Common Mistakes in Financial Modeling

Common Mistakes in Financial Modeling

While reviewing and auditing financial models, a good financial analyst should be alert to the common types of errors that often plague financial models.

These are often less due to errors in Excel or other financial model applications you may be using, and more because of human error in formulating calculations or conversions in a financial model.

Common Errors in Financial Modeling:

  1. Conversion factors (kilobytes to megabytes, monthly to annual, millions to thousands, etc).
  2. Range included in totals (certain rows not included).
  3. Calculation formula not replicated across columns.
  4. Wrong row references in calculation formula.
  5. Wrong column references in starting time period (each column should typically contain references only from that column).
  6. Change in cell references in formulae referring to other workbooks.
  7. Algebraic errors (wrong use of brackets, plus/minus errors).
  8. Range limits not set (eg, having negative number of customers or negative distributor commission payments).
  9. Hard coded dummy numbers / assumptions perpetuating in the financial model due to oversight.

3 Golden rules for Financial Analysts to Avoid Errors in Financial Models:

  1. Be diligent when building the financial model, a little concentration and attention to detail early on will save you a lot of time and work later.
  2. Ask another person not in the financial modeling team to conduct a detailed audit, very often a fresh pair of eyes may spot errors then are’nt obvious to someone who’s been looking at the same spreadsheet for days or weeks on end.
  3. Perform sanity checks on outputs through benchmarking exercises, always use your common sense and business knowledge to ensure that the results of your financial model (e.g. individual product revenues or cost items, etc) are realistic and aligned with what you may expect them to be.

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One Response to “Common Mistakes in Financial Modeling”

  1. Good list of common mistakes. I also liked the third point in the golden rules. The entire financial modeling exercise would turn futile if the projections are not aligned to reality. It is necessary to be modest with the projections even if you are aggressive in your business. There are so many extraneous factors that pressure the business and so it is better to accept a surprise than a shock. I think one more golden rule is to “be flexible”. The environment in which the business operates or is expected to operate sometimes changes so dramatically and so fast that all the numbers projected may be thrown out of the realm of reality very easily. This is why it is necessary to be flexible with the assumptions. When the reality changes, the model should take that into account and change the numbers. For example for seasonal businesses we can make three different sets of projections based on optimistic, pessimistic and realistic scenario. Whichever materializes, the user has to select it to see the numbers change instantaneously. For building Financial Models visit our site financialmodel.net

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