Financial models are designed around a set of financial theories and practices. So if you want to get started in financial modeling, you must have a solid understanding of finance. This would include:
1. Cash Flow from Operations – Calculating the cash flow a company generates from its operations.
2. Discounting of Cash Flows – Calculating all future values back to some value today so that everything can be compared and calculated collectively.
3. Weighted Average Cost of Capital – Calculating the cost of funding a business in terms of its debt and equity.
4. Capital Asset Pricing Model – Calculating the cost of equity based on what an investor would require above and beyond the risk free rate of return.
5. Risk Return Trade Off – Recognizing risks or uncertainty in your financial model such as the inclusion of sensitivity analysis.
If you are unclear as to how these practices work, then you should go back and complete some of the courses from Module 1 – Business Finance. For example, some of the financial calculations and analysis are covered in Course 2 – Introduction to Financial Analysis while financial theories are covered in Courses 3 and 4 – Fundamentals of Corporate Finance. This is the knowledge base that drives most financial models. This courses are available at www.exinfm.com/training/
Let’s get started with something fundamental to most financial models which is cash flows. This is a primary objective of many financial models – modeling cash flows. So you need to think in terms of how to calculate a benefit stream such as cash flows. An easy place to start is with the Income Statement, making different adjustments to arrive at operating cash flows and then looking at what sources and applications will generate and require cash flows going forward. This brings us to a second important point about many financial models - Historical Financial Statements are a common input for financial models.