Three common misconceptions about financial modeling

Financial modeling is, and always has been, one of the key finance sector skills that distinguishes the great from the good. From my experience the closer you get to the cutting edge of multi-billion-dollar deals, the greater the expectation that you know your way around a financial model.

Yet while this remains the case, there has never been more misinformation surrounding those looking to develop financial modeling skills and use these skills to launch or advance their careers.

There is a simple reason for this: conflicts of interest. The result is that the financial modeling sector has become a lot like the Grand Bazaar in Istanbul; players fight for your attention so they can sell you whatever they are selling.

With this in mind, I wanted to clarify what I believe are three common misconceptions about financial modeling for anyone keen to leverage this incredibly powerful skill set, with a view to maximizing the success of your personal career journey whilst minimizing the risk of wasting time and money.

Misconception 1. Every financial model is different

Source: Traditional financial modeling consultancies.

Since the dawn of financial modeling, many of the world's most vocal financial modelers have espoused the view that every financial model is different, and therefore each model must be built from scratch. This view is usually expressed while scoping a model to justify an exorbitant time and cost estimate.

In fact, most financial models are very similar, and can be built reusing parts of previously built financial models. And this is true even for different types of financial models, whether it be a budgeting model, FP&A model, or project finance model.

Truly great financial modelers understand that the key concepts underpinning every financial model are the same, and one of the common characteristics of less impressive financial modelers is that they lack the clarity of understanding to realize this.

For example, we recently built a project finance model for a client looking to finance a gas-fired generator. Many project finance modelers believe project finance modeling is completely different to operational and FP&A modeling, but in fact the concepts are largely identical - i.e. a build-own-operate (BOO) project finance model is effectively two financial models in series, the first focusing on funding construction and the second focusing on returns from operations. And, but for the inclusion of some handy project-based analysis such as a sources and uses of funds table, this construct is very similar to a well-built rolling FP&A model.

The problem with thinking every financial model is different is that it becomes impossible to know where to start learning financial modeling, and this overwhelming confusion often results in people believing they're not smart enough to become a great financial modeler, which is rarely the case.

So, here's the truth put very simply: The fundamentals of financial modeling are the same in almost every financial model, so learn the fundamentals before layering on the complexities that come with things like different industries and capital structures.

And here's the fundamentals: Financial statements, revenues and expenses, debtors and creditors, fixed assets, debt & equity, corporate taxation and other financial statement items. Yes, there's always going to be more than these concepts, but they will usually be layers on top of these concepts rather than independent of them. So build this understanding as your foundation then scale up from there.

And always remind yourself that most financial models are very similar.

Misconception 2. Spreadsheets are dying a slow death

Source: Non-spreadsheet software company sales teams.

We work with the largest investment banks, private equity firms, accounting firms and corporations in the world, and they all laugh when asked whether they believe spreadsheets are dying a slow death. Because they know they're not and arguably never will.

In fact, there are more spreadsheet users now than ever. There are well over 1 billion Office users and Microsoft Excel is the jewel in the crown of the Office suite. And with recent advancements to related BI programs such as Power BI, it's never been more important to know your way around a spreadsheet.

The reality is that spreadsheets continue to provide the best platform for building financial models of most businesses, as they are powerful, flexible and the most widely-used BI tool in the world.

Sales reps at cloud app providers love to predict the demise of Excel, denouncing errors in spreadsheets used on prominent deals, but their solutions simply don't provide the flexibility and user-friendliness of a well-built spreadsheet-based financial model. They are also less secure in many ways, which is why most advisors baulk at using anything other than Microsoft Excel for confidential deals models.

I was recently speaking with a reporter asking about Modano, and he asked why Modano is 'stuck in Excel' given that 'the whole world has gone cloud-based'. I laughed and told him only people who don't have the skills to build financial models would ever consider moving away from the desktop version of Microsoft Excel, and that in any case Microsoft Excel is now 100% cloud-connected anyway. You can even co-author spreadsheets with people on the other side of the world.

In short, never believe the myth that spreadsheets are dying, and never underestimate the value to your career of being able to build high-quality financial models in Microsoft Excel. It is a skill shared by almost every successful finance sector executive I know.

Misconception 3. A qualification makes you a great modeler

Source: Financial modeling qualification providers.

The financial modeling sector is constantly evolving, such that the focus of new fee revenues has shifted over the past 20 years from model builds and audits to training and certifications. Search the web and you will find an ever-increasing number of certifications, each vying for your attention and cash. We even offer one ourselves at Modano, although it is currently part of the training in our subscriptions rather than something we promote independently.

Certifications are valuable in that they are better than nothing and provide evidence of your willingness to invest time (and money) in improving your financial modeling skills. But don't believe the misconception that a certification will in itself make you a great financial modeler. It's really just the beginning of your journey.

Financial modeling is different to more regulated sectors such as accounting and audit, in which arguably independent bodies like CPA and ICAEW provide ongoing confidence to the industry that their members meet the minimum skill requirements for the sector.

The financial modeling sector has never agreed on a single approach to anything, not even a set of basic best practice guidelines, so any certification you receive will unfortunately be tainted with views which will not be held universally. So make sure you understand this when deciding whether to pursue an accreditation.

In my opinion, financial modeling skills are a lot like coding skills, in that many of the best coders in the world are self-taught or have learned via working with other experienced coders. Many haven't even studied computer science, but it really doesn't matter as they simply know their stuff. And it's obvious just from speaking with them.

There's one indisputable truth in financial modeling: Most financial modeling skills are acquired osmotically, usually by working through financial models built by more experienced financial modelers. And in this regard, very few people in the financial modeling sector ever really create anything new.

Hence, while an accreditation is better than no accreditation, I will always look to understand how much exposure a financial modeler has had to high-quality financial models, as this will usually be the primary determinant of their financial modeling skill level.

So if you're serious about becoming a great financial modeler, dedicate most of your energy to ploughing through complex financial models, as this will get you promoted a lot faster than any certification you invest in.

It's for this reason I always recommend a Modano subscription to anyone wanting to learn financial modeling, as a single subscription - which costs a fraction of the cost of most financial modeling accreditations and includes an accreditation - contains access to an almost infinite number of high-quality financial models, each of which has been built by the best financial modelers in the world and used and reviewed many times over 20 years. And we know it works from watching how fast our new team members become great modelers.

Having said all of this I, like everyone else in the financial modeling sector, am conflicted when giving you advice. So take or leave it as you choose, but whatever path you choose to become a great financial modeler always be aware of the three misconceptions I've discussed in this article.

Onwards.

Michael Hutchens

CEO | Modano