There are 5 key steps that enable individual financial analysts and financial modeling teams to develop realistic and credible financial models in a structured manner.
By following this simple approach carefully and in a disciplined manner, you will be able to develop financial models that are robust, manageable, easy to understand & delegate, and error-free.
The 5 key steps are:
- Project planning
- Design and build the financial model
- Testing the financial model
It is essential for the lead financial analyst to evaluate risk and potential pitfalls of developing the model.
For instance, the lead financial analyst could evaluate the relative importance of the model in decision making, the need for macros, the financial modeling team’s knowledge and size, and the eventual audience that the financial model results will be presented to.
Project deliverables should also be clearly defined to ensure that expectations are managed for both the financial modeling team and the eventual audience that the financial model results will be presented to.
If this exercise is going to be a team effort, we should be clear on the roles within the team at this stage, and the resources and time commitment that will be available over the course of the exercise.
In this stage, the financial modeling team should identify the output parameters of the financial model. The financial modeling team should also design all calculation formulas and identify the inputs required for the financial model.
Design and build the model
In this stage, the financial modeling team should define the financial model spreadsheet elements and the links between them. The financial modeling team should fix a time frame and project schedule for completion of the financial model.
Financial model results report layouts should also be designed, as should an overall layout diagram of the architecture of the financial model be put together at this stage.
Note, the financial model will always be growing – Keep the layout diagram up to date.
Testing the financial model
When a first draft of the financial model is complete, the financial modeling team should perform checksums to ensure that the results and calculation formulas in the financial model are consistent.
Cell maps should be created to ensure cells are copied correctly.
While reviewing and auditing models, be alert to the common types of errors.
The financial analyst should keep a log of all amendments made to the financial model to ensure a proper audit trail and documentation of changes made.
A guide to using the financial model should also be developed to ensure that future users are able to get familiar and use the financial model with ease.
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