Build a Financial Model from Scratch A Step by Step Guide - FasterCapital (2024)

1. Define your financial model's purpose

When building a financial model, the first step is to define the model's purpose. This may seem like a simple task, but it's actually one of the most important steps in the process.

The purpose of a financial model is to forecast future financial performance. This could be performance of a company, a project, or an investment. The model should be built in a way that allows for easy changes to assumptions, so that different scenarios can be tested.

There are a few different ways to approach this task. The first is to think about what you want to use the model for. Do you want to forecast sales for the next year? Project expenses? Evaluate a new product launch? Once you have a general idea of the model's purpose, you can start to think about what inputs and outputs will be necessary.

The second approach is to look at existing models and adapt them to your own needs. This can be a helpful starting point, but it's important to make sure that you understand how the model works before using it. Otherwise, you could end up making inaccurate predictions.

Once you have a clear idea of the purpose of your financial model, you can start to build it out. The next step is to gather the data you'll need to populate the model. This data can come from financial statements, market research, surveys, and other sources. Once you have this data, you can start to input it into the model and begin to build out the formulas.

building a financial model from scratch may seem like a daunting task, but it's actually not as difficult as it sounds. By taking the time to define the model's purpose and gather the necessary data, you can create a powerful tool that will help you make better decisions about your business or investment.

2. Understand the inputs and outputs of your model

If you're looking to build a financial model from scratch, it's important to first understand the inputs and outputs of your model. This will help you determine what information you need to include in your model, and how that information should be formatted.

The inputs of a financial model are the assumptions and inputs that drive the model. These can include things like sales growth, expenses, capital expenditures, and interest rates. The outputs of a financial model are the results of the model, which can include things like profitability, cash flow, and return on investment.

When you're building a financial model, you'll need to consider both the inputs and outputs of your model. This will help you build a model that is accurate and informative.

3. Choose the right software for your needs

financial modeling software comes in all shapes and sizes. There are many different software programs out there that can be used for financial modeling, and the one you choose will depend on your specific needs.

If you are just starting out, you may want to choose a program that is relatively simple to use and doesn't require a lot of technical knowledge. Microsoft Excel is a good option for this, as it is a widely used program that most people are familiar with.

If you are looking for something more powerful, you may want to consider a program like Crystal Reports or Tableau. These programs offer more features and functionality than Excel, but they can be more difficult to use.

Once you have chosen a software program, you will need to decide what type of financial model you want to build. There are three main types of financial models:

1. Static models: Static models are used to predict the future financial performance of a company under a certain set of assumptions. They are typically used for long-term planning purposes.

2. Dynamic models: Dynamic models are used to predict the future financial performance of a company under different scenarios. They are typically used for short-term planning purposes.

3. monte Carlo simulations: Monte Carlo simulations are used to predict the future financial performance of a company under a range of different potential outcomes. They are typically used for risk analysis purposes.

Once you have decided on the type of model you want to build, you will need to gather the necessary data. This data can come from a variety of sources, including financial statements, market research, and company filings.

Once you have all of the data you need, you will need to input it into your chosen software program. This process can be time-consuming, but it is essential to ensure that your model is accurate.

After you have input all of the data into your model, you will need to run it through a series of tests to ensure that it is working properly. This process is known as validation.

Once your model has been validated, you can begin using it to make predictions about the future financial performance of your company.

Choose the right software for your needs - Build a Financial Model from Scratch A Step by Step Guide

4. Set up your basic model framework

Any good financial model starts with a well-designed framework. This is the structure that will house all of your assumptions and calculations, and it should be flexible enough to accommodate different scenarios.

The first step is to set up a tab in your spreadsheet for each major section of your model. For example, if you're building a model to forecast a company's revenue, you might have tabs for "Revenue," "Expenses," "Assumptions," and "Summary."

Next, you'll want to add headers to each tab. These headers will be the names of the different inputs and outputs in your model. For example, in the "Revenue" tab, you might have headers for "Product A Sales," "Product B Sales," and "Total Revenue."

Once you have your basic framework in place, you can start adding in your assumptions and calculations. As you build out your model, keep in mind that it should be easy to understand and use. If someone else were to look at your model, they should be able to quickly figure out how it works.

If you're not sure where to start, there are plenty of resources available online that can help you build a financial model from scratch. Just do a quick search and you'll find plenty of tutorials, templates, and examples to get you started.

5. Input assumptions and historical data

Assuming you want to build a financial model from scratch in excel, there are a few key inputs you'll need in order to get started. The first step is to input your assumptions. This could be things like inflation, tax rates, growth rates, etc. Once you have your assumptions entered, you'll need to input historical data. This data could be sales, expenses, headcount, etc. Once you have all of your inputs entered, you can start building out your model.

The first thing you'll need to do is build a basic income statement. This will show your revenue and expenses for a given period of time. Once you have your income statement built, you can start adding in more complex items like depreciation, amortization, and interest expense. Once you have all of the major components of your income statement built out, you can start building your balance sheet.

The balance sheet is a bit more complex than the income statement, but it's still relatively easy to build. The balance sheet shows your assets and liabilities for a given period of time. Once you have your balance sheet built out, you can start working on your cash flow statement.

The cash flow statement is the most complex of the three financial statements, but it's still relatively easy to build if you take your time and use a good reference guide. The cash flow statement shows how much cash is coming in and going out of your business for a given period of time. Once you have your cash flow statement built out, you can start working on your valuation.

There are a few different ways to value a business, but the most common method is to use a discounted cash flow analysis. This method values a business based on the present value of its future cash flows. If you want to learn more about how to value a business, I highly recommend reading my blog post on the topic.

Once you have your financial model built out, you can start using it to make decisions about your business. For example, you can use your model to help you decide how much debt to take on or whether to lease or buy equipment. You can also use your model to evaluate different investment scenarios and see which one is likely to provide the best return on investment.

6. Build out model functionality

As you build out your model, you will want to consider what functionality you want to include. This will be determined by the purpose of your model. If you are building a model to track the financial performance of a company, you will want to include features that allow you to input data and generate financial statements. If you are building a model to evaluate different investment scenarios, you will want to include features that allow you to input data and calculate returns.

There are a few key features that all financial models should include:

Inputs: This is where you will input your data. This can be in the form of assumptions, such as sales growth or interest rates, or it can be in the form of actual financial data, such as revenue or expenses.

Outputs: This is where your model will generate results. This can be in the form of financial statements, such as an income statement or balance sheet, or it can be in the form of returns, such as IRR or NPV.

Calculations: This is where your model will perform the necessary calculations to generate the outputs. This can be in the form of simple arithmetic, such as adding or subtracting, or it can be in the form of more complex formulas, such as those used to calculate financial ratios or discount cash flows.

Formatting: This is where you will format your model so that it is easy to read and understand. This can be in the form of cell formatting, such as font size or color, or it can be in the form of conditional formatting, such as data bars or color coding.

Once you have determined the functionality you want to include in your model, you will need to build out the individual features. We will walk through how to do this for each of the above features.

Inputs:

The first step is to create a cell for each input you want to include in your model. You can do this by clicking on the cell where you want the input to go and then typing in the name of the input. For example, if you want to include a sales growth assumption, you would create a cell called Sales Growth.

Once you have created a cell for each input, you will need to specify what type of data the input will accept. This can be done by selecting the cell and then clicking on the Data Type drop-down menu in the Cell Properties section of the Home tab. For example, if you want the sales growth input to be a percentage, you would select Percentage from the drop-down menu.

Outputs:

The first step is to create a cell for each output you want to include in your model. You can do this by clicking on the cell where you want the output to go and then typing in the name of the output. For example, if you want to include an income statement, you would create a cell called Income Statement.

Once you have created a cell for each output, you will need to specify what type of data the output will contain. This can be done by selecting the cell and then clicking on the Data Type drop-down menu in the Cell Properties section of the Home tab. For example, if you want the income statement output to be a table, you would select Table from the drop-down menu.

Calculations:

The first step is to create a cell for each calculation you want to include in your model. You can do this by clicking on the cell where you want the calculation to go and then typing in the name of the calculation. For example, if you want to calculate sales growth, you would create a cell called Sales Growth.

Once you have created a cell for each calculation, you will need to specify what type of data the calculation will accept. This can be done by selecting the cell and then clicking on the Data Type drop-down menu in the Cell Properties section of the Home tab. For example, if you want the sales growth calculation to be a formula, you would select Formula from the drop-down menu.

Formatting:

The first step is to select the cells that you want to format. You can do this by clicking on the cell and then dragging your mouse over the adjacent cells. For example, if you want to format an entire column, you would click on the column header and then drag your mouse over all of the cells in that column.

Once you have selected the cells that you want to format, you will need to specify what type of formatting you want to apply. This can be done by clicking on the Format drop-down menu in the Home tab and then selecting from the various options. For example, if you want to apply currency formatting, you would select Currency from the drop-down menu.

7. Test and refine your model

1. Run a sensitivity analysis: This is a great way to test how sensitive your model is to changes in assumptions. For example, you can vary the interest rate or growth rate assumptions and see how this affects your results.

2. Check for errors: It is important to check your model for any mistakes or errors. A common error is using the wrong formulas or forgetting to link cells.

3. Simplify your model: If your model is too complicated, it will be difficult to understand and use. Try to simplify it as much as possible.

4. Get feedback: Ask someone else to review your model and give you feedback. This can be a great way to identify any errors or areas that need improvement.

Test and refine your model - Build a Financial Model from Scratch A Step by Step Guide

As a financial analyst, you may find yourself in a position where you need to share your financial model with others. Whether you're sharing your model with a colleague, client, or boss, it's important to make sure that your model is easy to understand and use.

Here are a few tips to help you share your financial model with others:

1. Use clear and concise language

When creating your financial model, use clear and concise language. This will help to ensure that your model is easy to understand and use.

2. Use formatting to your advantage

Use formatting to your advantage when sharing your financial model. Highlight important information and use colors to help guide the reader through your model.

3. Use charts and graphs

Charts and graphs are a great way to visually represent data in your financial model. Use charts and graphs to help the reader understand key concepts in your model.

4. Include a description of your model

Include a description of your model when sharing it with others. This description should include an overview of the model, its purpose, and how it works.

5. Provide instructions for using your model

Provide instructions for using your model when sharing it with others. These instructions should be clear and easy to follow.

By following these tips, you can ensure that your financial model is easy to understand and use.

Share your model with others - Build a Financial Model from Scratch A Step by Step Guide

9. Get feedback and continue improving

The previous section showed you how to build a basic financial model from scratch. In this section, we will focus on how to get feedback and continue improving your model.

First, let's look at how to get feedback. The best way to get feedback is to ask someone who is knowledgeable about finance and modeling. If you don't know anyone, you can post your model on a forum or online community and ask for feedback.

Once you have received feedback, it's important to take it into account and make changes to your model accordingly. Remember, there is no perfect model and there is always room for improvement.

Now let's look at some ways to improve your model. One way to improve your model is to make it more user-friendly. This means making it easy to understand and use.

Another way to improve your model is to make it more accurate. This means ensuring that your assumptions and calculations are correct.

Finally, you can also improve your model by making it more efficient. This means making sure that it doesn't take too long to calculate results or that it doesn't use too much memory.

Improving your model is an ongoing process and you should never stop trying to make it better. By following the tips in this section, you should be able to make significant improvements to your model.