Financial Modelling Using Excel: The 7 Steps to Success
By Afia Ahmad
A financial model outlines how a business works. The main purpose is for decision making and performing financial analysis to impact a company’s profitability.
Developing a financial model using Excel can be complex and time consuming. It requires advanced planning and a systematic approach. Before you start, research well and learn as much as you can through online courses. Once you’re clear about your model idea, design it on paper. Here are the 7 key steps to follow:
1) Define & Structure the Problem
The first step is to take time to understand the reason behind creating the model. Make sure you clearly define the problem you’re aiming to solve. Discuss this with stakeholders and establish just how accurate or realistic the output needs to be. This will structure your thoughts and ensure clarity when creating your model.
2) Identify Input and Output Variables
There are two type of variables- independent and dependent variables. Independent variables are the numbers manually fed into Excel without any formulae while Dependent variables vary depending on the Independent variables. You need to list out all the inputs your model needs based on your discussion with stakeholders so that you can enter them as independent variables in your model.
Your input variables will have an influence on your model outputs. The output always needs to be accurately calculated to prevent error. If you lay out your spreadsheets with the output in mind, you save a lot of time.
3) Understand Mathematical & Financial Aspects of the Model
Start building the model only if you’re certain of solving a problem by hand. Before creating the model, understand the finance and mathematics of it. Learn Excel through Excel tutorials or by undergoing Excel Training. If you’re confident in accurately cracking the calculations by hand only then can you write necessary formulae or instructions for the computer to perform.
4) Design the Model
This is the core phase of the process. It will be much easier to build and design the model if your specifications are in order and reflect the users’ wishes. The specifications include the detailed structure of the model and how it will be laid out in Excel. When building the Excel spreadsheet, create your own template which will be the basis for all your sheets in the model. Start with the basic sheets. Discuss details of the financial model with the users regularly so that it meets expectations.
5) Test the Model
Initially, start by testing your model on small data sets so that it becomes easier to find and fix bugs or errors. For the hidden bugs, test the model with a range of input variables. Understanding how changes in the independent variables will affect the dependent variables will increase the likelihood of creating a successful model. When building a complex model, test it at every step and at regular intervals.
6) Document the Model
This means recording every function, formulae, flowcharts, diagrams, etc so that the model is handled properly, even by those who weren’t involved in the development process. It would also allow you or others to know where exactly edits can be made. Document the process as you develop the model and finish it after your model is fully created.
7) Monitor & Update the Model
It is unlikely that the model will be successful at first attempt. Keep monitoring the output and checking for errors. Changes in the model will require you to regularly update and document it.
The key is to plan well, assess your progress against the plan and tweak your model to provide a clear picture of what lies ahead.