analysts, and other decision makers. However, the value of these models is amplified when they are shared with a wider audience. By ensuring that models are accessible to all levels of users, the data they contain can be utilized more efficiently.
Adapting Models to Various Access Levels
Creating network diagrams in Excel should be tailored to fit the viewer’s level of access. For example, a complex financial model can be altered to display just the data they will need to make decisions. Through this process of “simplification”, user’s can still understand the concepts without having the understanding of all aspects of the model.
Ensuring Accuracy of Shared Data
Before allowing wider access to financial models, it’s important to make sure that the data it contains is correct. This is very important because incorrect data can lead to significant losses if acted on. To ensure accuracy, it’s important to double-check every entry in the model. Managers can also add data validation rules to the input boxes, which help to identify incorrect input from users.
By adapting the models to various access levels and ensuring accuracy of shared data, it is possible to ensure the widespread use of models created in Excel. This can allow decision makers to maximize the efficient utilization of their financial resources.
Conclusion
Network diagrams in Excel can be an effective way to model a company’s financial flows. This can provide important insights into the company’s financial status and future prospects, allowing investors to make informed decisions. With the help of Excel, financial models can be manipulated quickly to gain a better understanding of the dynamics of the financial position of a company.
Summarizing Use of Excel for Modeling Financial Flows
Exploring financial flows through network diagrams in Excel can lead to better insight into the financial position of a company. The diagrams can be used to show the relationships between cash flows, investments, and debts. This can allow the investor to gain greater insight into how the company’s financial performance will evolve over time.
Benefits of Using Financial Models for Prospective Investors
Using models to represent a company’s financial flows can also help investors more accurately predict the potential outcome of their investments. This can make them more comfortable making decisions, as they have a clearer understanding of the financial position of the company. Additionally, the use of such models can help them accurately estimate the potential risks involved, giving them a better understanding of the risks associated with the investments.
Using network diagrams and financial models in Excel offers investors a valuable tool for evaluating a company’s financial position, allowing them to make more informed decisions about their investments. Regardless of the size or type of company being analyzed, these tools can offer valuable insights into its financial flows.