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Priyanka Prajapati | Investment Banker

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People have a misconception that Financial Modelling is a very difficult task and it takes a lot of effort to build one. Financial Modelling is often regarded as one of the most difficult exercises in the industry and some people find it nearly impossible to build one financial model.

Here, in this article, I will give you some useful tips which will make your model building exercise much easier. These are some of the easy steps to be adopted while working on a model that will make the exercise more fun. These tips will make any model look professional and will majorly avoid any chances of hassle being faced by the analysts and the investors/ evaluators.

1. Understanding of the Industry and Competitors

Some start working on the model directly post the company’s evaluation without even reading about the Industry. However, it is equally important to get a sense of the industry and doing a competitive company’s analysis in order to make the projections.

One should keep in mind that the projections should not be majorly off from the Industry standards and competitors unless there’s a specific reason to justify the same deviation.

It is always considered a good exercise to gather knowledge of other companies’ financials and ratios before projecting the target. This makes the model more reliable and in line with the Industry.

2. Colour Coding

Make different colour codes for the following to make it easily understandable by the model evaluator:

  1. Audited Numbers
  2. Assumptions
  3. Ratios
  4. Forecasting

These colour codes can be in the form of cell background colour, font colour, font size, font type etc. There are two major benefits for colour coding:

  1. It makes a model look professional
  2. One can easily distinguish the numbers in the abovementioned heads 

3. Make a separate tab for Assumptions

It is required to make a separate tab of assumptions in your model and you’re required to keep it separate from all the numbers. The assumption is the most critical part of the model and it serves as a foundation for the projections taken. Hence, investors want to specifically take a look at the assumptions taken.

4. Discussion with the Management

It is extremely important to get the assumptions validated by the management once. As management is running the business and they understand about the company better than anyone. Analysts can write the numbers on excel but it is in management’s hands to make those numbers real.

Analysts should properly discuss these numbers with management and take their observations into consideration. And, the model should be discussed with the majority of people in the management.

5. Make notes for any business point/ observation

A model can be built on various numbers and various scenarios, it is important to list all the observations and critical points in notes for an investor to understand the assumptions taken. Notes justify the answer for taking x assumption instead of y.

For Example; if a company has decided to source their raw materials from a different vendor which is offering them materials at a lower price. It will reduce the raw materials costing taken in Statement of Profit & Loss by some percentages. Mentioning the same reason in notes will give investor/ evaluator an understanding as to why the reduction in raw material prices is built in the model.

6. Break complicated formulas into pieces

Incorporating complicated formulas in a model makes it difficult for others to understand. To make a model more understandable, you are required to split all the complicated formulas or all the complicated steps into various formulas and steps respectively.

Breaking of steps will be slightly longer than the previous complicated method but it will be easy to operate while you will be working on the model along with making it simpler for others.

It there is any complicated formula used in the model, then it is important to provide its simple breakup in notes with proper examples.

7. Make “Index”, “Summary” and “Charts & Graphs” Tab

The model consists of several tabs and it takes hours to go through each and every model item in detail. Hence, analysts are advised to make a summary and charts tab separately for all the important numbers including Revenue, Gross Profit, EBITDA etc.

It gives a summary of the important values forecasted in the model and one does not have to go through the whole model to understand the business in brief. They can simply take a look at these two tabs in detail.

You can also insert hyperlinks on the index sheet for one to directly reach to the required tab by just clicking on the hyperlink. Also, hide some of the extra working files in your model for clean-up.

8. Audit the Model

Once you complete the model, get it auditing by a couple of people to remove all the unexpected errors. There are two ways of auditing:

  1. Do audit yourself- By checking each and every formula inserted and the assumptions are taken.
  2. Share with others for audit- It is important to get the model audited by at least 2 people because every other individual will come up with their own points and they will not miss something which you might have missed.

Investment Banking companies typically are located in tier- 1 cities like Mumbai, Delhi, Bangalore and Hyderabad with major IB companies in Mumbai. As Mumbai is termed as a financial capital, thus, along with stock exchanges, insurance companies, brokerage firms, mutual funds, Mumbai also houses to investment banking companies on a large scale.

And, with the growth of tier- 1 cities in financial matters, investment banking companies are also shifting to places like Delhi NCR, Bangalore and Hyderabad.

If you’re looking to join an investment banking company then you are required to shift to these locations as cities like Mumbai, Bangalore, Delhi NCR, Hyderabad etc. are a hub of the financial services industry.

International Investment Banks having presence in India

Goldman Sachs

One of the top global investment banks which is well respected in its own field. It offers various services including investment banking, securities services, Global Markets, Research and wealth management.

JP Morgan Chase

It is a multinational bank offering services in various financial services domain. It is the largest bank ranked by S&P Global. It started its operations by offering commercial banking services and later expanded to other areas.

Citibank

Founded in 1812, it started as a banking division into consumer space. Citibank is into most of the financial services activities ranging from consumer banking services to HNIs services to Corporate Banking.

Morgan Stanley

It is a financial services Business conglomerate operating in various services including wealth management, research, investment management etc. across 36 countries. 

Bank of America Merrill Lynch

It is one of the largest banks of the world operating in similar services as to other largest banks. Now, its name has changed to Bofa securities. It is different from Merrill which is a wealth management division.

Credit Suisse

It is a global Investment bank and financial services company that is also engaged in services like private equity, asset management, research etc.

Deutsche Bank

Deutsche Bank is a global investment bank with its major Business into Investment Banking division. It is present across in more than 60 countries. It is into private banking, Business banking, insurance and wealth management services as well.

UBS

It is a global financial services company operating in more than 50 countries. It largely operates in four interdependent divisions- Global Wealth Management, Personal & Corporate Banking, Asset Management and Investment Banking.

Barclays Bank

Started by James Barclay, Barclays is a British originated multinational Bank currently operating across the globe. It is into services like private banking, personal banking, corporate banking and investment banking.

BNP Paribus

It is a bank based out of Paris and currently is one of the largest (8th) banks of the world. It has presence in over 70+ countries. It helps various corporates and its clients in Investment Banking solutions.

HSBC

HSBC, Hong Kong and Shanghai Banking Corporation, is another one of the largest banks of the world (7th largest) spread across more than 65+ countries through 4,000 offices. HSBC first originated in Hong Kong and then later shifted to London.  It is into various Businesses including commercial banking, investment banking, private banking etc.

Leading Investment Banks of India

Avendus Capital 

Avendus Capital is one of the largest Indian originated Investment Banks that offers various financial services including M&A, Due Dilligence, Private Equity, Investment Banking, private placement, restructuring, recapitalization, turnaround, and valuation advisory services.

  • Established Year: 1999
  • Type: Boutique Investment Banking Firm
  • Business: M&A, Due Dilligence, Private Equity, Investment Banking
  • Headquarters: Mumbai
  • Careers Link: https://www.avendus.com/india/careers

Axis Capital Limited

Axis Capital Limited, which was earlier called as Enam Securities Private Limited and a part of Axis Bank, is one of the leading Investment Banks engaged in boutique and mid-market investment banking services. It is currently into various services including Equity Capital Markets, M&A, Structured Finance, Private Equity and Investment Banking.

  • Established Year: 2005
  • Type: Wholly owned subsidiary of Axis Bank
  • Business: Equity Capital Markets, M&A, Structured Finance, Private Equity, Investment Banking
  • Headquarters: Mumbai
  • Careers Link: https://www.axiscapital.co.in/careers

Edelweiss Financial Services Limited

Edelweiss Financial Services Limited is a part of Edelweiss group which was co- founded by Rashesh Shah in 1995. The group is into various services including Credit facilities, Investment & Advisory, Insurance, Wealth Management, Asset Management, Corporate Advisory etc. and it is operating various divisions through different subsidiaries. The competitors of Edelweiss are Centrum India and SMC Finance.

  • Established Year: 1995
  • Type: Part of conglomerate Edelweiss group
  • Business: Credit, Investment & Advisory, Insurance, Wealth Management, Asset Management, Corporate Advisory
  • Headquarters: Mumbai
  • Careers Link: https://www.edelweissfin.com/edelweisscareers

JM Financial Institutions Securities

JM Financial Services is a complete solution provider of all the financial services from Investment Banking to Wealth & Asset Management to Mortgage Lending & Distressed Credit to brokerage services. It is well known company for Private Equity Services as well and currently operates in midmarket business.

  • Established Year: 1998
  • Type: Financial Services group
  • Business: Investment Banking, Wealth Management, Mortgage Lending, Distressed Credit, Asset Management
  • Headquarters: Mumbai
  • Careers Link: https://www.jmfl.com/Careers

ICICI Securities Limited

ICICI Securities is a technology-based firm present across 77 cities of India and providing all the integrated services to its clients which includes Investment Banking, Institutional Broking, Retail Broking, Private Wealth Management, and Financial Product Distribution.

  • Established Year: 1995
  • Type: Technology-based firm and a part of ICICI Bank
  • Business: Investment Banking, Institutional Broking, Retail Broking, Private Wealth Management, and Financial Product Distribution
  • Headquarters: Mumbai
  • Careers Link: https://www.isecpwm.com/careers.html

IDBI Capital

IDBI Capital, a wholly-owned subsidiary of IDBI Bank, is a leading financial services company providing a complete package of services including Capital Markets, Investment Banking, Institutional Broking & Distribution, Retail Broking & Distribution, Fund Management, Private Wealth Management, and Research.

  • Established Year: 1993
  • Type: Wholly owned subsidiary of IDBI Bank
  • Business: Capital Markets, Investment Banking, Institutional Broking & Distribution, Retail Broking & Distribution, Fund Management, Private Wealth Management, and Research
  • Headquarters: Mumbai
  • Careers Link: https://idbicapital.com/careers.asp

O3 Capital Global Advisory Services

O3 Capital, edge to edge competitor of Avendus Capital, is a mid-market Investment Banking Company involved in the business which includes Corporate Finance, Investment Banking, and Alternate Asset Management. O3 capital has hired experienced professionals into the company and has opened offices in countries other than India as well.

  • Established Year: 1993
  • Type: Mid-Market Investment Bank
  • Business: Corporate Finance, Investment Banking, and Alternate Asset Management
  • Headquarters: Mumbai
  • Careers Email: careers@o3capital.com

Veda Corporate Advisors

Veda Corporate Advisors is a Chennai based boutique and mid-market Investment Bank. It is one of the largest Investment Banks of Chennai. And like other IBs, it also employs people with high professional acumen and serves clients in services like Mergers & Acquisitions, Structure Debt Finance and Private Equity.

  • Established Year: 2003
  • Type: Boutique Investment Banking Firm
  • Business: Mergers & Acquisitions, Structure Debt Finance, Private Equity
  • Headquarters: Chennai, Bengaluru
  • Careers Link: https://vedacorp.com/careers/

Spark Capital

Spark Capital is one of the leading mid-market Investment Banks of India which is located in Bengaluru. It is engaged in services including Investment Banking, Institutional Equities, Fixed Income Advisory and Wealth Advisory and it is very active in deals closures. Spark Capital always managed to maintain themselves to be on the league table.

  • Established Year: 2001
  • Type: Mid-Market Investment Banking Firm
  • Business: Investment Banking, Institutional Equities, Fixed Income Advisory and Wealth Advisory
  • Headquarters: Bengaluru
  • Careers Link: http://sparkcapital.in/careers/

Unitus Capital

Unitus Capital, founded in 2008, is India’s first established Impact based Investment Banking Company. It is engaged in services including Structure Debt Finance, Private Equity and Corporate Advisory for companies that are creating impact in the lives of the individual. For Example, Environment related companies, Food & Agriculture, Micro Financing, Fin-tech etc.

  • Established Year: 2008
  • Type: Impact based Investment Banking Firm
  • Business: Structure Debt Finance, Private Equity, Corporate Advisory
  • Headquarters: Bengaluru
  • Careers Email: info@unituscapital.com

MAPE Capital Advisors

MAPE is a leading Investment Bank of India engaged primarily into M & A and Private Equity. It also provides other services including Corporate Advisory, Debt, Real Estate Financing etc. MAPE is ranked as top 10 Investment Banks of India on the basis of their number of transactions.

  • Established Year: 2001
  • Type: Mid- Market Investment Banking Firm
  • Business: Mergers & Acquisitions, Private Equity, Corporate Advisory, Debt, Real Estate Financing
  • Headquarters: Bengaluru
  • Careers Link: http://www.mapegroup.com/careers.html

For securing an Investment Banking job at a good package, it is extremely important to crack the interview in an excellent manner and leave an extraordinary impression on the interviewer. Interview consists of case study or an assignment round and personal face to face discussion round.

And unlike other finance interviews, Investment Banking Interviews are more in depth and candidates find it difficult to crack the interview questions because of the following reasons:

  • Diversity of questions asked (Questions are asked from varied topics, basically from anywhere and everywhere from finance concept)
  • Intensity of the questions asked (One topic can be questioned in a detailed manner)

Here, in this article, I have created a list of questions which interviewers usually ask while hiring for an entry level profile of Investment Banking. There are multiple skills on which the interviewers test an individual and I will be covering majority of those skills in this article.

Major Questions asked in an interview of Investment Banking Job Profile

 1. Personal/ background Questions:

Primarily, any interview in Investment Banking starts with questions related to personal/ personal background questions in order to gauge the basic understanding of the candidate. These questions are asked to judge the attitude and personality of an individual towards life and his/ her career. This serves as a first step in the interview and defines the whole direction, structure and timing of an interview

These questions include:

  1. Brief on your education and experience?
  2. What are your strengths and weaknesses?
  3. What is your family background?
  4. What is unique about you?
  5. What do we consider you for this job?
  6. What are your best skills?
  7. Do you prefer to work independently or as a team?
  8. Rate yourself in the following skills – Excel Skills, Powerpoint Skills, PPT Skills, Team Building Skills, Analytical Skills, Communication Skills, Interpersonal Skills, Stress handling skills etc.

2. Career related Questions:

Another stream of questions which interviewers ask in Investment Banking interview is related to career and life goals. It determines the willingness of a candidate for the job and determination towards the field.

These questions include:

  1. What are your career goals? How do you see yourself after a span of 5 years or 10 years?
  2. Why are you choosing finance as a career option?
  3. Why are you looking to enter into Investment Banking Industry?
  4. Where do you see yourself in Investment Banking in future; whether in front end or back end? And, why?
  5. How this job/ profile will help you in achieving your career goals?
  6. Are you planning to pursue any further study, MBA, CFA etc. for your growth?
  7. How will you cope up with your studies and your job in future?
  8. Till how long, you are planning to stay with our company?

3. Finance related Questions:

This is the major part of the overall interview process and interviewer usually asks questions from any topic related to finance which may vary from ratios to cash flows and from company’s financial statement analysis to finance statements’ preparation.

These questions include:

  1. What is the structure of Statement of Profit & Loss, Balance Sheet and Cash Flows Statement?
  2. What do you mean by liquidity ratios, solvency ratios, profitability ratios?
  3. What is debt equity ratio, ROE, ROCE, ROA, Net Margin, EBITDA Margin, Assets Turnover, financial leverage etc.?
  4. What is Dupont Analysis, how is it helpful in determining ROE?
  5. What is the difference between net profit, cash flow from operating activities and cash profit?
  6. What all numbers will you consider while looking at a financial position of a company?
  7. As an equity investor, which are the most important ratios that you will calculate before making investment decisions?
  8. What is working capital and how will you calculate working capital days?
  9. What are the ways to projects revenue of a company?

4. Financial Modelling and Valuation related Questions:

Investment Bankers spend hundreds of hours on building financial models and conducting valuations of multiple businesses. Thus, Interviewers expect candidates to have some knowledge of financial models and valuations which they test either from an assignment or from direct interview questions.

Generally the questions include:

  1. How will you forecast revenue/ turnover of a company?
  2. What is the process of making financial models?
  3. What are the different types of financial models prepared by the Investment Bankers?
  4. Draw a projected Profit & Loss account of a company based on its past numbers.
  5. Explain the valuation techniques in detail.
  6. What is the difference between relative and absolute valuation?
  7. How do you compute valuations through trading and transaction comparable?
  8. Explain a rough DCF Valuation Model.
  9. How do you compute discounted cash flows?
  10. What are free cash flows?
  11. What is difference between cash flows at the end of the year and free cash flows?
  12. What is difference between FCFF and FCFE?
  13. What is the formula of FCFF and FCFE?
  14. Explain CAPM model in detail.
  15. What is WACC and why do you compute it?
  16. What will be the impact on WACC if there is high debt in the company?
  17. What do you mean by Beta? And, how do you calculate Beta?
  18. What is the difference between levered and unlevered Beta?
  19. What is terminal value?
  20. How will you compute growth rate (g) while calculating terminal value in cash flows?

5. Accounting related questions:

Investment Banking has its roots lying in finance and knowledge of basic accounting is required for finance. This is the primary reason why CAs are increasingly getting hired in IB profiles. Accounting questions serve as a basic assessment topic for any finance profile and hence it is must for any interviewer to judge the candidate knowledge in accounts domain as well.

These questions include:

  1. What are the sub heads of Non-Current Liabilities, Current Liabilities, Non-Current Assets and Current Assets?
  2. Why deferred tax assets and deferred tax liabilities come in balance sheet?
  3. What are the ways of calculating depreciation?
  4. What is the difference between EBIT and Operating Profit?
  5. What are the two ways to show fixed assets value in Balance sheet?
  6. Where all does debt (in which head) comes in balance sheet?
  7. Which accounting standards do we follow in India?
  8. Does GST appear in accounting books? If yes, then where?
  9. When do you capitalize any expense rather than putting it in profit & loss as an expense?
  10. What is shareholder’s equity? What is the difference between convertible equity and shareholder’s equity?
  11. What is the difference between basic and fully diluted shareholding pattern?

6. Resume Questions:

Another key question type is to ask questions directly from the resume objecting certain points. This usually happens in HR interview and they are restricted to asking questions on resume and personality.

These questions might include:

  1. Can you walk me through your resume?
  2. Specific questions on your educational background; For example; if you have done CFA or CA then the interviewer will ask curriculum related questions of CFA or CA
  3. Specific questions on your interests and hobbies
  4. Specific questions on certifications/ courses

7. Other Questions:

These questions include:

  1. Personality/ psychometric questions
  2. Behavioral questions
  3. Questions on the Interviewer’s company/ organization
  4. Package and salary related questions
  5. Questions for interviewer

Note: The questionnaire list is totally inclusive and not exhaustive

Investment Banking is one of the most trending term in the world of finance. Nowadays, many experienced professionals and graduates want to be an Investment Banker. It is one of the hardest, most lucrative and best paying jobs in the world. 

As more and more people are aspiring to be an Investment Banker and jobs are limited in this domain, recruiters are picky and choosy in hiring the best talent. It makes slightly tough for any fresher to enter into this high profile industry. 

Nonetheless, if you have analytical mind and you are very keen to make your career in Investment Banking then with the right education and right knowledge, you can successfully build your way in IB.

Education Criteria for entering into IB Industry 

1. MBA (Finance)

Investment Bankers prefer MBA Finance as top applicants’ profiles over other profiles. MBA Finance teaches students all the discipline as required in IB domain including finance, accounting, business acumen, marketing, financial analysis, management consulting and accounting knowledge.  Investment Banking is a mix of all the disciplines with majors in finance.

If a candidate is from top tier colleges (IIMs/ IITs, ISB, FMS, Xavier’s, IIFT etc.) then it becomes comparatively easier for them to enter into IB Industry.

2. CFA

If you’re a Chartered Financial Analyst (CFA) Charter, then you can easily make your way to IB industry. However, if you’re a CFA Level 3 candidate or CFA Level 2 candidate, then also you can enter into IB. CFAs are mostly preferred in industries like Investment Banking, Management Consulting, Hedge Funds, Mutual Funds, Brokerage firms, Insurance and Investment Firms etc.

3. CA

Another preferred education requirement is of a Chartered Accountant (CA). CAs are shifting to Investment Banking Industry on a large scale because of its paying structure and its popularity among the CA students. Another segment which enthusiasts CAs is to get into Financial Due Diligence team of Investment Banking.

4. Graduation

The bare minimum education requirement is to get a graduate degree in any discipline. But graduation will only make you enter into IB at an entry level (Intern). You can enter to Analyst or Junior Analyst level if you have graduated from a renowned institute.

One can immediately become an Investment Banker post-graduation but you need to have good experience, knowledge and further qualification to sustain in it.

Things to improve to enter into IB Industry 

1. Analytical Skills:

You need to improve your Analytical Skills along with other skills (including but not limited to communication, presentation, excel, interpersonal etc.). Analytical skill plays an integral role in IB Industry. 

Working on research and Financial Modelling requires a great analytical mind to adapt and learn these quickly.

2. Mathematical Skills:

This is one of the keys skills for entering or sustaining in IB Industry. If you’re unable to do basic math then IB is not the right industry for you. 

There are individuals who have thrived in this industry through excellent math’s knowledge. Investment Banking’s math is much more than making equations and solving it. 

3. Basic Finance Knowledge:

No Finance recruiter will hire you if you lack in basic finance knowledge i.e; knowledge of three basic statements (Profit & Loss Account, Balance Sheet and Cash Flow Statement), Analysis of the three Statements, Ratios, Securities, Present Values etc.

Finance knowledge is must to crack any interview for finance profile or related domains. An Investment Banker has to work on all the aspects of finance and it is expected from the candidates to be well versed with them.

4. Excel and PowerPoint Skills:

80% of the Investment Banking work constitute of working on Excel and PowerPoint presentations. You are required to be handy with the basic and advanced working of both the tools. 

You can take a video session or video course to learn working on Excel and PowerPoint which will make you job ready without making it a hindrance in your day to day work

5. Financial Modelling: (Plus Factor)

It is a plus for any recruiter if you have a sound knowledge in Financial Modelling. As Investment Bankers work day in and day out on models, they always haunt for people who can build models from scratch.

Ways to get into Investment Banking

1. Approach to the right personnel

The best way to get your application heard in Investment Banking is to find the right personnel and approach to him directly. While writing a job application, it is required to highlight all the key points in the mail body or cover letter to attract the right eyeballs. 

Usually, you should directly reach out to either Associates or Vice Presidents as they are influential in hiring process in Investment Banking industry other than the HRs.

2. Secure an Internship in Investment Banking

If you already secure an Investment Banking Internship experience, then it becomes easier for you to secure a job in the same Industry. It is comparatively effective to get an Internship position over getting an Analyst position directly. 

3. Be a part of Analyst programs

Most of the big-bracket Investment Banks (Goldman Sachs, JP Morgan, Morgan Stanley, Credit Suisse etc.) conduct Analysts programs in their company for budding and aspiring candidates to join them as an Analyst. You can be a part of either of the programs and showcase your interest in IB to the employer in front. 

4. Build Connections

Building connections and networking is an important part of the job. Connections with the Investment Bankers or with the corporates can help you land a good profile job in Investment Banking.

5. Pursue an Investment Banking Course  

There are several institutes which help candidates in learning the core of investment Banking. They help candidates from scratch of learning the nuances of IB till the time of securing a high profile job in the same industry.

Wall Street School is one of those institutes. It has designed a course specifically for budding students who are aspiring to enter into Investment Banking Industry. 

Usually people, who are new to the concept of financial models, have a misconception that there is only one type of financial model which is a three statement model (including Statement of Profit & Loss, Balance Sheet, Cash Flow Statement). 

However, there are various types of financial models and they are used for different purposes. We will be discussing about these models in this article.

Types of Financial Models

  1. Three Statement Model
  2. Credit Rating Model
  3. Discounted Cash Flow (DCF) Model
  4. Comparable Analysis Model
  5. Merger Model
  6. Leveraged Buyout (LBO) Model
  7. Model with Scenarios

Three Statement Model

This is the very basic kind of model which only includes three financial statements (Statement of Profit & Loss, Balance Sheet and Cash Flow Statement), as suggested by the name. It requires one to make certain assumptions and only work on the future projections of these 3 statements. There are subsequent schedules which are required to be prepared which will support the statements including:

  1. Depreciation Schedule
  2. Fixed Assets Schedule
  3. Working Capital Schedule
  4. Debt Schedule 
  5. Tax Schedule etc.

Credit Rating Model

Credit rating Model is usually prepared by the Banks, NBFCs or other Financial Institutions for the purpose of assessing credit worthiness of the borrower. It is only prepared for the purpose of extending debt funding to the borrower. 

It involves working on various ratios including liquidity (like DSCR), Profitability (Interest Coverage Ratio, Profit Margins), Solvency (Debt Equity Ratio, Total Liabilities to Equity Ratio etc.) Credit Rating Model stresses upon the structure of interest payments and principal repayments by the borrower in a timely manner. 

Discounted Cash Flow (DCF) Model  

DCF Model is another prominent type of model which is prepared by Investment Bankers, Management Consultants, Private Equity or Venture Capital people to conduct valuation through cash flows of the company.

They are two types of valuations- Absolute Valuation and Relative Valuation. Absolute Valuation consists of valuation performed through DCF, Dividend Distribution Method etc. Relative Valuation consists of valuation conducted through Trading and Transaction Comparable. 

Valuation using DCF method is usually prepared in DCF model. It is an addition of three statement model with valuation calculation which is an extension from the forecasted cash flows.

Comparable Analysis Model

Comparable Analysis Model is very similar to DCF Model. It is also a composite of three statement model and the valuation. However, the only difference in Comparable Analysis model is that it is made through comparable analysis valuation or valuation multiples using trading and transaction comparable. 

Trading comparable is performed through assessing the valuation multiples of similar companies listed in the stock exchanges and transaction comparable is performed through evaluating the fund raising or M&A transactions of similar companies happened in the past.

Merger Model

Merger Model, as the name suggests, is prepared specifically in case of merger or acquisition of the target by the acquirer. This is a unique type of model which captures the financials and financial performance of both the companies (Target and the Acquirer) with the adjustments of their synergies.

Typically, there are three steps to prepare a merger model as listed below:

  1. Preparing a separate model of the acquirer with future projections
  2. Preparing a separate model of the target with future projections
  3. Merging both the models into keeping some of the adjustments for the synergies which both the companies will bring to each other’s business.

Leveraged Buyout (LBO) Model

Leverage Buyout is a situation in which the acquirer buys a target company using very small portion of his own capital and a major portion of debt or non-equity source which is raised from the market (Banks, NBFCs, Financial Institutions etc.). Assets of the both the companies usually become the collateral of the loan in this situation. 

The model is built keeping in mind both the situations:

  1. Acquisition of the target company
  2. Raising loan from the market through collateralizing assets of the companies

Major characteristic of a leveraged buyout model is that it only considers debt or non-equity source (like, mezzanine debt, subordinate debt etc.) as a source of external capital in order to earn highest return from the investment as debt is the cheapest source currently which is available in the market.

Model with Scenarios (Convertible Model)

This is a unique type of model which is prepared by high skilled financial analysts. They link the whole model in such a manner that one can see different projections of different scenarios in just one model. The same model shows different results when one changes the scenarios from the assumption sheet.

Usually model with scenarios are prepared keeping three situations in mind:

  1. Optimistic (Management)
  2. Actual (Base)
  3. Pessimistic (Conservative or Investor) 

Preparation of financial models requires precision and might take even more than 3 weeks of time to complete one fully.

Do you really think that preparation of financial models is a complex task and only financial analysts can perform that task? Or is it really tough to work on complex and lengthy financial models which are even time consuming? 

Well, if it is performed in a proper sequential manner with proper steps, then the complexity breaks down into pieces and it becomes easier to make a professional model.

In the article below, I’ll give you a detailed step by step approach to prepare Financial Models.

Step 1 : Know your Company

It is extremely important to first study about the company whose financial model is getting prepared. This basic study will serve as the base in preparation of the model.  

You can learn about the company through: 

  1. Public sources, 
  2. Company’s website
  3. Discussion with the management of the Company etc.
  4. Published annual reports and analysts’ coverage reports (if the company is listed)
  5. Regulatory Authority of respective countries (if the company is unlisted)

For example; If you are looking for a company which is based in India, then refer to the link of MCA (Ministry of Corporate Affairs) Website for extraction of the basic information relating to the company.

Step 2 : Understand the Industry Dynamics

Next step is to read and understand the industry dynamics from industry analyses reports. It is required to first determine the right industry of your company as majority of the companies function as per their industry dynamics. 

For Example; if you are looking at a company which is operating a QSR (Quick Service Restaurant) Chain in India, then you are required to look at consumer industry then dig down into further subsets of the industry.

Step 3 : Start with the Audited Numbers

Once you are ready with your study on the company and the industry, first step is to start with the insertion of audited numbers (Statement of Profit & Loss, Balance Sheet & Cash Flow Statement) in excel sheet in a proper format for the last 3-4 years. 

It is highly recommended to incorporate audited numbers for a minimum tenure of last 3 years as it helps in better consideration of growth projections.

Step : 4 Find the Assumptions

Next thing is calculate the past ratios like Revenue Growth, Expenses to a percentage of Revenue, Gross Profit Margin, EBITDA Margin, Working Capital Days etc.

Based on the calculation, you are required to forecast the same ratios for future years to calculate the forecasted numbers. 

For Example; if your company has grown by a Revenue CAGR (Compounded Annual Growth Rate) of 20% for last 3 years and the Industry is also growing by the same rate for future years, then you can also assume the same growth rate of Revenue for next 2-3 years.

Assumptions need to be created in a separate tab for Revenue, Cost, Balance Sheet items and other numbers.

Step 5 : Forecast the Income Statement

Post finding the right assumptions, you should start calculating all the forecasted numbers of Statement of Profit & Loss (P&L) from top to down till all the expenses except Depreciation, Finance cost (Interest) and Income tax.

Till this stage, you will get the forecasted EBITDA figures on your sheet. 

As a Financial Analyst, if you are having very initial rounds of conversation with the investors for fund raising, then forecasted numbers till EBITDA will suffice and you will engage in detailed conversation with the investors at later stages.

Step 6 : Prepare the Supporting Schedules

Before jumping to working on Balance Sheet (BS) directly, it is important to prepare supporting schedules for Balance Sheet. These schedules may include:

  1. Fixed Assets Schedule – To show the bifurcation of fixed assets
  2. Depreciation Schedule – To show depreciation calculation on various fixed assets as per the relevant country laws
  3. Tax Schedule – To Show bifurcation of current tax and deferred tax
  4. Equity Schedule – To show bifurcation of equity and retained earnings and money required for funding
  5. Loan Repayment Schedule – To show interest and principal obligation occurring periodically
  6. Working Capital Schedule – To show the calculation of Receivables, Payables and Inventory 
  7. Schedule for other Balance Sheet Items
Sample Tax Schedule

Step 7 : Complete Statement of Profit & Loss (P&L) and Balance Sheet

Next is to complete the projection of P&L and Balance Sheet through the referencing of schedules build in earlier step. 

You can complete P&L after linking Depreciation, Finance Cost and Income tax from respective schedules. Similarly.

Balance Sheet can be completed through linking subsequent schedules except linking Cash & Bank Balance (Cash & Bank Balance will be calculated post completion of Cash Flow Statement) 

Step 8 : Complete the Cash Flow Statement:

Cash Flow preparation is the easiest part in overall Financial Modelling exercise.

Once the P&L and Balance Sheet (BS) are ready, it only leaves the task of incorporating formulas and doing the linking with P&L and BS for Cash Flow Completion. 

Cash Flow Statement leaves a balance of Cash and Bank at the end of the year which will get linked with the BS’s Cash Balance and will complete the “Three Statement Financial model”.

Step 9 : Prepare Free Cash Flows

Before reaching to this step, you have already succeeded in preparation of “Three Statement Model” i.e; P&L, BS and Cash Flow Statement. 

Further task is to get into Valuations and Sensitivity Analysis.

For Valuation, you are first required to calculate Free Cash Flows to the Firm and Free Cash Flows to Equity through already calculated numbers from 3 statements

Step 11 : Perform DCF Analysis

Next step is to calculate Cost of Equity through CAPM (Capital Assets Pricing Model) Model using Market Rate of Return, Risk Free Rate and Beta along with calculation of Cost of Debt using Interest Rate and Tax Rate which will be helpful in calculation of Weighted Average Cost of Capital (WACC). 

This WACC will be used as a present value rate for calculation of present value of future projected free cash flows. 

Step 12 : Perform Sensitivity Analysis

Post calculation of present value of free cash flows, it is required to do the scenarios check through Sensitivity Analysis.

In this, you are required to calculate various valuation results through changing your assumptions in Optimistic as well as Pessimistic manner. This helps in drawing better conclusion on the authenticity of the assumptions taken.

Step 13 : Perform Ratio Analysis

Performing of Ratio Analysis is considered as a near to completion step. In this step, you’re required to estimate profitability, solvency and liquidity ratios for investors to take better judgement on the investing decisions.

For Example; In your ratio analysis, you need to calculate ratios like Return on Equity, Return on Capital Employed, Return on Assets to highlight profitability position of the company to investors

Ratio Analysis

Step 14 : Prepare Charts and Graphs

Now, it is the time to do some representational efforts. One way is to make required charts and graphs of the important numbers in your first tab.

As Chart and Graphs help in better interpretation of data, you can use them to show those intrinsic values which you want to highlight to your investor.

Investors usually don’t get that much time to spend on just one model, hence, it is recommended to depict important values in a visually comfortable manner, i.e; through graphs.

Step 15 : Final touch up – (Index, Formatting etc.)

As your model is complete now, the only thing which is left now is to do some minor formatting, insert statements & schedules into table, prepare an index with hyperlink etc. 

You can also skip this part, but this step makes your model to look more professional and more attractive.

Frequently Asked Questions (FAQs)

Is it difficult to make a Financial Model?

If the entire process of making a Financial model is carried out in a structured manner, then it becomes easier to make a professional model.

How much time does it take to prepare a Financial Model?

It depends upon the complexity and scale of Business, industry and assumptions made while preparing it.

Is any prior knowledge required to make a Financial Model?

Yes, basic accounting knowledge is required to understand the financial statements of the company and predict future profits.

Financial Modeling – One of the most frequently heard term if you’re either in Finance industry, or you aspire to be a part of it.

Let’s understand, what’s so special about this term?

I’ll take a very basic example so that you can relate it to your everyday life.

Suppose you own a grocery shop, what are the expenses that you incur? They can be cost of purchasing veggies, fruits etc. Also, the shop rent expenses, electricity bills, the store keeper’s salary etc. Note them down.

Likewise, what are the sources of revenue? In this case, revenue is sources from sale of grocery items. As simple as that. Note them down too.

Do this for past 5 years. Find out the trend in revenue growth and the factors responsible for it, after making realistic assumptions. Likewise, find out the trend in cost increase/decrease.

Now, based upon these trends (which are themselves an outcome of your assumptions) project the future expenses and revenue of the company.

This will help you draft a future Profit & Loss Account and Balance sheet of a Company.

What is Financial Modeling?

Financial Modeling is an activity of preparing any company/ entity’s future financials (Statement of Profit & Loss, Balance Sheet, Cash Flow Statements, Schedules, Valuation etc.) through estimation of numbers in MS Excel (Or any other calculation tool). 

Financial Modelling is a number game and is usually prepared through linking various tabs in MS Excel. It is important to separate assumptions (inputs) from the entire model which are used for projection of financials (output). Various models can produce different results based on the inputs and assumptions that go into it.

These future financials are known as financial models. To view a basic financial Model, click the button below.

Types of Financial Models

There are various types of financial models which exist in today’s world. All these are made for different purposes. Some of the major types of financial Models are –

  • Three Statement Model
  • Merger Model
  • DCF (Discounted Cash Flow Model) Model, Sum of Parts Model
  • LBO (Leveraged Buyout Model) Model
  • Initial Public Offering (IPO) Model
  • Consolidation Model
  • Comparable Company Analysis

These models are generally prepared by Financial Analysts and their base salary ranges anywhere between $85,000 to $1,00,000 at an entry level. The demand of Financial Analysts is also rising with the increase in company’s preference on financial models for better management decisions. 

It is in Financial Analyst’s hands to control the numbers or the structuring of the model. He can increase or decrease the Profit or Loss in the model by changing the underlying assumptions.

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Why Financial Modelling is Important?

The main question is, Why does Financial Modeling even matter to businesses?

Importance of Financial Modelling lies in its usage for various purposes by several growing companies.

Companies prepare a financial model to get private equity funding from investors. They prepare the Financial models to predict the future value of a company, based on which the investor will infuse money and decide the share.

Even investors can prepare the same model. However, they will try to lower down the valuation, by taking different assumptions from those taken by the company.

Let’s see a near exhaustive list of uses of Financial Models

What are the uses of preparing Financial Models?

  • Understanding “Future Operational Performance” of an entity (e.g; number of employees required to hire, number of branches to open, number of quantities to be sold etc.)
  • Understanding “Future Financial Performance” of an entity (e.g; estimation of revenue required to earn, profit margins to generate, costs to spend in future)
  • Estimating the capital expenditure to be incurred in future (e.g; estimation of amount of machinery, furniture and building required)
  • Estimating funds required to fulfill future obligations (e.g; working capital financing, long term or short term financing by way of Private Equity, Public Equity or Debt funding)
  • Calculating cash flows/ free cash flows generated at the end of a given period (e.g; cash flow for operating, investing & financing activities, free cash flows to the firm and free cash flows to equity)
  • Calculating Enterprise Value or Equity Value of a Company (Including Intrinsic Value)
  • Analyzing certain ratios (e.g; profitability ratios, liquidity ratios etc.) 
  • Depicting the trend of a business and relating it with the Industry’s performance (whether a business is depicting an upward growth trend, static growth trend, downward growth trend, no growth trend, negative growth trend)
  • Performing study on multiple scenarios or sensitivity analysis 
  • Other advanced uses (e.g; calculating price of a security, merged financial predictions of two entities, comparable analysis, comparable ratio analysis, comparable valuation analysis, ascertaining exit strategy and Investor’s return during exit etc.)  

Who Prepares Financial Models?

Financial Modelling is widely acceptable and is getting a lot of attraction these days, especially by growing companies, Private Equity Funds, Hedge Funds, Investment Banking Companies, Brokerage Firms, Credit Rating Agencies, Equity or Investment Research Companies, Management or Corporate Consultancy firms etc. 

Let’s see Why do they prepare it –

  • Corporates – for Internal Management Decisions based upon Future Business Performance as predicted in Financial Models.
  • Investment Banking Firms – on the behalf of both their clients and their investors for Company’s Valuation.
  • Equity Research Firms – for publishing the reports on public sources to recommend buying or selling of any security.
  • Management Consultancy, Portfolio Management Firms – for advising their clients on various growth prospects
  • Private Equity Funds, Hedge Funds, Venture Capital Funds – for the calculation of their investment exit return.
  • Transaction Advisory Firms – for their clients to advice them on any transaction such as a merger or an acquisition.
  • Commercial Banks / Non Banking Finance Companies / MFIs – for estimating the performance of their lending portfolio.
  • Financial Due Diligence firms – for judging the accuracy of the valuation and financial models prepared by any other party.
  • Accounting or Chartered Accountancy Firms – for Financial Planning and Budgetingtheir own expenses and revenue.
  • Research and Outsourcing Companies – to outsource project for their clients; client can be a corporate, or an Investor

What are the Best ways to learn Financial Modeling?

DIY, Do it Yourself

The best but lengthy way to learn Financial Modelling is to learn it yourself as nothing is better than self-learning. If you’re extremely good with numbers and have analytical mindset then it is suggested that you should learn preparing models on your own by giving enough time for studying various concepts.

You can choose any sector and pick any listed company in the selected sector and start from industry study, past financials of the company, ratio analysis, management growth strategy and then go on to future projections through assumptions and other schedules. Last step is to dive into valuation part, sensitivity analysis, ratios and graphs depiction.

Take up an online Financial Modeling Course

The much faster way to learn Financial Modeling is to buy any online Financial Modelling and practice. These Modelling Courses will help you in the structuring, fundamentals, linking and formula building of a model. 

Be wise to choose a preferred Financial Modelling course and read the course contents before choosing to buy any online course.

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Join an Investment Banking (IB) firm at an entry level

The next way to learn Financial Modelling is to join any IB, Equity Research, Consulting or other companies at an entry stage either as an Intern or as a Junior Analyst. 

You will be working on the real world scenarios and live transactions which will require you to build complex models. Your job pressure and superior support will also help you to learn models much faster than required.

Frequently asked questions (FAQs) –

What is Financial Modeling?

Financial Modelling is an activity of preparing any entity’s future financials (Statement of Profit & Loss, Balance Sheet, Cash Flow Statements etc.) through estimation of numbers by taking realistic assumptions

What are the various types of Financial Models?

There are various types of financial models which exist in today’s world scenarios including Three Statement Model, Merger Model, DCF (Discounted Cash Flow Model) Model, Sum of Parts Model, LBO (Leveraged Buyout Model) Model etc.

How to learn Financial Modeling?

You can learn Financial Modeling through Online courses by The Wallstreet School, Udemy, Coursera etc.

What are the Job Prospects after Financial Modeling

A Financial Modeling expert can get Job in Private Equity Funds, Hedge Funds, Investment Banking Companies, Credit Rating Agencies, Equity or Investment Research Companies, Management Consultancy firms etc.