STEPS ON
BUILDING
FINANCIAL
MODELS:
FROM
SCRATCH
Define the
purpose of the
financial model:
Before you start building a financial
model, you need to have a clear
understanding of why you need it.
Are you building it for fundraising
purposes or to analyze your
company's financial performance?
Defining the purpose will help you
determine the scope of the model.
Determine the
key inputs and
assumptions:
Financial models are based on
assumptions, and these assumptions are
critical to the accuracy of the model. You
need to determine the key inputs and
assumptions such as revenue growth, cost
of goods sold, operating expenses, capital
expenditures, and other relevant
variables.
Choose a
software tool:
There are several software tools available
that can help you build financial models,
such as Excel, Google Sheets, or
specialized financial modeling software.
Choose a tool that best suits your needs.
Build historical
financial
statements:
The first step in building a financial model
is to create historical financial statements
for your company. This includes the
income statement, balance sheet, and
cash flow statement for the past 3-5
years. Use actual financial data from your
accounting system to create these
statements.
Build a
reconciliation tool:
In financial modeling, a reconciliation tool
verifies that financial statements—income
statement, balance sheet, and cash flow—
are accurate and consistent. It involves
identifying discrepancies between
statements and underlying assumptions
and making adjustments to align them.
Forecast the
financial
statements:
Once you have created the historical
financial statements, you can start
forecasting future financial statements.
Use the key inputs and assumptions you
determined earlier to forecast the
revenue, expenses, and cash flows for the
next 3-5 years.
Build the supporting
schedules:
Supporting schedules include detailed
schedules such as the debt schedule,
depreciation schedule, and working
capital schedule. These schedules help
support the accuracy of the financial
model and provide more granularity to
the forecasted financial statements.
Perform sensitivity
analysis:
Sensitivity analysis involves changing the
key inputs and assumptions in the
financial model to see how it affects the
financial statements. This helps you
understand the key drivers of your
business and how changes in the business
environment may impact your financial
performance.
Finalize the
financial model:
Once you have built the financial model
and performed a sensitivity analysis,
finalize the model by checking for errors,
ensuring formulas are correct, and
formatting the model for readability.
Use the financial
model:
Use the financial model to make
informed decisions about your business,
such as identifying areas where you can
cut costs or increase revenue.
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