Image Credit: File Photo
Financial modeling may not be a term that is familiar to many, but in the world of finance analysis, it is considered one of the most highly valued and sought-after skills. Why is that? Financial modeling can forecast a company’s future results by combining accounting, finance, and business metrics. According to Kavan Choksi, a business management and wealth consultant, this forecast can help investors, business owners, and financial analysts make better informed decisions about the company’s financial prospects.
Despite its significance, the art of financial modeling is still a relatively thinly understood concept that requires a high level of skill and expertise to execute accurately. Therefore, it’s crucial for anyone who wants to get into the world of financial analysis to understand the fundamentals of financial modeling to navigate this complex field effectively.
In the world of business, financial forecasting is essential to success. One tool used to accomplish this is the financial model, a spreadsheet that provides businesses with a projected financial performance for the future. This model relies on various factors, including a company’s historical data and outcomes and certain assumptions about the future.
The spreadsheet includes crucial financial statements: an income statement, a balance sheet, and a cash flow statement, as well as supporting schedules, which altogether are known as a three-statement model. For businesses looking to take their financial planning to the next level, more sophisticated models such as discounted cash flow analysis, leveraged buyout, mergers and acquisitions, and sensitivity analysis can be implemented. Businesses can make informed decisions to optimize their long-term financial performance by investing time and resources into financial modeling.
Why is Financial Modeling so important?
Understanding your business inside and out is necessary to make strategic financial decisions in the fast-paced business world. Thanks to financial modeling, companies can have an in-depth understanding of their organization and the impact of critical factors on their bottom line. Far from being a mere accounting tool, financial modeling enables businesses to prepare for unexpected situations and have a roadmap for their future planning efforts.
Kavan adds that by developing clear scenarios that mimic real-world situations, businesses can make smarter decisions and adapt to changes in the market. Ultimately, the value of financial modeling lies in providing accurate predictions for businesses, allowing them to be better positioned to meet and exceed their strategic financial goals.
Forbusiness operations, conducting periodic reviews of performances is an essential task. Not only does it help in obtaining valuable feedback, but it also enables businesses to make the necessary adjustments to increase overall earnings. With the help of advanced financial models, data mining can determine a company’s cash flow position after paying interest and debt repayment.
It provides a clear understanding of the funds required and the appropriate debt or equity financing strategies to implement. So, whether you’re a seasoned business owner, a curious entrepreneur, or simply interested in financial intricacies, periodic reviews and financial models provide an informative and engaging approach to understanding the complexities of business operations.
What is a Financial Model used for?
Financial models are necessary tools for making effective decisions in the world of business. With various uses, these models produce outputs that can be used for internal and external financial analysis. Kavan mentions that one of the biggest decisions made using these models is determining how to raise capital through debt, equity, or a combination of both.
Acquisitions and asset purchases are also often considered using financial models, as are organic growth opportunities such as expanding into new markets or opening new stores. When the time comes to sell off assets or business units, financial models assist in determining the best course of action. Budgeting and forecasting are important uses for financial models, helping businesses prepare for the future. These models are also used for capital allocation decisions, prioritizing which projects to invest in. Lastly, they are used to value businesses and perform financial statements and ratio analyses.
Kavan Choksi is a successful investor, business management and wealth consultant. Working strategically with companies across fast-moving consumer goods, retail and luxury markets — he leverages his vast experience to help clients turn around and revitalize their businesses. With his expertise in economics and finance, Kavan has developed a passion for investing over the years and enjoys helping others do more with their money. He provides thoughtful commentary to publications such as CNBC, Fox Business, Forbes, Business Insider, CEOWORLD Magazine, International Business Times, Financial Express, and The Epoch Times. Kavan is also a regular contributor for Nasdaq, where he shares his expert insights on what’s moving markets and the global economy.