Financial Modelling in Excel For Beginners

Financial modelling is a valued skill in financial analysis.

The aim of building financial modelling is to create an abstract representation of the company’s future in Excel. Financial models are effective for providing forecasts related to a company’s growth, equity value, discounted cash flow and other important parameters. There are different types of financial models. In this article, you will learn the steps for creating a financial model. 

Table of Contents

• Types of financial models
• Financial Modelling in Excel

Types of Financial Models

There are different types of financial models. Following are the top 10 most used financial models:

• Budget Model
• Forecasting Model
• Consolidation Model
• Merger Model (M&A)
• Option Pricing Model
• Sum of the Parts Model
• Three Statement Model
• Leveraged Buyout (LBO) Model
• Initial Public Offering (IPO) Model
• Initial Public Offering (IPO) Model
• Discounted Cash Flow (DCF) Model

Any financial model is built based on actual values and assumptions. Let us know the steps for building a financial model. These steps remain constant for most models. The only difference is in variables that are required. 

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Financial Modelling in Excel

Past 3-year Financial Information: You should have the financial information for the past three years. This is required to get a close estimate of the year-on-year growth rate prediction. You will be able to analyse the trends and have a better understanding of the financial statement.

Metrics Calculation: You will have to calculate various metrics that will help in providing the forecast. Growth rate, asset turnover, enterprise values are some of the metrics. 

Building Forecast: Based on the assumptions, you will build a forecast for the cash flow statement, balance sheet, income statement among other financial statements. 

Prerequisites for Building the Model

Those who have a strong fundamental knowledge of accounting can build financial models. Financial models are built based on accurate values and assumptions. Lesser assumptions will bring more accuracy to your financial model. 

Excel is essential since financial modelling involves a lot of complex calculations based on assumptions and actual values. You can use other software as well but to date. Excel has proven to be the most flexible and customizable tool. 

You should have knowledge of the MS Excel formula that is used for building these models. For understanding, we will start with the Discounted Cash Flow (DCF) Model.

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The Discounted Cash Flow Model (DCF)

Discounted cash flow is a valuation method where the value of investments is based on the expected cash flows in future. You are estimating the present value of an investment by predicting the estimated amount of future money generation by that asset. 

Variables in the Model

This model consists of the historical dataset as well as assumptions. We are taking the following assumptions: 

• Tax rate: You will consider the historical effective tax rate of the company to forecast tax. 
• Discount rate: It is the rate by which you can discount the cash flow in future. To calculate the discount rate.
• Perpetual growth rate: This cannot exceed the growth rate of the economy and hence it lies somewhere between historical inflation (2-3%) and GDP rate (5%). 
• EV/EBITDA Multiple: The enterprise multiple helps in determining the value of the company. If you belong to a high-growth industry, the multiple will be higher and if it is a slow-growing industry, the multiple will be lesser.
• Current price: Here, we are considering the present value of each share.
• Shares Outstanding: The number of shares available.

Excel comes in handy when we are calculating the DCF for n number of years. As the forecast time progresses, the calculations become complex. Excel helps in providing the forecast for the number of years of your choice.

In this analysis, you can notice that DCF has been calculated till the exit. Exit or terminal value is the expected business value beyond the forecast year. The time when we expect stable growth. We are also forecasting the unlevered free cash flow. To get this forecast, we are removing earnings before interest and taxes. Through this model, you will also be able to forecast equity value per share.

Conclusion

A financial model helps in thinking about the different aspects of the business that can impact it positively. Once you start building financial models, you are able to understand the cash flow situation within the company. Accordingly, the company will be able to build an appropriate funding strategy. Over the years, financial modelling helps the company understand the areas with the scope of improvement. It also gives a projection for the growth over time. 

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