Financial Modelling: An Overview of Common Methods

Financial Modelling: An Overview of the Most Common Methods

Whether you’re an analyst, investor or executive, it’s almost guaranteed that at some point you will need to build a financial model. A financial model is essentially a simplified representation of a company’s financial statements, helping users understand key performance indicators and risks associated with an investment. Financial models are used in many different capacities by various types of analysts and investors, but they all have the same goal: To make understanding the potential profitability and risk associated with an investment as straightforward as possible. In this blog post we explore the most common methods for building financial models, along with their use cases.

What is a Financial Model?

Financial models are representations of the financial statements of a company. They are used to forecast key financial metrics, such as cash flow, the return on investment or risk. In a nutshell, financial models help users understand the potential profitability and risk associated with an investment. A financial model can be broken down into three essential stages: Data, Calculation and Presentation. In the data stage, information such as current market conditions, company performance or financing terms are entered into the model. Next, in the calculation stage, the data is manipulated and combined to produce new data, such as the company’s cash flow. Finally, in the presentation stage, the calculated data is presented visually as graphs and charts.

Create a data-based financial model

A data-based model is built around an Excel spreadsheet or table. Data-based models can be very simple, and they allow you to create very robust models with a huge amount of flexibility. Data-based models are easy to build and allow you to manipulate the data however you want. A data-based model is useful when you already have a good amount of data available and want to create a model around that data. With this method, you can easily incorporate new data as it becomes available. This is especially useful if you want to include data from different sources. Data-based models are appropriate when you need to create a model that shows basic information like cash flows or balances.

Build a regression-based financial model

A regression-based model is a data-based model that also includes some statistical analysis. Regression-based models are useful when you want to forecast future events based on existing data. This model type is particularly helpful for predicting future cash flows, interest rates or other values that are affected by other factors. A regression-based model is appropriate when you want to create a model that shows a high level of detail about future cash flows. This type of model is best for use cases that involve predicting future values based on existing data.

Use an AI platform to build a machine learning financial model

Machine learning models use artificial intelligence algorithms to automatically create a model based on data. Machine learning models are most commonly used to predict future events based on existing data. This can include predicting future cash flows, revenue or risk. Machine learning models are appropriate when you want to create a model that can predict future values based on existing data. These models are best for use cases that involve continuous regression.

Create a qualitative financial model

A qualitative model uses phrases and sentences to describe and illustrate the financial statements. This model type is useful when you want to go beyond the basics and give a more detailed description of the company’s finances. A qualitative model is appropriate when you want to create a model that goes beyond the basics. This type of model is most commonly used when you want to provide a detailed description of the business and its financials.

Summing up

Financial modelling is an essential skill for anyone in the financial services industry. It is used by analysts, investors and other professionals to understand a company’s financial outlook and forecast potential cash flow. Financial models can be built using various modelling methods, depending on the complexity of the model and the skill level of the person creating it.