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What is a financial forecast model?
A model takes a company’s key financial statements and forecasts
them into the future, usually for a five to ten year period. It is rare to
forecast beyond this, as longer periods are harder to predict and the
numbers become more uncertain.
A model is typically set up in an Excel file which will have separate areas
for the financial statements themselves, forecast assumptions and
workings. Excel formulas link the forecast numbers to forecast
assumptions. The assumptions are commonly based on estimated
future growth rates and margins for each line item in the company’s
income statement and balance sheet, and so estimating assumptions is a
key part of the modelling process. Poor assumptions will result in a poor
quality forecast. One way to check the quality of the forecast is to look at
the trends in projected margins and growth rates based on the estimated
numbers produced in the model and so most models will also have a
complex ratio and analysis section.
Once the basic forecast has been built, the model can be used for further
types of analysis, and additional worksheets such as discounted cash
flow valuation or leveraged buyout valuation can be added.
Financial models are widely used in the banking environment and by
corporates. Models can help in making important financial decisions such
as new investments, divestments and restructuring.
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