A financial model is a quantitative representation of a business, project, or investment. This article reveals 9 principles for enhancing models to achieve greater results and build stakeholder trust.
Strategic Structuring for Ultimate Clarity
The structure of a financial model is its foundational blueprint. A well-structured model ensures clarity, which is a key factor for trust. Stakeholders should be able to navigate the model easily and grasp its logic quickly. The use of a clear and consistent color-coding scheme, where hard-coded values are highlighted, significantly reduces the risk of errors and confusion. Clear and consistent labeling of cells is also vital.
Centralize Assumptions, Eliminate Hard-Coding
Centralizing key assumptions serves as the foundation for a flexible and transparent model. This allows stakeholders to see what assumptions are made and why. Regardless of the model's complexity, having a single tab for inputs simplifies scenario testing significantly. It's crucial to avoid hard-coding projections to enhance the model's quality and dynamism.
Leverage the Integrated 3-Statement Core
An integrated model that links the income statement, balance sheet, and cash flow statement provides a comprehensive view of a company's financial health. Connecting the three statements through formulas demonstrates a deep understanding of the business. Ensuring the balance sheet balances is an important check that verifies the accuracy of calculations and model logic.
Applying these nine principles in financial modeling allows analysts to create reliable, transparent, and trusted decision-making tools, significantly enhancing their influence on stakeholders.
