Good Financial Model

What Makes a Good Financial Model?

This brief guide will outline the hallmarks of a “good” financial model.

1. Good assumptions

An effective and efficient model can help a company see and reach its future performance goals in various situations. This means that for a financial model to function successfully, the documented quantitative values need to be realistic and appropriate.

The model should reflect key business assumptions directly without being over-built or cluttered with unnecessary details. This will ensure the model remains truthful and represents reality and that it is reasonable, with previous data/ performance numbers, defensible assumptions, and projected performance. The assumptions and conclusions must be very clearly conveyed within the model.

2. Flexible

A good financial model will also be flexible. This is portrayed in both the design and technique, as it must allow the model to be flexible in the immediate term and adaptable in the longer term.

The model must have the ability to change with dynamic schedules. This grants model users the ability to plug various numbers into cash flow projections, depreciation schedules, debt service, inventory levels, the rate of inflation, etc., to run scenarios and make modifications over an extended period by different analysts. A good financial model should be able to be adjusted and manipulated in any field. The key to flexibility is simplicity.

3. Easy to follow and understand

Lastly, a model must be easy-to-follow. The entire model needs to be easy to read and follow to get the most out of it for analysts and business owners. In other words, the model needs to make the complex look simple. 

Principles of Financial Modeling

A good financial model should be free of errors and easy to read and understand. With that, these principles will cause the model to be easier to navigate, check, and rely on.

1. Consistency and formatting

Consistency in a model layout and organisation is essential to ensure the reader understands its logic and that it can be successfully passed from author to author. This consistency can consist of appropriate columns, the number of sheets, page breaks, numbers and formulas, and proper formatting.

2. Efficiency

Efficiency in a model will allow both the person putting the model together and the analyst to make the best use of their time. This means paying attention to the formulas and numbers going onto the sheet. It also includes how these numbers are organised and portrayed with the end goal in mind.

3. Clarity

As mentioned above, the model needs to make the complex look simple. The model needs to be easy to follow for the one producing the model and those dissecting it and using it to forecast future financial numbers.

Have you ever tried to build or work on a financial model? Leave your comments in the comments box.