Understand the Basic Building Blocks of a Good Financial Model

The annual summary of the performance of a company can be termed as a financial model. This financial model helps in constructing forecasts for the future financial performance of the company. There are different financial models such as the 3 statement model, DCF model and industry specific model.

All the models mentioned above use knowledge about the operations of the company, accounting records, corporate finance and excel worksheets as the basic building blocks. As such, the above are required to generate workable financial models which will be helpful in future growth of the company.

Knowledge of company operations is the first building block for a good financial model. It is important to know the exact work a company engages in and the different processes used in producing the specific goods and services. Without the knowledge of operations it would not be possible to list out the exact activities involving input and output of cash flow. Hence, lack of knowledge about the operations may lead to faulty models and forecasts for the future.

Accounting records are the second most important aspect of building a good financial model. It is imperative for a company to have accurate accounting records. All the financial transactions must be clearly and honestly recorded so that there is a clear understanding of how the funds have been utilized. Important information with regard to the company management and achievement of company goals is revealed from the accounting records. Hence, accurate accounting records are another key building block of a good financial model.

Corporate finance is the third important building block of a good financial model. It is important to use the principles of financial planning and financial monitoring. Financial planning sees that the organization is aligning its activities to the strategic goals, both, short and long term. Financial monitoring refers to the monitoring of funds and how they are utilized within the organization for various activities. Monitoring also involves overseeing the setting of the budget and the keeping of accounting records. This enables the corporate finance team to produce timely and accurate financial reports.

Maintaining excel spreadsheets that contain all the financial and accounting data in detail is one the most important building blocks for a good financial model. Maintaining a regular record on excel spreadsheets enables the managers to create a good and accurate financial model. It is also helpful in helping create an internal controls system whereby the data stored is helpful in creating the necessary checks and balances.

With the above four building blocks in place, any company can build a good financial model. There are several certificate corporate finance courses online which can help understand financial models better.