Financial Modeling

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Meaning and definition of financial modeling

Financial modeling refers to the process through which a company builds up a financial representation of some, or even all aspects of the company or the given security. The financial model is generally featured by performing calculations, and making recommendations on the basis of that information. Moreover, the model might also précis specific events for the end user in addition to providing direction regarding possible alternatives or actions.

As explained by Investopedia, financial models can be created in different ways including the use of computer software and the use of a pen and a paper. For instance, a financial model can précis investment management returns or might help in estimating the market direction.

Accounting of financial modeling

In investment banking, corporate finance, and the accounting profession, financial modeling is mainly synonymous with cash flow forecasting. This generally includes preparing detailed company specific models which are used for the purpose of decision making and financial analysis. The applications mainly include:

  • Business valuation, particularly discounted cash flow, but counting other valuation problems.
  • Management decision making and scenario planning (like “what is”, “what if”, “what has to be done”, and similar more.
  • Cost of capital
  • Capital budgeting
  • Project finance
  • Financial statement analysis

Why is financial modeling important?

Financial modeling acts as a useful tool which enables business options and risks to be estimated in a cost-effective way against various assumptions, recognize optimal solutions in estimating financial returns and understand the effect of resource constraints thus leading to more effective business decisions.

Financial modeling can be referred as an art and like any other art form, it requires constant [practice and commitment to develop expertise in this area. In the present day world, many companies are becoming globally integrated with the international economy through the way of acquiring/establishing international operations. This calls for the requirement of strong financial models which can assist in performing the evaluation of every country’s operations, reflect on multiple currencies in their model, estimate varying capacity utilizations to estimate the optimal capacity under changeable industry demand-supply scenarios and similar more cases.  

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