Financial Model: What It Is and the Types That Exist

In the world of finance, there are countless tools and resources for managing the daily operations of companies, and one of them is the financial model, a framework used to represent the financial reality of a company. Do you want to know in more detail what it entails and the types most commonly used in the sector? 

Finance began to be defined as a science around the 1950s, over 70 years of history, theory, and practice, which have produced important formulations such as the financial model, a tool we focus on in this article. What exactly is a financial model? What is it used for? What types of financial models are used in the field of economics, business administration, and management?

What is a financial model?

The first question is obvious: what do we mean when we refer to a financial model? What is it? It is a tool used in the world of economics and finance that includes a set of operations and mathematical equations, statistics, and data used to predict the financial behavior of a business, potential investments, or other economic operations.

Several key aspects to better specify what a financial model is: 

• A tool used in economics, business administration, and organizational management.
• It combines various financial variables, data, operations, and other mathematical resources for later analysis.
• It allows professionals to make future predictions about a company's economic performance.

What is a financial model used for?

And what kinds of evaluations can be conducted using this tool? What is a financial model used for? 

1. It provides a global view of a company's financial status. 
2. It analyzes different variables in perspective with historical data and future projections, regarding assets, liabilities, revenue, liquidity, investments, etc. 
3. It facilitates decision-making. From the thorough analysis of these and other aspects, certain strategies are planned and specific actions are implemented. 

The financial models used are resources for all types of companies, from SMEs to medium and large firms. They must be executed by professionals properly trained in economics and related subjects, which are covered at EAE Barcelona in comprehensive programs such as the Master in Finance and the Master in Financial Management. 

How is a financial model created?

In both training programs, students gain an in-depth understanding of key aspects of how a financial model is created. Several key aspects define the process: 

1. There are specific programs to create financial models in economics.
2. The primary tool is the spreadsheet, used to collect cash flow, investments, income statement forecasts, and other data.
3. It includes both current and historical information, gathering economic data that could influence the company's future, with graphs and visual data to facilitate results communication. 
4. Numerous inputs and outputs are collected to later map the company's financial health for the financial model in question.

This tool is used in the finance and economic administration departments of all types of businesses. It is especially important as it facilitates decision-making and the implementation of corporate strategies. It often serves as the foundation for actions requiring strong financial health and for recalculating business plans during economic crises within a corporation.

Types of financial models

There are several types of financial models currently in use. The most common in economics are: 

• Valuation model: used to determine the value of a business or investment when considering options for resource allocation. 
• Financial statement projection model: probably the most used. This model predicts the financial health of a company in the short, medium, and long term, taking into account revenues, expenses, profitability, and other factors.
• Simulation model: another key tool in economics. It is particularly valuable for conducting simulations that closely reflect real-world scenarios. The goal is to predict business behavior in relation to specific actions or potential investments. 
• Sensitivity analysis model: this evaluates the potential financial behavior of a company or investment under possible future scenarios.
• Asset allocation model: used to determine which assets should be assigned to a project or investment to maximize return while minimizing risk. 

Having outlined the key aspects of what a financial model is, important considerations when creating one, and the different types available, it is important to emphasize that this is a tool for professionals in economics. Those executing these models must have both technical knowledge, gained through specialized programs, and important skills. Critical thinking is essential due to the complexity of the analyses, along with strong communication skills, as results often need to be presented to teams to support decision-making. 

Financial models are indispensable resources for strategic decision-making in companies and organizations. They serve as a key tool when designing a corporate financial plan.