Top 10 types of financial models

 

Top 10 types of financial models

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There are many different types of financial models.  In this guide, we will outline the top 10 most common models used in corporate finance by financial modeling professionals.

Here is a list of the 10 most common types of financial models:

1. Three Statement Model
2. Discounted Cash Flow (DCF) Model
3. Merger Model (M&A)
4. Initial Public Offering (IPO) Model
5. Leveraged Buyout (LBO) Model
6. Sum of the Parts Model
7. Consolidation Model
8. Budget Model
9. Forecasting Model
10. Option Pricing Model

 

Image: Advanced Financial Modeling & Valuation Course

 

More detail about each type of financial model

To learn more about each of the types of financial models and to perform detailed financial analysis, we have laid out detailed descriptions below.  The key to being able to model finance effectively is to have good templates and a solid understanding of corporate finance.

 

 

#1 Three Statement Model

The 3 statement model is the most basic setup for financial modeling. As the name implies, in this model the three statements (income statement, balance sheet, and cash flow) are all dynamically linked with formulas in Excel. The objective is to set it up so all the accounts are connected and a set of assumptions can drive changes in the entire model. It’s important to know how to link the 3 financial statements, which requires a solid foundation of accounting, finance, and Excel skills.

Learn the foundations in our online financial modeling courses.

 

#2 Discounted Cash Flow (DCF) Model

The DCF model builds on the 3 statement model to value a company based on the Net Present Value (NPV) of the business’ future cash flow. The DCF model takes the cash flows from the 3 statement model, makes some adjustments where necessary, and then uses the XNPV function in Excel to discount them back to today at the company’s Weighted Average Cost of Capital (WACC).

These types of financial models are used in equity research and other areas of the capital markets.

 

#3 Merger Model (M&A)

The M&A model is a more advanced model used to evaluate the pro forma accretion/dilution of a merger or acquisition.  It’s common to use a single tab model for each company, where the consolidation of Company A + Company B = Merged Co.  The level of complexity can vary widely. This model is most commonly used in investment banking and/or corporate development.

 

#4 Initial Public Offering (IPO) Model

Investment bankers and corporate development professionals also build IPO models in Excel to value their business in advance of going public. These models involve looking at comparable company analysis in conjunction with an assumption about how much investors would be willing to pay for the company in question. The valuation in an IPO model includes “an IPO discount” to ensure the stock trades well in the secondary market.

 

#5 Leveraged Buyout (LBO) Model

A leveraged buyout transaction typically requires modeling complicated debt schedules and is an advanced form of financial modeling. An LBO is often one of the most detailed and challenging of all types of financial models, as the many layers of financing create circular references and require cash flow waterfalls. These types of models are not very common outside of private equity or investment banking.

 

#6 Sum of the Parts Model

This type of model is built by taking several DCF models and adding them together. Next, any additional components of the business that might not be suitable for a DCF analysis (e.g., marketable securities, which would be valued based on the market) are added to that value of the business.  So, for example, you would sum up (hence “Sum of the Parts”) the value of business unit A, business unit B, and investments C, minus liabilities D to arrive at the Net Asset Value for the company.

 

#7 Consolidation Model

This type of model includes multiple business units added into one single model. Typically, each business unit has its own tab, with a consolidation tab that simply sums up the other business units.  This is similar to a Sum of the Parts exercise where Division A and Division B are added together and a new, consolidated worksheet is created. Check out CFI’s free consolidation model template.

 

#8 Budget Model

This is used to model finance for professionals in financial planning & analysis (FP&A) to get the budget together for the coming year(s).  Budget models are typically designed to be based on monthly or quarterly figures and focus heavily on the income statement.

 

#9 Forecasting Model

This type is also used in financial planning and analysis (FP&A) to build a forecast that compares to the budget model. Sometimes the budget and forecast models are one combined workbook and sometimes they are totally separate.

Learn more: see a step-by-step demonstration of how to build a forecast model.

 

#10 Option Pricing Model

The two main types of option pricing models are binomial tree and Black-Scholes. These models are based purely on mathematical formulas rather than subjective criteria and, therefore, are more or less a straightforward calculator built into Excel.