Building a financial model in Excel could be very tough sometimes. There are many things that you should put into consideration to help you create not only a great but also an effective financial model. Here are the aspects you should know before developing a financial model in Excel.
#1. The Goal of Creating the Model
The first thing you should consider well is the purpose behinds the creation of the financial model. To help you to narrow the goal down, there are some you need to consider well. The first is the valuation date of the model since the DCF model used in the Excel will discount the cash flows that occur in the future.
#2. The Format Used in the Model
The format of the model is a crucial element since a good financial model should be readable easily. For example, you need to separate all assumptions with the output or calculations. This is to make sure that you can easily find out parameters that you need to change whenever it is necessary in order to affect the valuation.
#3. Structure of the Financial Model
The structure is the next aspect in creating a financial model that should be considered well. To create a good structure of the financial model, you need to develop three statement models. In other words, the output result by the model should be able to represent Cash Flow Statement, Balance Sheet, as well as Income Statement.
#4. Model Correction
There are many cases in which the financial model created is inconsistent or incorrect. In this way, this is very crucial to make some automatic corrections to be added to the model. With the model correction, we can immediately find out if there is something incorrect with the model.
#5. Things Should Be Prevented
In order to help you to start building a financial model in relatively short time, there are some things should be avoided include circular references since they look more complicated and many people will tend to think that the model is incorrect. Another thing should be avoided are links to external files and you are strongly recommended to replace them with hard-coded data for more practical reasons.
#6. Build an Operating Model
The operating model can be created by separating the assumptions found in the respective section. The next thing to do is by creating Debt Schedules and Fixed Assets. How much time you will need to create the operating models fully depends on the complexity of the business model.
#7. Creating Financial Ratios and Financial Statements
Once you could complete the operating model properly, you will be able to create financial statements in much easier ways. All you need to do is by putting the figures you need from the model in the right section of the three statements made before.
#8. DCF Valuation
Building DCF valuation is the next thing to do and you will need the Weighted Average Cost of Capital (WACC) to complete it. You might put the discount rate or simply calculate the WACC as the input factor.
#9. Executive Summary
Once the DCV valuation model is completed, means that you close to the end of the building process. Thus, it comes the time to create Executive Summary that contains brief explanations of the key figures exist in the model.
#10. Analysis of Sensitivity
The analysis of sensitivity is the last thing you should put into consideration when building a financial model. This is important to help you check all of the parameters used in the model and correct them.