What is Financial Modelling? - Introduction #financialmodeling course
Summary
TLDRThis script discusses the importance of financial modeling for future planning, emphasizing the need for interconnected financial statements that reflect changes automatically. It highlights the use of Microsoft Excel for creating models that link data assumptions to profit and loss, balance sheet, and cash flow statements. The script outlines the significance of financial models in resource planning, scenario analysis, and business valuation, stressing the interdependence of business elements and the need for a sophisticated approach to financial modeling.
Takeaways
- 📊 Financial statements are a summary of all the financial aspects of a business, including key reports such as the income statement, balance sheet, and cash flow statement.
- 🔑 The first three financial reports (income statement, balance sheet, cash flow statement) are crucial and are often referred to as the three financial statements.
- 🚫 The remaining two reports are considered less important and will be ignored in the course discussion.
- 🔮 Preparing financial statements for the future based on estimates is called financial modeling, which is a key focus of the course.
- 🔗 Financial models should meet qualitative requirements, ensuring that the statements are interconnected and changes in data are reflected across the model.
- 💡 Microsoft Excel is highlighted as an excellent tool for creating interconnected financial models.
- 🔄 Interconnection in financial models means that figures should flow logically between the profit and loss statement, balance sheet, and cash flow statement.
- 💼 The purpose of financial modeling includes resource planning, scenario analysis, and business valuation, which are essential for business decision-making.
- 📈 Resource planning involves forecasting financial needs such as capital, staff, expenses, and cash flow at specific times, which are all interlinked.
- 📊 Scenario analysis allows businesses to prepare for different future outcomes by adjusting input variables in the financial model and observing the impact across reports.
- 💹 Business valuation is dependent on future cash flows and profitability, which can be estimated using a comprehensive financial model.
Q & A
What are financial statements?
-Financial statements are a summary of all the financial aspects of a business, providing an overview of its financial health.
What are the key reports that are part of financial statements?
-The key reports that are part of financial statements include the Profit and Loss Statement, the Balance Sheet, and the Cash Flow Statement. These are also known as the three financial statements.
Why are the first three financial reports considered more important than the remaining two?
-The first three reports are considered more important because they cover the main financial picture of the business, while the remaining two are not as crucial for understanding the overall financial health.
What is a financial model?
-A financial model is a representation of a business's financial projections based on estimates and assumptions about future performance.
What are the qualitative requirements for preparing financial statements for the future?
-The financial statements for the future should be connected to a central data source, interconnected with each other, and any changes in the data should be reflected automatically across the whole model.
How can changes in data be reflected automatically in a financial model?
-Changes in data can be reflected automatically in a financial model by linking the data and assumptions page to the financial statements, so any modifications in the data will update across all reports.
Why is Microsoft Excel considered a good tool for creating financial models?
-Microsoft Excel is considered a good tool for creating financial models due to its flexibility, ease of use, and ability to link data across different sheets and formulas.
What is the significance of interconnecting financial reports in a model?
-Interconnecting financial reports ensures that figures that need to move from one report to another, such as from the Profit and Loss Statement to the Balance Sheet, are accurately and automatically updated.
Why is resource planning important in financial modeling?
-Resource planning is important in financial modeling because it helps to determine the required capital, staff, expenses, and cash needs at specific times, which are all interlinked and dependent on various business factors like sales volume.
How does a financial model assist with scenario analysis?
-A financial model assists with scenario analysis by allowing changes in input variables, which then automatically update all reports, making it easy to analyze different potential future scenarios.
What role does a financial model play in business valuation?
-A financial model plays a crucial role in business valuation by projecting future cash flows and profitability, which are key determinants of a business's value.
Outlines
📈 Understanding Financial Statements and Models
This paragraph introduces the concept of financial statements as a summary of a business's financial health. It emphasizes the importance of the first three financial reports (income statement, balance sheet, and cash flow statement) over the remaining two, which are considered less significant. The speaker then transitions into discussing financial models for future projections, highlighting the need for these models to meet qualitative requirements such as data centralization and interconnectivity. The idea is that any change in the underlying data should automatically update across all connected financial reports. The paragraph concludes with a mention of using software like Microsoft Excel to facilitate this process and the importance of linking financial reports to each other, ensuring consistency and accuracy in financial planning.
💼 Importance of Financial Modeling for Business Planning
Paragraph 2 delves into the practical reasons for creating sophisticated financial models. It outlines the necessity of resource planning, where understanding sales volume and its impact on various business aspects like plant machinery, working capital, and operational expenses is crucial. The paragraph also touches on the importance of financial models for scenario analysis, allowing businesses to prepare for different future outcomes by adjusting input variables and observing the effects across all financial reports. Lastly, it discusses the role of financial models in business valuation, emphasizing how knowing future cash flows and profitability is essential for determining a business's worth. The paragraph concludes by stating that these interconnected financial aspects necessitate a comprehensive financial model, leading into the preparation of such a model in the subsequent lecture.
Mindmap
Keywords
💡Financial Statements
💡Profit and Loss Statement
💡Balance Sheet
💡Cash Flow Statement
💡Financial Model
💡Interconnected
💡Resource Planning
💡Scenario Analysis
💡Business Valuation
💡Microsoft Excel
💡Retained Earnings
Highlights
Financial statements are a summary of all the financial aspects of a business.
The first three reports of financial statements are also called the three statements and are the most important.
The remaining two statements are not as important and will be ignored in the course discussion.
Preparing financial statements for the future based on estimates is called a financial model.
Financial models must meet qualitative requirements, such as being connected to a central data source.
Changes in data should be automatically reflected across the entire financial model.
Microsoft Excel is recommended for creating interconnected financial models.
Financial models should interconnect reports, ensuring figures move accurately between them.
Retained earnings in the balance sheet should be linked to the profit from the profit and loss statement.
The cash flow statement's closing cash value must match the balance sheet.
Financial models are crucial for resource planning, including cash and staff requirements.
Sales volume impacts many aspects of business, and financial models help plan for these interconnections.
Financial models are used for scenario analysis to prepare for different future outcomes.
Business valuation depends on future cash flows and profitability, which a financial model can predict.
The lecture will cover the preparation of a three-statement financial model starting from the next session.
Transcripts
welcome back so we have learned what are
financial statements and we saw that the
financial statements are basically a
summary of all the financial aspects of
business
we also saw that what are the key
reports that become part of financial
statements and what is covered in each
of these reports
we also told you that the first three
reports are also called the three
statements and the remaining two
statements are actually not that
important the first three reports
actually cover the main picture of the
business so we are going to ignore that
for the remaining discussion in this
course because because the topic that we
are going to talk about is only focused
on these three reports
now you have learned how to prepare
financial statements from the past data
but what if if we have to prepare
financial statements for the future
based on the estimates definitely
if we do that that is called a financial
model
but that is not just it you just simply
cannot produce your financial statements
for the future in any random format and
call it financial model that is not the
way
we have to make sure that our financial
statements that we are preparing for the
future do meet some qualitative
requirements and these are
financial statements should be connected
to a central data and then these should
also be interconnected
and this also means that any changes if
we make in the data should be changed
across the whole model now let me
explain that to you with the help of a
diagram
let us say we have all the data and
assumptions and estimations that we have
made for our business according to the
business plan so what is going to be the
price how many units we are going to
sell what is going to be the cost Etc
once we have all this data we will
prepare profit and loss statement
balance sheet and the cash flow
statement Based on data but that data
will be linked from the data and
assumptions page in a way that if I go
back and make any changes in that data
that change should be reflected
automatically in all of these reports
and this can be done very easily using a
software and Microsoft Excel is
definitely the best for that
and the second thing is not just we have
to connect these reports with the data
we also have to interconnect these
reports and with interconnect we mean
that if there are any figures that have
to go from profit and loss statement to
balance sheet that should be done and
similarly if there are any values that
have to go from profit and loss
statement and the balance sheet to the
cash flow statement that should also be
done and similarly if there is any value
that has to come from cash flow to
balance sheet that should also be
covered let me quickly give you some
examples of that we know that in the
balance sheet the retained earnings that
are reported also include the profit
value from the profit and loss statement
so we have to link that together
and then
there are values in the profit and
losses statement and the balance sheet
on the basis of which we prepare our
cash flow statement that is also going
to be the case and we know that the cash
flow statement has the closing cash and
cash equivalent value that matches the
balance sheet so we have to take care of
that as well in fact we will be
discussing even more when we will
actually be preparing that so the last
point will be discussed in even further
detail
but now let us talk about a very
important thing and that is why why we
have to prepare a financial model
especially in such a sophisticated way
and there are multiple reasons for that
the first one is resource planning
you need to plan your resources like how
much money do you need how much how many
staff members do you need what are going
to be the expenses how much cash you are
going to need at what specific time
and the thing is everything in the
business are is interlinked what that
means is so for example if we talk about
sales if the sales volume increase or
decrease that will be impacting a lot of
different things and until you know your
sales volume you can't even plan how
much plant and Machinery you are going
to need what will be your working
capital and what are going to be your
operational expenses all of these things
are actually some way or the other
dependent on sales
and unless you need your got to know all
of these things planted Machinery
working capital and operational expenses
you cannot answer the requirement of the
questions like what are going to be the
capital requirements I mean I mean how
much money do you need what are going to
be the labor related or HR staff related
requirements and what are going to be
the cash inflows and outflows at what is
specific times you you will not know
that and finally
until you know the capital requirements
and the cash flows you won't know how
much debt and Equity you need to start
your business so all of these things are
interlinked we first need to identify
what is going to be the volume of my
business I mean what is going to be the
volume of sales and then we have to work
backwards and all of these things are
going to be interconnected so that if
the volume of sales changes at any
specific time everything else should be
automatically updated in my model so the
first thing that we need financial
modeling for is the resource planning
secondly we need financial model for the
scenario analysis listen when we start a
business or when we are in a business
and planning for the future we cannot
certainly say that what is going to
happen in the future
things may God in go in a little bad
direction or may sometimes go in an even
better Direction so we should be able to
analyze different scenarios and once you
have a fully interlinked financial model
we are just changing input variables on
one sheet can give you the complete
update on every other sheet on every
other report you can do the scenario
analysis very easily and the third
reason is business valuation
if I have to sell my business today or
even a component like five percent or 10
percent of my business today I need to
know the value of my business and the
value of the business is dependent on
the future cash flows and future
profitability so unless I know what is
going to happen in the future and how
much money in the business is going to
generate in the future I can never know
the value of my business so all of these
things are interlinked and to answer
these questions we basically need a
financial model to begin with
and now we are moving towards
preparation of financial model and we
will begin from the base base value base
form of the financial model that is the
three statement model so we will prepare
these statements in the way we have
described let us start doing that from
the next lecture
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