A financial model is an abstract financial presentation of your business at a future date. It’s a tool that relies on assumptions to perform calculations and derive recommendations based on that data.
It allows you to set realistic goals and see whether you are on track to achieve them. However, financial forecasts are exactly what they are—predictions about the performance of your business, hence are not always 100% accurate. You will have to develop assumptions by setting up formulas and conditions to keep them as close to reality as possible.
A good analyst for financial modelling Australia services can help you build a model by following specific disciplines and avoid the following costly mistakes:
5 Financial Modelling Mistakes to Avoid
- Failure to Plan
In a financial model, what most often don’t think through is identifying who will use it, what it will be used for, what the scope will cover, and what level of detail is required. Failure to consider these can over-complicate your model, resulting in possible issues like unnecessary information input or missing out on critical ones.
Avoid this mistake by painting a clear picture of how you want your financial model to work. Identify the problems it will solve; the end-users of the model and how they will use it. Plan its structure accordingly and constantly monitor whether your assumptions continue to hold true throughout the process.
- Lack of Structure
Most models have several sheets that are either too long or disorderly. Your financial goals are not random and thus shouldn’t be randomly included in your model.
Organise your sheets in this logical structure: assumptions, calculations, and output. It will make it easier for users to determine the areas you should work on. It also helps to have a table of contents where you can hyperlink and easily get to the sheet without scrolling through the entire model.
- Building Complex Models
There are many ways you can complicate your financial model:
- Making more assumptions than necessary – The more assumptions you make, the less realistic your decisions are. Using 10-15 assumptions should be enough to give you more accurate results.
- Excessively using complex formulas – Instead of being complicated and time-consuming to follow through, a good financial model should be easy to interpret. The rule of thumb is to keep the formulas within half the length of the formula bar.
- Hardcoding financial projections – This is another classic way to make your formula more complex. The problem here is that you can easily forget where the data is coming from, making it impossible for you to validate the numbers.
- Using inconsistent formats – The formats in your model should be identical across the sheets. Use the same fonts, styles, borders, labels, and descriptions where possible. The key here is consistency so you don’t confuse the reader.
A financial model should make the user’s life easy: the inputs should be identifiable, accessible, and easy-to-use so users can get the information they need in a manner that they understand.
- Failure to Check for Errors
Error checks should be standard where balances are required. For instance, cash in the balance sheet should match that of in the cash flow statement.
You can set up automatic error checks using the audit function in Excel. The same goes for sanity checks, which is essential in aspects such as average revenue per salesperson. All these checks should ensure that the calculations can be verified using different methods.
- Failure to Add an Executive Summary
An executive summary makes your model more understandable. One look at it should give the reader an overview of the model, including key assumptions, drivers, and other findings. On your part, the summary should help you identify the focus for presenting your financials.
It should include accounts such as profit and loss, balance sheet, and cash flow in a graph.
In conclusion, your financial model should make the life of the user easy. It should present the information in a way that they can access with ease. In addition to the table of contents, consider adding instructions, explanations, and guidance.
By following these steps, you can significantly reduce your chances of making mistakes.
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