Before you do anything, you need to have a plan. You cannot star running before you start walking or even know the direction in which you need to go. Planning is the most important part of completing any task. Execution done according to a well-made plan succeeds whereas even hard work fails when there is no planning.
Explaining the complicated term
Financial modeling can be explained as the model or plan of a real financial state of affairs. The model represents a mathematical calculation, based on the present assets, schemes and future investments connected to a particular project. It has many different connotations. It is a combination of accounting, finance, and mathematics and applies to many users using different tools.
How does it help?
First, the model looks at the history of the company, the various financial decisions made by the company in the past and how they had an impact on its balance sheet and profit and loss record. Its past performance helps to predict a future model and that also helps to provide numerical values to every aspect. You can estimate the value of the company based on this mathematical model.
Applications in Finance
- It is the most basic method used by bankers and investment analysts. The model can help them to forecast the financial revenues of a company. Then they can advise their clients, both seller, and buyers, about the investments.
- In the same way when all the financial values are carefully represented in a model, then they can determine the risks associated with the fund and it can also predict the future returns to a certain extent.
- Any company is rated according to its past financial results and balance sheets, as the performance of the company is calculated based on the financial results. The model helps the analysts to use the history and projected results and then come up with a ranking. This rank is used by people to decide whether to invest in a particular company or not.
- Even within a company the financial experts and the top management have to understand the viability of various on-going and future projects. Any plan, even if very ambitious and desired, may not be feasible financially. The company has to be careful about deploying its resources by considering the debt and equity mechanism of every project.
- Financial models are also used by the corporate finance teams to understand the real picture of their financial status. Then they can allocate the funds to various projects accordingly.
Last but not the least at the time of selling or buying a company, this model is of extreme importance. These models are important in preparing the past performance reports, debt status, and future revenues. The mathematical component ensures precision and accurate forecasts and that is why it is recommended for use in every company.