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Explain about modelling in financial management.
Financial modelling is a process of creating company’s financial performances in a spread sheet or excel sheet. It is created based on historical performances and assumptions about future. Various numerical models and theories will be used by the financial analyst to forecast the future earnings of the company.
Objectives of financial modelling are as follows −
- Valuing a business.
- Raising capital.
- Growing the business.
- Selling/divesting assets and business unit.
- Capital allocation.
- Budget and forecasting.
Types of financial modelling are given below −
Three statement model − Income statement, balance sheet and cash flow are called three statements. All the related formulas are linked in excel to create a financial model.
Discounted cash flow (DCF) model − DCF model will be based on three statement model, by taking cash flow in three statement model. Necessary adjustments are made to discount them back to today.
Merger model − It is an advanced model. Investment banking and corporate development are most commonly used to evaluate pro forma of accretion.
Initial public offering model − This model is used to evaluate their business before going to public. This model uses comparable company analysis.
Leveraged buyout model − This model displays all financial models in details by creating them as a layers.
Sum of the parts model − This model will be created by using and adding different DCF models.
Consolidation model − In this different business units are added into single model. Each business has different tabs and finally report will be displayed by consolidation tab.
Budget model − As the name suggests, it is used to get budget for coming years by using financial planning and analysis.
Forecasting model − It is used to compare the budget model by forecasting.
Option pricing model − Only numerical or mathematical formulas are used to build this model. Binomial tree and Black-Scholes are types of option pricing model.
Steps to build financial modelling involve −
- Historical results/assumptions.
- Preparation of Income statement.
- Preparation of Balance sheet.
- Supporting schedules.
- Finial preparation of income statement and balance sheet.
- Preparation of cash flow statement.
- DCF analysis.
- Sensitivity analysis and scenarios.
- Create charts and graphs.
- Finial model.
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