An in-depth explanation on different types of Financial Modelling and the Steps involved in building a financial model.

1. Financial Modelling
30th Apr 2023
By
Rashmi Gowda KM
(Financial analyst at Alphastream.ai)

2. What is financial modelling?
• It is an art of combining accounting, finance and business metrics to
create an “abstract representation of a company in excel, forecasted into
future”.
• A forecast of a company’s future based on assumptions and past
performances

3. Uses of financial modelling
• Making business decisions
• Making investments in private/public companies
• Pricing Securities
• Decisions in corporate transactions (M&A, divestiture etc.)
• Projecting a company’s financial performance, Data Analysis
• Check the roadmap to profitability
• Check investment requirement etc..

4. Who uses?
• Investment bankers
• Equity research Analysts & Associates
• Private Equity Analysts & Associates
• Credit Analyst
• FP&A analyst & mangers
• Corporate development analysts & mangers

5. Types of financial modelling

6. 1) Three Statement Modeling
In the 3 statements model, the income statement, balance sheet, and cash flow statement all are linked together with the excel
formulae, and this helps in the analysis of historical financial statements and forecasting future statements. Forecasting of
financial statements will help financial analysts to understand how the company will perform after taking into consideration a
variety of assumptions.
2) – Discounted Cash Flow (DCF) Modeling
The DCF valuation modeling is done taking three statement model as a base and is used to calculate the value of the business or
the company’s net present value (NPV) of the future cash flow. The DCF modeling takes the projected cash flow from 3 statement
model and discounts them to their present value after making necessary adjustments.
3) – Merger Finance Modeling
This type of modeling is used to analyze the merger and acquisition decision of two companies. A merger happens when two
companies come together under mutual agreement, whereas an acquisition happens when one company overtakes others in
return for some cash price.
4) – Initial Public Offering (IPO) Model
This model looks into the market with the help of a comparable company’s analysis to understand how much the investors will be
ready to pay for the company’s stock in an IPO.
5) Leveraged Buyout (LBO) Modeling
A leveraged buyout is the acquisition of one company by another company with the help of borrowed funds. Leveraged buyout
modeling helps in the determination of the value that the buyer would be ready to pay and the level of debt that would be
needed to be raised. It also calculates the present and future cash flow of the company to be purchased.

7. 6) – Sum-of-the Parts Modeling
This financial model is used to calculate the value of each division in the organization separately to determine its worth if any
other company acquires it. The sum of the parts method is calculated through different types of analysis methods like discounted
cash flow (DCF) model, asset-based valuation , market value, etc. Each part is then added together to derive the value of the sum
of the part (SOTP).
7) – Consolidation Modeling
Consolidated modeling is prepared by consolidating all 3 financial statements, i.e. income statement, balance sheet, and cash
flow statement of different business units into one.
8) – Budgeting and Forecasting Modeling
The financial analysts perform the budget modeling to determine the budget for the cost and income of the company for the
upcoming time. Budgets are generally prepared on a monthly or quarterly basis. They depend upon historical income statement
for input purposes. Whereas, the financial analyst does forecast modeling to prepare a forecast against the budget. Many times
budget and forecasting modeling is done on the single tab together, and other times they are done separately.
9) – Option Pricing Model
The financial analysts use the option pricing model to determine the theoretical value of an option, i.e. the value of an option
after taking all the known input under consideration. It helps financial analysts in deciding the fair value of an option. It is a
mathematical model prepared based on mathematical formulas.

8. Steps in building financial model