Financial Modeling 101: Learn the Basics in Just 15 Minutes

If you’re curious about how businesses predict their financial future, financial modeling is the key. It’s a skill that helps you see how a company might perform, based on data and assumptions.

In this blog, we’ll break down financial modeling in a simple way so that you can understand the basics in just 15 minutes!

What is Financial Modeling?

Financial modelling is the process of creating a numerical representation of a business or investment’s financial performance. It entails creating a model in Excel or some other spreadsheet-based application that is able to model the likely financial results of different decisions

This framework applies historical data as well as assumptions and projections about the company’s future to estimate its income, cash flow, expenses and other financial metrics

In essence, a financial model allows one to forecast (predict) future financial performance. It could respond to questions such as:

• How much revenue is the company going to earn within the next year?
• How will obtaining new investment impact in cash flow of the company?
• What’s the best pricing strategy for a product based on cost and sales projections?

Why Financial Models Are Important

Financial models are more than just numbers on a spreadsheet—they’re powerful tools that influence major business decisions.

Here’s why financial models are so important, among other reasons

• Budgeting & Forecasting: Financial models assist businesses in determining their future by predicting revenue and costs. This process allows resources to be allocated more efficiently, while also allowing businesses to pivot quickly if things are not going to plan
• Valuation: Financial models assist in establishing a company’s worth in a business acquisition or disposal. They estimate how much future cash flows are worth today, allowing buyers and sellers to agree on a fair price
• Strategic Planning: Financial models help businesses test different strategies. For example, a business might use a model to analyze how a price change or cost-cutting decision could impact profitability. This helps decision-makers choose the most beneficial course of action

Become A Certified Financial Modeling Expert In Just 2.5 Months

A Guide to the Basics of Financial Modeling

At its core, one can think of a financial model as a blueprint for how a business may perform in the future periods.

It is all the four simple components working together to give you a snapshot of the financial reality of the business Let’s dissect its elements

1. Inputs

The inputs are the starting point of any financial model. These are the numbers or data you provide to the model. Think of them as the raw material that feeds into the model. Inputs can be many things, such as:

• Past sales: This is how much the business has earned in previous years. You use this data to understand the company’s performance
• Expenses: These are the costs of running the business, like salaries, rent, and other operational costs
• Growth rates: These are the expected increases in sales or expenses. For example, you might assume that sales will grow by 5% next year

Without accurate inputs, the financial model won’t give you reliable results, so it’s very important to gather the correct data

2. Calculations

Now that you have the inputs, the next thing you will do is to use them in calculations. And the magic happens in the calculations.

This is where you take all the inputs above and use them to come up with important financial things, such as:

• Profit: This indicates how much the business earns after costs are paid from revenues
• Cash flow: This tells you how much cash the business is expected to have at the end of a period. It’s important to understand if the company will have enough money to pay bills, invest, or grow
• Revenue: This is the total amount of money the business earns from selling goods or services

You will use formulas to do these calculations. For example, to calculate profit, you subtract expenses from revenue. Formulas are essential because they turn the raw data (inputs) into useful information

3. Outputs

After all the calculations, you get the outputs. Outputs are the results or outcomes of the financial model, and they tell you the financial story. Outputs can include:

• Financial statements: These are reports like the income statement, balance sheet, and cash flow statement. They summarize the company’s financial health
• Charts: Visual aids like graphs or bar charts that help you quickly understand the data. For example, a chart might show how revenue is expected to grow over the next five years

Outputs are what you look at to make decisions. They are the end result of all the work done with inputs and calculations

4. Assumptions

Finally, we have assumptions. Assumptions are the guesses or estimates you make about things that are hard to predict. These could include things like:

• Sales growth: You might assume that sales will grow by 10% next year based on market trends or past performance
• Tax rate: You need to guess what the company’s tax rate might be in the future based on government policies
• Interest rates: Assumptions about how much the company will have to pay for borrowing money in the future

We must make assumptions because the future is not known. They assist you in determining, in an unspecified way, what is likely to happen

However, reasonable assumptions based on good data should be made. (Read: Your financial model is wrong if your assumptions are wrong)

Also Read – Step-By-Step Guide To Build A Financial Model From Scratch | By Proschool Experts

Financial models are of different types, but they are made specifically for constructing intelligent financial decisions for businesses. Here are some common ones:

Some of the most Popular Financial Models

Discounted Cash Flow (DCF) Model

The DCF model helps figure out how much a company is worth by predicting how much money it will make in the future. It then adjusts those future earnings to reflect their value today

• How it works: The model predicts future cash flows (money the company will earn) and then “discounts” them to today’s value using a specific rate
• Why it’s useful: It helps investors understand the current value of a company based on future earnings, which is helpful when raising money or during acquisitions

In simple terms, it tells you how much a company’s future profits are worth today

Merger and Acquisition (M&A) Model

The M&A model is used when companies are merging or one is buying the other. It helps estimate how much the combined company will be worth and how it will perform financially

• How it works: It compares the financial data of both companies and predicts how the merger or acquisition will affect their finances. It also looks at potential benefits, like cost savings or higher revenue
• Why it’s useful: This model helps businesses decide if merging or acquiring another company is a good financial move

It’s essential for companies considering mergers or acquisitions to understand the financial impact of combining businesses

Budgeting Model

A Budgeting Model allows businesses to plan ahead of time about how they intend to make and spend their money over a defined period of time which is generally a year. It’s a crucially simple tool for controlling cash

• How it works: The model predicts where the company would earn and spend money, allowing for year-long planning It also compares actual results to the budget to keep things on track
• Why it’s useful: This one allows you to control spending for your business and make sure you’re under your budget in order to control your spending and ensure that you’re financially sound

This model is key for managing cash flow and making sure a company doesn’t spend more than it earns

Leveraged Buyout (LBO) Model

The LBO model is used to evaluate how much debt a company can handle when being bought using borrowed money. It’s mostly used in private equity deals

• How it works: The model looks at how much debt a company can take on and still pay it off with future earnings. It checks if the company can generate enough cash to cover loan repayments and interest
• Why it’s useful: It helps investors determine if a company can handle the debt needed to buy it without risking financial trouble

This model is essential for private equity firms to understand if a company can survive after being bought with a lot of borrowed money

Also Read – What is Leveraged Buyout Modeling & how can you learn it?

Why Each Model Matters

Whether you’re valuing a company, planning for the future, or analyzing a merger, financial models provide the structure and data needed to make informed choices

• DCF helps with valuations based on future performance
• M&A helps evaluate the impact of mergers or acquisitions
• Budgeting helps keep businesses on track financially
• LBO helps assess the feasibility of acquisitions financed by debt

Also Read – 8 Types of Financial Models, Their Applications & Examples

Building Your First Financial Model

Creating your first financial model might sound complicated, but it’s actually a lot simpler than you think.

By breaking it down into easy-to-follow steps, you’ll quickly get the hang of it. Here’s a step-by-step guide to help you build your very first financial model

Start with a Template

The easiest way to get started is by using a template. Excel is a popular tool for financial modeling, and it offers many templates that can help you organize your work.

A template gives you a basic structure to follow, so you don’t have to worry about starting from scratch

• Why use a template? Templates provide predefined sections and formats that help you stay organized and ensure your model includes all the necessary components (like income statement, balance sheet, and cash flow)
• Where to find templates? You can find free templates online or in Excel itself. You could also use paid resources, but free options work well for beginners

Starting with a template will save you time and reduce mistakes, especially when you’re just starting out

Also Read – 9 Best Financial Modelling Courses – Online & Offline

Gather Your Data

Before you start building the model, you need to gather the data you’ll be working with.

This could include:

• Past revenue: Look at how much money the company earned in previous years
• Expenses: Collect data on costs like salaries, rent, utilities, and other operational expenses
• Assumptions about future growth: For example, you might assume that sales will grow by 5% each year or that operating costs will increase by 10%

Having this data is essential because it forms the foundation of your financial model. If you don’t have real data, you can use estimates but try to make them as realistic as possible

Set Assumptions

Next, you’ll need to make some assumptions about what might happen in the future.

Financial models are about predicting what could happen, so you’ll need to assume some things, like:

• Sales growth: For example, you might assume sales will grow by 5% per year based on historical trends
• Cost increases: You might assume that your expenses will rise by 3% due to inflation or other factors
• Tax rates: You’ll need to decide what tax rate you’re going to use for calculations

It’s important to base your assumptions on solid data. If you don’t have enough information, try to find industry benchmarks or historical data to help guide your assumptions

Create Financial Statements

Once you’ve gathered your data and made your assumptions, it’s time to create the financial statements.

These are the core of any financial model, and they will help you project how the company will perform. The three main financial statements are:

• Income Statement: This shows the company’s revenues, costs, and profit over a period of time (usually a year). It helps you understand how much the company is making and spending
• Balance Sheet: This shows what the company owns (assets), what it owes (liabilities), and its equity (the difference between assets and liabilities)
• Cash Flow Statement: This tracks the flow of cash in and out of the company. It’s important because a company can be profitable but still run into trouble if it doesn’t have enough cash to pay its bills

When creating these statements, link them together so that changes in one part (like revenue) automatically update other sections (like cash flow)

Do Your Calculations

Once your financial statements are set up, it’s time to perform the calculations. You’ll use formulas to calculate important metrics like:

• Profit: Subtract expenses from revenue to find out how much the company is making
• Cash Flow: Calculate how much cash is coming in and going out. This is especially important for making sure the company has enough liquidity
• Growth Rates: Use your assumptions to calculate how much you expect sales or expenses to grow over time

In Excel, you can apply built-in functions such as SUM, AVERAGE, or even more sophisticated financial formulas like NPV (Net Present Value) or IRR (Internal Rate of Return) to conduct these computations

Analyze the Results

Finally, after performing all the calculations take a step back and look at your results. Examine your finances and consider what:

• Does the model look realistic? For example, if sales are projected to grow 20% in one year, is that reasonable based on the data you have?
• Are the cash flow projections realistic? Does the company have enough cash to cover its expenses?
• Do the numbers make sense? If something looks off, go back and check your assumptions and calculations

It’s important to review your model multiple times to ensure that everything is accurate. You can also run different scenarios by adjusting your assumptions (for example, what would happen if sales growth was only 2% instead of 5%)

Also Read – Top 14 Financial Forecasting Models for Accurate Projections

Tips for Organizing Your Financial Model

• Keep It Simple: Start with the basics and add more as you get comfortable
• Use Color: Color-code parts of the model (like inputs, calculations, and results) to make it easier to read
• Break It Into Sections: Keep your model organized by separating assumptions, calculations, and financial statements into different sections
• Use Clear Formulas: Make sure your formulas are easy to follow. This will help you spot mistakes later

Common Mistakes to Avoid While Creating Your First Financial Model

• Linking Errors: Make sure your financial statements are correctly linked. If revenue is in one sheet, it should show up in others
• Too Many Assumptions: Don’t guess too much. Stick to the key assumptions that really matter
• Not Testing Your Model: Always check how your model behaves under different conditions. What happens if sales grow 10% instead of 5%?

Tools and Resources for Learning Financial Modeling

Software and Tools

The most commonly used tool for financial modeling is Excel. It’s great because it has all the functions you need, like formulas, charts, and tables

Other tools include:

• Google Sheets: This is similar to Excel but works online and is great for collaborating with others
• Specialized Software: Programs like Quantrix or Tableau are used for more advanced modeling, but Excel is enough for most beginners

Also Read – 12 ways to make financial modelling Excel more visually effective

Learning Resources

• Books: Some good books to help you get started include:
  • “Financial Modeling” by Simon Benninga
  • “Investment Valuation” by Aswath Damodaran
• Online Courses: Websites like Coursera, Udemy, and LinkedIn Learning offer courses on financial modeling
• Tutorials: Free tutorials and blogs can help you learn the ropes. Websites like Investopedia and the Corporate Finance Institute (CFI) have beginner-friendly guides

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If you’re ready to take your financial modeling skills to the next level, IMS Proschool offers a comprehensive Financial Modeling Course.

You will learn from scratch to an expert level so that you can prepare the proper financial models required by all organisations.

Conclusion

In 15 minutes, you have an understanding of the basics of financial modeling. Now you know what it is, why it matters, and the key steps to building your own first model

FAQs

What skills do you absolutely need for financial modeling?

You should know how to interact with Excel, be familiar with financial statement lines, and have basic comfort with math and finance

How long does it take to learn financial modeling?

It takes approximately 3–6 months to master, depending on how much you practice

Can I learn financial modeling without a finance background?

Yes, many people learn financial modeling without a finance background. There are plenty of beginner-friendly courses available

What industries commonly use financial modeling?

Financial modeling is used in industries like investment banking, corporate finance, real estate, and consulting

Are there certification programs for financial modeling?

Yes, courses like those offered by IMS Proschool and Corporate Finance Institute (CFI) offer certifications that can boost your career prospects