Financial modeling is a critical tool for making informed economic decisions about companies and projects. A financial model is a structured set of calculations that generates a projection of the financial outcome. Adhering to best practices in financial modeling ensures your models are well-designed, well-documented, maintainable, verifiable, and relevant for influencing users’ economic decisions.
What Makes a Good Financial Model?
A good financial model should be built according to the following best practice methodology:
- Well-Designed: The model should be logically organized with a clear structure.
- Well-Documented: All components, assumptions, and calculations should be fully and clearly documented.
- Maintainable: The model should be easy to update as conditions change over time.
- Verifiable: An independent auditor should be able to easily check and verify the model’s accuracy.
- Relevant: The model’s outputs should be able to meaningfully influence the economic decisions of those who use it.
Essential Skills for Financial Modeling
Successful financial modeling requires a combination of skills:
- Microsoft Excel proficiency
- Strong finance and accounting knowledge
- Familiarity with relevant industry practices, corporate taxes, regulations, etc.
- Robust problem-solving abilities
- Keen design sense to create clear, trustworthy models
Model Design Methodology
The design of a financial model should follow this standard methodology:
Inputs Worksheets
- Avoid overloading assumptions on one sheet
- Separate time-based and non-time-based inputs
- Keep actual data distinct from assumptions
- Only allow inputs, no calculations
- Use data validation rules
Workings (Calculations) Sheets
- Use links to import data from inputs sheets
- Formulas only, no hard-coded values
- Consistent formula conventions
- Normally positive value convention
- Limit use of nested IF functions
- Use a base column for formula logic
Financial Statements Sheets
- Link to calculations sheets
- No links between financial statements
- Formulas only
- Clean formatting ready for printing
- Build cross-checks for statements
Summary Sheets
- Use graphs to highlight key information
- Format for clear printouts
- Link to calculations sheets
- Separate outputs for different stakeholders
Further Best Practices
- Mark temporary formulas with fill colors
- Present data horizontally
- Build checks, audits, and alerts
- Never hide any components
By following these financial modeling best practices, you can create robust, trustworthy models that provide reliable analysis to drive smart economic decisions.
