Financial Modeling Definition and Quiz for Stock Investments

Understanding financial modeling

Beginner

Financial modeling is the process of developing financial projections for a company, typically in a spreadsheet. It can be performed for both public and private companies, and is one component of fundamental analysis. See also investment modeling.

Synonym: pro-forma model

For context, it's safe to say that nearly all financial analysts have a comfort level with building financial models in Excel. The ability to create reports quickly is one advantage over a programming language. Common uses include developing financial projections, building pro-forma financial models, and downloading and populating data from service providers.

Spreadsheets for financial analysis offer the following advantages:

Pervasive - cheap or free and knowledge is widespread.
Easy to learn - grid format is easier to learn than programming.
Visualization - easy to construct charts and graphs.
Functionality - intermediate financial and statistical operations built-in.

Commonly cited disadvantages of spreadsheets include:

Error prone - as many as 80% of spreadsheets have errors.
Rarely audited - reviewing all cells is uncommon.
Data relationships - referential integrity tests are less robust than in a database.
Formatting is slow - inconsistencies across spreadsheets take time to adjust.

In a Sentence

Pam: Did you hear that sell-side analyst on the call grill the Ford CEO on SG&A guidance?
Eve: Yep, another example of the blame game. His financial model of EPS missed by a penny.

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Quiz

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Which of the following is not typically analyzed when financial modeling? | Cash Flows or Capital Expenditures or Stock Correlations

Stock Correlations

Which is not a drawback associated with financial modeling in a spreadsheet? | Ability to handle big data, cell formula errors, software dependencies, or speed

Software dependencies. Unlike with programming, spreadsheets require less maintenance.

Questions or Comments?

Still unclear on Financial Modeling? Check out the deep-dive into Excel where we build advanced financial models for evaluating stocks with a free data set and 27 videos, in Quant 101.

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Financial Modeling Definition and Quiz