The Science of Building a Financial Model

Model building is a science as much as an artform. For now however, lets leave the Da Vinci’s and breakdown the science.

Most people think developing a model is just build a section, build a section, … do that 100 or so times and voila! You have a model!

Now, since you are a super intelligent person who loves not wasting your time, you’ll know this is absolute junk.

Model building is a complex activity. Complex because it is broken down into a number of sub-activities, each of which you will need to do well to have a good result (read: working model).

The activities are as follows

• NAVIGATING exploring the model; in order to synthesise information to give you a picture of the goals of the model, and the next steps.
• BUILDING: Develop the structures of the model out of formulas.
• FORMATTING: Ensure the model is coherent, and easily digestible for other human users.
• CHECKING: Check the building work has been done properly.
• AMENDING: If there are preliminary errors spotted, amend these.
• ANALYSIS: Stitch the findings together to generate meaningful analysis (i.e. analysis that supports decision making)
• AUDIT: Conduct an audit to ensure that the model is calculating correctly.

There are deliberate, repeatable steps that you need to do for each of these activities. People develop these skillsets at different stages. Generally analysts forget the Checking stage, in their eagerness to jump to analysis. And then you end up with a financial model which gives you junk results. Or if you don’t use cell styles, you’ll be less inclined to do the Formatting stage,

And of course there are shortcuts for each one of these activities, and if you don’t know the shortcuts, you aren’t going to be playing the game at the optimal level.

If you’re going to build even one model – make sure you get the Top 15 Shortcuts for Financial Modelers PDF (it’s free) – you’ll thank me after you’ve built your model.

Or if you want to get your training in a more methodical way, see Excel DNA which will help you out with this too.

The ICAEW have also codified model development – see their financial modeling code here.