What is Financial Modeling?

Financial modeling refers to the presentation and analysis of financial data of a business or an investment, in order to know how future events and decisions can affect such performance. Financial models are helpful when a company or firm is about to make important business decisions. Financial modeling entails creating a data representing the profits and losses, earnings and expenses of a business so that the effects of decisions made by the management of other future events can be calculated.

How Does Financial Modeling Work?

Financial modeling is a model that seeks to represent the output or performance of a business, investment portfolio or project. For a company, financial modeling is a representation of aspects of a company's operations in terms of finances. Executives of board members of companies often use financial models to evaluate the expenses, profits, losses and earnings of the company. These models are crucial when important business decisions are to be made in the company. Aside from company executives, financial analysts, planners and advisors also use financial models to examine how a change in policy or a future event would affect the financial performance of the company.

Other Uses of Financial Models

Aside from the importance of financial models that are listed above, other uses include the following:

• Financial models help in evaluating the performance of a business in relation to other businesses in the same industry.
• Financial models are crucial for strategic planning and business positioning of companies.
• These models give insight to the cost of expenses of investments and projects that a business wants to undertake. This is important for financial planning or business budgeting purpose.

Real World Example

In the real world, financial modelers often use the spreadsheet to highlight the summary of a company's expenses and earnings. Sales growth of a business are also calculated. When this financial data is presented, modelers compare the performance or sales growth of different quarters and the impacts of decisions made by company executives or future events on such performance. Financial modeling also helps to estimate sales growth and performance if certain decisions are taken. How well company A is performing when compared to company B in the same industry can be identified through financial modeling. The performance of various investments and projects can also evaluated.