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FINANCIAL MODELING AND FINANCIAL FORECASTING

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FINANCIAL MODELING

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Financial modeling is a task of building an abstract representation of a real-world financial situation. It is a mathematical model designed to represent the performance of the financial asset or portfolio of a business, project and/or any other investment/business.

Financial model can also be seen as a tool used by a financial analyst to forecast the performance of an investment/ business into the future based on historical data and assumptions.

Financial modelling is a process of creating a summary of a company’s income and expenses using a spreadsheet to make a decision or to calculate the impact of a future event.

Financial analyst most often uses it to analyze and anticipate how a company stock is performing or might perform and how this performance might be affected by future events or decisions.

Financial modelling is used for various decision making such as

*To estimate the value of a business
*To make decisions on a strategic planning to test different scenarios
*To make decisions on company’s performance
*To make decisions on whether or not to invest in a business
*To make decisions on whether or not to sell or divest a business segment/section or the whole business.
*To make decisions on raising capital or mergers & acquisition.
*To compare competitors in an industry.

Some examples of financial models are Three statement model, sum of the parts model, initial public offering (LPO) model, consolidation model, budget model, scenario analysis, sensitivity analysis or in-depth appraisal, Discounted cash flow analysis (DCF) model, leveraged buyout (LBO) model etc.

Information to be included in a financial model

Depending on the size of a business, Information to be included in a financial model may include all or some of the following;

*Assumptions and drivers
*Income statement
*Statement of financial position
*A cashflow statement
*Supporting schedules
*Valuations
*Sensitivity analysis
*Charts and graphs.

Users of financial Modelling
*Bankers
*Financial institutions
*Equity researchers
*Private equity
*Public accountants
*Portfolio managers
*Students and/or researchers

There is a need to carry out a thorough data validations in order not to make a costly mistake. These validations are used or relied on so as to reassure the end-users that the calculations and assumptions within the model are correct and the end results is reliable to a large extent.

To make validations, data can be sent to an outside party (with a signed confidentiality agreement or arrangement) to help validate the information contained.

FINANCIAL FORECASTING

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Let’s go briefly into financial forecasting

Financial forecasting describes a process used by a company to predict future revenues, expenses and cashflow.

Financial forecasting helps the executives with concise and accurate predictions that can be used in making future plans for the company barring unforeseen circumstances.

There is a need for the executive directors to provide a roadmap for the business in areas like business decisions, financial decisions, hiring, budgeting, sales and purchases decisions etc.

The executive should be able to use financial forecasting to help the company make reliable, profitable and confident financial decision that will determine where the company is going to.

“Without financial forecasting a company might be heading forward but it would possibly go off a cliff.”

Financial forecasting methods

*Straight line forecasting method

*Moving average forecasting method

*Simple linear regression forecasting method

*Multiple linear regression forecasting method

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