Financial Modeling in Excel
This article will dive you into the ocean of Financial modeling in Excel and how to create financial modeling in it.
Financial modeling is an umbrella term for the financial management of any business. If you are wondering how to predict the growth of your business in the future, It is a standalone tool that can help you with analyzing past, and current scenarios by giving the assumptions of future events in the market. This model can become your best financial decision-maker. Financial modeling in Excel is in the higher recommended as the working becomes comfortable and flexible with Excel sheets. It displays wide analyzing options like charts, pivot tables, and graphs that show pristine data to make efficient analyses. One must be sound in Financial modeling and excel to be on the crest of a wave.
This article will dive you into the ocean of Financial modeling in Excel, how to create financial modeling in Excel, types of financial modeling, and the benefits of financial modeling.
Financial Modeling in Excel
Financial Modeling is closely regarded with the history of accounting and banking. Back in the older days, accounting was done manually with pen and paper. With technological advances and inventions of software, the ledger book of accounts got replaced with spreadsheets. The usage of Excel sheets has made the work precise and easier. Businesses started taking substantial turns that required a proper growth tracking tool. Excel becomes such comfortable spreadsheet-based software.
Financial Modeling in Excel is a mathematical representation with an Excel spreadsheet that tracks and predicts the financial operations of a company. The valuation and other financial analyses are done with the formulas, data inputs, and other functions in the Excel spreadsheet. It requires past data, current performances, and assumptions to predict future results. Excel is very useful because of its user-friendly interface.
Excel has many in-built financial functions such as NPV (net present value), FV (Future value), IRR (Internal rate of return), and PMT that make difficult financial calculations easier. It can be accessed by multiple users at the same time to work on a financial model. Visualizing financial data is pretty easy with options like graphs, charts, and pivot tables. It is a very cost-effective and systematic solution for analyzing financial performance and forecasting future events.
Importance of financial modeling in businesses
When you start a business, you invest in many workforces to maintain manufacturing policies, supply chain regulators and so many other operations. While every other thing is looked out for smooth functioning, it is also important to look for proper financial functions. It is important to track the performance of the company financially and analyzing, it helps work more effectively.
To analyze this, you need historical data, current operational scenarios, budgets available, investing options, and also predictions of future markets. Financial modeling is a boon for every business to understand the performance and scale up in the industry. There are more specific reasons why it is important in business. Let us have a look at the benefits of financial modeling in business.
- Decision Making – It assists professionals to make smarter decisions regarding investments and plan their operations strategically.
- Budgeting – It helps to plan the budget depending on the existing asset and other expenses.
- Forecasting – It predicts future trends and financial performances and adjusts the company’s operations according to it.
- Risk Management – It assesses and manages financial risks.
- Performance evaluation – It can evaluate a company’s past, and present performances and finds areas that need improvement.
Building financial modeling in Excel
Building Financial Modeling in Excel accommodates you with its techniques and practices. It requires sound knowledge and understanding of finance and expertise in using Excel. To create a financial model in Excel, the following steps have to be carried out:
- Gathering data and assumptions – Data reports like financial statements, industry performance reports, and market assumptions are to be gathered which will give an analysis of the past and present performances to make clear assumptions of the future.
- Setting up the structure of the model – A basic outline of the model is created, inclusive of various sections for the balance sheet, cash flow report, income statement, and other relevant data.
- Entering and organizing data in the Model – The data is entered into the appropriate columns and rows. This makes the sheet look organized and readable.
- Testing and Revising the Model – To check the flexibility and validity of the model, various statistical scenarios are run which will help sort the potential errors. Make any necessary adjustments if required.
Types of financial models you can create on Excel
The highlight of having types of financial models is that it provides a better understanding of sales and accounting. The models are used by corporate professionals, investment bankers, research analysts, and equity professionals.
- Company financial models – Different types of financial models can be created in Excel. They are the Three-statement model, Discounted cash flow model(DCF), Merger model (M&A), Initial public offering model (IPO), Leveraged buyout model (LBO), Sum of the parts model, Consolidation Model, Budget Model, Forecasting Model, and Option Pricing model. To build these models, certain inputs like revenue of the company, expenses, assets, sales performances, and gross margin are required. With these details, financial accounting and forecasting can be done.
- Valuation models – A valuation model is an analytical approach that determines the value of the asset, the company’s stock, and another financial status. A valuation can be done on the company’s basis or in comparison with other similar companies or assets. It takes financial and economic data to make assumptions and calculate the result. Valuation models range from simple to complex that uses advanced arithmetic techniques. Discounted cash flow methods, dividend discount methods, and option pricing models are some of the common valuation methods. Further, the valuation model falls into two categories and they are as follows:
- Absolute valuation model – This model determines the individual market’s true value of the assets with no dependency or comparison of other markets. This simply focuses on the company’s inherent characteristics such as profits, cash flow, dividends, and assets.
- Relative valuation model – Unlike the Absolute valuation model, this compares other companies’ fundamentals like investment and assets. This model uses financial ratios like price-to-earning(P/S), Price book (P/B), and Price to sales(P/S). It gives a more comprehensive view of an asset’s worth.
- DCF – Discounted Cash Flow (DCF) is a valuation method used to estimate the value of an investment based on its expected future cash flows. It involves projecting the cash flows that the investment is expected to generate over some time and discounting them to present value using a discount rate. The discount rate represents the opportunity cost of investing in the subject asset, taking into account the time value of money and the investment’s risk. DCF is considered to be a more rigorous and accurate method of valuation compared to other methods, such as relative valuation and comparable company analysis, as it takes into account the specific financial performance of the investment being valued. However, it is also more complex and time-consuming, as it requires a detailed projection of future cash flows and a thorough analysis of the discount rate.
Disadvantages of using Excel in financial modeling
Though Excel has been in wide use, there are limitations and disadvantages to working in Excel. Some of them are listed below
- Lack of accuracy – Excel involves manual entries of data which may cause typographical errors and in some cases, incorrect formulas can cause errors. Excel rounds off numbers automatically which gives inaccurate results if the calculation involves a large number of intermediate results. It has limited decimal places and inconsistent data types where data types can get mixed up. Other data corruptions like software glitches and power failures may also lead to inaccurate results.
- Complexity – It can be complex due to its complex formulas and calculations which becomes difficult to maintain the model structure. It involves many assumptions which make tracking challenging. Integrating data from various sources can also increase the complexity of the model.
- Limited functionality – Excel becomes slow while dealing with large amounts of data which leads to decreased efficiency and productivity. It does not provide real-time data which can limit the functionality of the model.
- Limited collaboration opportunities – Excel does not collaborate easily with any other data sources or systems. It is a standalone model and hence it is hard to access and analyze data effectively.
- Poor scalability – It is difficult to manage when the models become larger and more complex. This increases errors and decreases the efficiency of updating and maintaining the model.
- Lack of security – Excel is vulnerable to unauthorized modification and also to data corruption or loss. Hence, it lacks security.
Eqvista as a financial modeling tool
Excel has its limitations which makes the functionality difficult and erroneous sometimes. Creating spreadsheets, finding and implementing formulas, and tracking sales, all have high risks as it is manual. When business owners already have too many on their plate, they cannot keep analyzing things, especially in a complex model like Excel. At Eqvista, we do professional accounting with our specialized features. Eqvista includes two complex models that help you in tracking your company”s performances, assets, and interests, and in making smarter decisions.
Features of Eqvista that make it a helpful alternative to Excel
The two models that eqvista provides are Round Modeling and Waterfall analysis. This is an exemplary alternative to Excel as they help organizations calculate share dilution implications and exit strategies. Eqvista has this smart built-in algorithm to manage such complications. Round modeling tool allows the investors to run a test of different scenarios with multiple functionalities, unlike other sources with basic operations. Waterfall analysis uses a waterfall chart to understand the payout of the company and its total value. Scenario modeling is another feature that helps in predicting the future under different circumstances.
Examples of how Eqvista can be used in financial model
Eqvista, Waterfall Analysis, and Round Modeling Analysis tools are all helpful techniques for making well-informed choices. Our application allows shareholders to view the dilution of their share ownership as new investments come in, allowing them to make more informed financial decisions and avoid potential disagreements. Here are some examples of how our Financial modeling tools work.
Example of Round Modeling Analysis
The sample company, Finance Inc, has the following information (same as their cap table):
- 20% ownership of 2,000,000 Common shares for $20,000
- 25% ownership of 2,500,000 Preference A shares for $2,500,000
- 25% ownership of 2,500,000 Preference B Shares for $2,500,000
- 15% ownership of 1,500,000 Preference C Shares for $1,500,000
- 5% ownership of 500,000 Warrants
- 10% ownership of 1,000,000 Options
- One Convertible note for $3,000,000 with 10% interest annually
The preference shares also have a conversion rate of 2 (worth twice the amount of common shares)
The cap table of Finance Inc. on the Eqvista App is as below:
In this case, the pre-money valuation will be $10,000,000, the post-money option pool will be 10%, and the new investment will be $1,000,000. For ease of use, we shall compute the convertible notes on a pre-money convertible basis and exclude conversion rates and convertible note interest from the various criteria.
The following lists the inputs and the values’ breakdown:
The pre-money valuation of the company’s shareholders would look a lot like the cap table, with the exception that instead of the original share value amounts, $10,000,000 would be shown.
However, the post-money values would be different for the current share classes, as they would undergo some share dilution from the introduction of the new investment and new option class.
You can see in the chart below that each equity type is diluted, with their ownership share reduction going to 10% for the new options, and 9.09% for the new investment of $1,000,000. For instance, the founder class of common shares are diluted by 4.91%, from 20% to 15.09%. This also results in a reduction of the value of the company from $2,000,000 to $1,660,000.
Have your financial modeling done by Eqvista!
Developing and maintaining a business should not feel hectic. Every business owner cannot rely on research analysts to track the status of their company. Financial modeling is complex when done manually and hence Eqvista comes with special features to do the legwork for you. You can run a scenario analysis, and create financial models with round modeling and waterfall tools in Eqvista. To move relentlessly into the future, get help with Eqvista!