How to Avoid Common Errors When Building Financial Models
Financial models must be free of error in order to be most impactful to a business
Financial models serve as valuable tools used for multiple types of analysis that provide insights to the companies of their practitioners. Financial models are used for assessing a potential new acquisition opportunity, entering a new market, analyzing different pricing strategies, and many other uses. Most financial modeling is done in Microsoft Excel, however, Google Sheets can be used. My recommendation is to use Excel because of the more advanced functionality and formula options.
Many professionals in the financial services industry say that valuation is both an art and a science. Ironically, the main tool used to compute a valuation is not an art, but a science. Building successful and useful financial models requires strong attention to detail, analytical horsepower, and the ability to lay data out in an organized and structured manner. That said, financial modeling is a tool that can be leveraged by any function in an organization.
Financial models are tools used to drive all aspects of a business, for example:
- Cap table management
- Debt schedule
- Pricing analysis
- Profit & loss
- M&A transactions
- Resource planning
- Scenario analysis
I can name many more use cases for financial models, but the ones listed are the most common.
The main point of this article is to highlight common errors that people often make when building financial models. The most common mistakes that should be avoided are:
Best Practices to Avoid Errors
I’ve made a lot of the errors mentioned above throughout the years. I’ve listed out some best practices learned over the many models I’ve built:
1) Use proper formatting (more information on this here)
- Consistent font, font size throughout the workbook
- Blue font color for inputs
- Black font color for calculated outputs
- Green font color if data is linked to another tab
2) Audit every single tab
- Review formulas, simplify lengthy formulas where possible (avoid nested IF statements if you can)
- Clearly label line items and leave comments where necessary
- Create sanity checks to make sure the numbers make logical sense
3) Ensure the model has a logical flow, so it’s easy for someone else to review it
4) Delete or hide any data that are not used to drive calculations/formulas
My formal financial modeling training came from a Wall Street Prep bootcamp. One of my friends who works in banking recommended the Corporate Finance Institute. I think both are solid options for those who are new to the art of financial modeling.
Learning how to build financial models will prove valuable for people working in a variety of roles such as finance, sales, marketing, strategy, operations, and product management. These skills are transferable across all industries. Feel free to reach out to me directly if you would like specific advice on how financial modeling could be useful in your current role.