A financial model is basically an abstract presentation on a real life financial problem. Making and referring to this can be really helpful in terms of economics and business management. Many of students in my Excel Training session ask about financial modeling and its do’s and don’t. As there are certain mistakes people tend to make while making a financial model in excel.
Here is the list of 10 don’t while you prepare financial Model:
Sometimes, In order to make a financial model too short and simple, the writers tend to leave certain things to the prior knowledge of the reader. For the same purpose, sometimes, they also make too many excel sheets in one model. With the motive of making it clearer to the reader. But what this ends up doing is confusing the reader with respect to the model.
Hence, it’s good to try keeping the model simple, but one must always make sure the measures he takes towards this aren’t counter-productive.
It is bad to keep the Excel formula too simple, but it is worse to make it way too complex for the readers to follow. Very long formulae can be confusing as well as hard to follow. The writer should make sure he doesn’t make an Excel formula longer than half the length of the formula bar, as a general rule.
Lacking logical structure:
All the excel sheets in a financial model should always be arranged in a logical structure so as to provide the reader with a clear and easily deducible information flowing from the first page to the last. A common mistake is that sometimes the authors don’t know what part needs to be written on a separate sheet and what not. Furthermore, once all the sheets are final, it is sometimes difficult to figure out which one should go after what.
A simple solution to the first problem is that one should always be on a lookout for the key factors affecting the financial model, and elaborate these on different sheets. About the second problem, one should always make a contents page which would allow the readers to toggle between pages which much more ease.
A very important feature of a financial model is that it is flexible, meaning that it can reflect the effect of the slightest changes, like a 3% rise in the price of a certain commodity, on the economy. If in order to get such effect you need to make a lot of manual changes to the model, you can know that something is seriously wrong with the model, and start again.
Hard coded numbers:
One of the first lessons you learn while learning financial model is that the numbers being included in the financial model should not be hard coded. This is because they make it tough for the reader to follow the program. Sometimes, however, it is unavoidable to add such numbers. For such situations, one should always highlight such numbers with a comment explaining how the author reached those numbers.
Not performing the error and sanity checks:
Every person creating a financial model must, at regular intervals, run an error check using formula auditing function in excel on the whole model. This is because the slightest typographical error in such a model can change the whole model. Apart from this, the sanity checks also help a lot in figuring out if there’s an error with the model. Suppose your model shows that adding 2 people to the existing group of 3 can help you triple your sales. This looks outrageous prima facie, but might just be true. That’s what a sanity check helps you verify.
Lacking executive summary:
Every financial model is bound to have an executive summary, where you can include the various accounts like cash, profit & loss or balance sheet. Moreover, this is the place where you inform the reader about the key drivers running the business model, and key assumptions taken in while making the financial model. In order to make this more attractive and helpful, the above-mentioned accounts can be shown in the form of a graph relating to the model.
Ignoring the balance sheet and cash flow:
These are two things which ensure a proper functioning of your model at the slightest change. Hence, while making a financial model, one must always make sure he judges the cash flow and balance sheet accurately.
One of the most basic errors made while making a financial model is formatting cells in excel sheet differently. This looks very irregular, not to mention how it increases the chances of mistake. Hence, all the sheets in a financial model should be as consistently formatted as possible.
Formula errors are the easiest to make and the hardest to catch. Hence, one must always be careful while writing or changing the formulae of his financial model.