6-8 Short Financial Modeling Decisions Utilized by Companies

Financial modeling is a process used to represent a company's financial situation by creating different models. The value of this model consistently increases in the finance industry. Financial modeling involves various techniques such as discounted cash flow, leveraged buyout, and option pricing models. It also includes credit rating, ratio analysis, and merger and acquisition analysis. The scope of financial modeling is wide, with applications in decision-making, capital budgeting, forecasting, and internal planning. However, it has limitations, including the reliance on future performance forecasts, terminal value, and weighted average cost of capital. Despite these limitations, financial modeling remains an essential tool for businesses to make informed decisions.

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Financial modeling
Overview
Financial modeling has become the course of advanced finance, excels skills and comprehensive
knowledge used to understand financial models. This course is different from other course as it is
known as university course. Financial modeling is recognized
The aim of following course
Introduction
A financial model used to build excels to estimate business performance in finance in future. The
estimation is simply leads to companies past performance, presumptions about future and
requirement in preparation of income statement, cash flow statement and balance sheet and three
statement models. From thesis, latest models of various types can be made such as discounted
cash flow analysis, leveraged buyout, mergers and acquisitions and sensitive analysis. Financial
model output is used to make decisions and financial analysis performance, both inside and
outside of company. Company inside executives will consider financial model in decision
making:
1. Capital raising in debt or in equity form
2. Acquisition of business assets

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3. Business growing organically included new stores opening, entering into new market
segment.
4. Estimation of future and budgeting.
5. Value relevance in business
6. Allocation of capital prioritizing projects.
Objectives of financial modeling
The main objective of financial model is the success of foreign investment made by investors.
Financial modeling helps the corporate management in decision making and also financial
analysis preparation:
1. Valuing a business
2. Capital raising
3. Business growth
4. Acquisition making
5. Selling assets and divesting business units
6. Allocation of capital
7. Forecasting and budgeting
What characteristics have sound financial model?
The good financial model implies:
Understandability: The transparencies of designs used are easy to understand.

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Reliability: Control checks used to error free excel so that error
Easy to use: Instead of too much struggling to make simple results from bad model using the
financial model one can produce the analysis.
Key issues: The key issues focused on financial model are not to waste much time in immaterial
items development.
How to build financial models
Historical results and assumption:
The first step of financial model building is withdrawing the previous income statements of firm.
The statements are designed in excel format to cover the information of financial statement. The
forecasted decision
Balance sheet:
Through income statement balance sheet can make. Calculation covered the account receivable
and payable and accounting should be done according to them.
Supporting schedules
Debts schedule and interest schedules are prepared in this step. The debt schedule releases the
past recorded data and increases debts and deducts the payment done. Interest is calculated on
the remaining balance.

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Completing the income statement and balance sheet:
The schedule provided the information to apply in income statement and balance sheet. Net
income, taxes provision, earning before tax (EBT) are calculated. Investors equity is also
analyzed.
Cash flow statement
After the balance sheet and income statement completion the next step is to construct the cash
flow statement. Now, reconciliation method can also be used in building cash flow statement.
Performing discounted cash flow analysis
The valuation of business and cash flows should be obtained from the given statements. The rate
of return and
Sensitive analysis and scenarios
This analysis named sensitive analysis integrates into the financial modeling. One of the main
step helps in risk involvement in the investment and planning in the business.
Charts and graphs
Professional analyst prepares a clear analysis communication of the resulted statements. The
executives placed do not pay their attention towards inside working of the model that’s why the
need for charts in demand and need to be made. The resulted statement concisely provide the
graphs and charts
Stress test and audit

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The tools implemented in auditing must be used assure the given formulas used in excel. A stress
test developing heavy scenarios and ascertain the functioning as per expected financial model.
Importance of financial modeling
Financial modeling importance lies in financial planning. In corporate world the main decisions
are implemented through financial modeling. Financial modeling also covers the capital
budgeting concept. With financial cash flow statement analysis and resource allocation financial
model helps in determining cost of capital. Throughput analysis of debt equity structure, the
purpose is also to serve the expected returns to investors. This model advises regarding risk
engagement associated with some decisions and also utilized in company’s operation.
Financial modeling uses
The value of this model consistently increases in rapid manner in the finance industry.
To manage and estimate risk financial modeling acts as
Financial modeling is an activity to represent financial situation of company by creating different
model.

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Final models are statistical and mathematical terms aimed at representation of performance of
business.
The bases to understand company’s performance analysis are:
Income statement
Cash flow statement
Balance sheet
Types of financial models
A financial model is an act to prepare model reflect a situation of real world finance. One of the
mathematical technique used model.
There are different kind of financial models the maximum number of model determines
valuation process while some estimate the future and evaluate the risk, performance of individual
approach and also macroeconomic diversified trends within the area. A given audited financial
statement and preparation of financial model linking the three various statements. Companies
have different approaches to reflect the revenue item and balance sheet item. During the making
of such models the classification under different criterion to normalize biasness, inflate and
deflate revenues, profit, cash flow and etc.
Credit rating:

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Credit rating involves the further extent to do 3 - 5 years of projection. And integrate other
framework such as such as future demand in the firm, quality and power of management,
collateral security quality, to conduct present loan account etc.
Ratio analysis:
The profile of company’s business based on geographical location where the company operate,
the category of product and services it provide, target customers etc. Next is financial profile
included the size of the company , upper limit to lower limit etc. the comparison in between
companies through the ratios implication and that ratios can be PE ratio, PB ratio.
Discounted Cash Flow Model
Most important method of measuring cash flows. The projected free cash flows expectation is to
extract and discount them to represent a net present value of an investment and how easily can
they break from the similar methodology.
The given formula can be expressed as:
Discounted cash flow: CF1/(1+R) + CF2/91+r) + …….
+ CFn/(1+r)
R = discounted rate of return
N = life of the project
To calculate NPV, It is based on the positive and negative aspect if it becomes positive we
should keep further proceeds and if it becomes negative no investment should made.

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NPV = Cash flows present value – cash outflows present value
Leveraged Buyout Model
The acquisition of a public company and a private company comprised of borrowed amount.
Ownership signifies the firm’s cash flows for servicing the borrowed fund that means the debt
amount and the interest, the overall return realized by the investors
Comparable company analysis
The process known as comparable company analysis used to analyze the firm value using
parametric of same size businesses in the same industry it operates
PE multiple=
PE Valuation is also called as earning multiple and price multiple.
Merger and acquisition:
Considering merger and acquisition financing options involves cash, stock, debt , hybrid, share
swap ratio, expected synergy post Meager and acquisition , control premium.
Option pricing model:
The statistical models are very composite and used by option traders (professional). There are
few framework whose values fit together at present value such as strike price, underlying price
and also an option for days to expire . the estimation (forecasting) or assumptions covered

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another framework for volatility, computation of theoretical value for the opyion at specific time.
This model is comprised of two models:
Binomial model
Black- Scholes model.
Scope of financial modeling
Financial modeling has wide scope with its application over decision making, decision making of
mergers and amalgamation, capital arising, capital budgeting, forecasting and estimation, internal
planning and valuation.
Limitation of financial modeling
The financial modeling limitation consists of factors:
 Presumption and forecasting about future performance in
 The high reliability over terminal value that cover the high volume of net present value of
business.
 Weighted average cost of capital reliability.
 The tendency in excel models contain so, errors that can not found simply.
 Unable to predict future what is going to happen?
References :

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Zopounidis, C., Doumpos, M., & Kosmidou, K. (2018). Preface: analytical models for financial
modeling and risk management. Annals of Operations Research, 266(1-2), 1-4.
Aït-Sahalia, Y., Cacho-Diaz, J., & Laeven, R. J. (2015). Modeling financial contagion using
mutually exciting jump processes. Journal of Financial Economics, 117(3), 585-606.
Murthy, S. R. (2019). Excel Based Financial Modeling for Making Portfolio Management
Decisions. Information Management and Busine Spanos, P. M., Galanos, C. L., & Liapis, K. J.
(2019). Corporate Financial Modeling Using Quantitative Methods. In Economic and Financial
Challenges for Eastern Europe (pp. 161-183). Springer, Cham.ss Review, 11(2 (I)), 35-41.
Hui, Y., Wong, W. K., Bai, Z., & Zhu, Z. Z. (2017). A new nonlinearity test to circumvent the
limitation of Volterra expansion with application. Journal of the Korean Statistical
Society, 46(3), 365-374.
Alexander, L., Das, S. R., Ives, Z., Jagadish, H. V., & Monteleoni, C. (2017). Research
challenges in financial data modeling and analysis. Big data, 5(3), 177-188.
Remillard, B. (2016). Statistical methods for financial engineering. Chapman and Hall/CRC.
Drever, A. I., Odders‐White, E., Kalish, C. W., Else‐Quest, N. M., Hoagland, E. M., & Nelms, E.
N. (2015). Foundations of financial well‐being: Insights into the role of executive function,
financial socialization, and experience‐based learning in childhood and youth. Journal of
Consumer Affairs, 49(1), 13-38.

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