Definition - What does Financial Modeling mean?
Financial modeling is the process by which an organization creates a representation of some or all of its operational aspects. The idea behind creating such a model is to forecast the financial position of the company based on its historical financial parameters.
Divestopedia explains Financial Modeling
Financial modeling includes mathematical representations of key financial and operational ratios that analyze how a business reacts to certain economic events. In general, financial modeling contains many different financial aspects such as cash flow projections, debt, inflation, inventory, depreciation, revenue stream and more. These models show the current financial situation of the company and the future possible situation.
There are many different types of financial models, depending on the current financial situation of the company and its needs. Such models include:
- Discounted Cash Flow Model
- Leveraged Buy Out Model
- Merger and Acquisition Model
- Option Pricing Model
Choosing a model depends to a large extent on what an organization is aiming to achieve. They can be used for a variety of purposes such as:
- Understanding how a company will react to a certain economic situation
- Estimating the amount of money that an organization should borrow for its growth or operational expenses
- Analyzing the value of a firm for IPOs or a business sale
- Defining the risk level and making preparations
- Comparative analysis for the purpose of investments
- Addressing the pressing issues of the company such as a falling market share, slow rate of growth or high levels of attrition
For many corporate financing activities, including raising debt/equity or selling a business, the financial model is one of the first analysis prepared.