6 Most Common Types of Financial Modeling Techniques
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6 Most Common Types of Financial Modeling Techniques

financial modeling techniques

A business needs to have a solid financial foundation to support their future. Understanding expenses and revenue helps a business project its potential financial position. One of the ways that businesses do this is through financial modeling, which the website Corporate Finance Institute defines as, “a tool that’s built…to forecast a business’ financial performance into the future. The forecast is typically based on the company’s historical performance, assumptions about the future, and requires preparing an income statement, balance sheet, cash flow statement and supporting schedules.”

Businesses from just about every kind of industry use some kind of financial modeling, including finance professionals, real estate, non-profits, banking and investment firms, oil and gas companies, and government entities.

In addition to a business wanting to forecast the material and labor hours needed for an upcoming year, financial modeling is sometimes used to prepare research for business mergers or as a prerequisite for an Initial Public Offer (IPO) when a business goes public and shares can be bought and sold on the stock market.

Here are some of the most common ways to create this kind of financial forecast.

1. Three statement model: This is one of the more basic, standard forms of financial modeling. The goal of this model is to help a business understand how their three financial statements – the income statement, balance statement, and cash flow statement) are linked.

2. Leveraged buyout (LBO) model: This a more advanced, complicated financial model. As the name suggests, it’s a model used when a company is buying out another company and using a significant amount of funding to complete the purchase. An LBO model helps a business understand if it can take on the purchase debt and predict if it will make a profit after a certain amount of time, along with selling the business. It is a detailed and challenging financial model that is not used very often outside of private equity and investment firms.

3. Consolidation model: This type of model includes multiple business units added into one single model. Each business unit has its own set of financial data that’s consolidated against the other business units to create a single worksheet. If the Yum! a brand created a consolidation model, it would examine the finances of each of its business units, including KFC, Taco Bell, and Pizza Hut.

4. Initial Public Offering (IPO) model: This financial model is used primarily by investment bankers and developers who want to understand the value of a business before going public. This model looks at comparable companies and works to analyze how much investors will be willing to pay for shares in the organization before going to sell shares.

5. Budget model: This is used to model finance for accounting, finance, and business professionals to plan a budget for the upcoming year or years. Budget models are typically designed to be based on monthly or quarterly figures and are a primary focus on the income statement of a business.

6. Forecast model: The forecast and budget models are often conducted around the same time and sometimes combined for a better understanding of the overall predicted financial position of a company. A budget helps to dictate what a business should approve in terms of spending based on past data, while a forecast model usually helps a business understand how much their business might change, predict fluctuations in sales, and other business variables.

While this list doesn’t cover modeling that could help in any given business situation, these common methods can help you approach most financial situations. Financial modeling is a long-standing way of understanding the financial position and potential of a company and is regularly used to assess everything from future stock prices to annual budgets and everything in between.

Marianne Chrisos
Marianne Chrisos
Born in Salem, Massachusetts, growing up outside of Chicago, Illinois, and currently living near Dallas, Texas, Marianne is a content writer as a company near Dallas and contributing writer around the internet. She earned her master's degree in Writing and Publishing from DePaul University in Chicago and has worked in publishing, advertising, digital marketing, and content strategy.
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