Why Is Financial Modelling So Important?

Financial Modelling has greatly increased in importance in the present day and age. Financial Modelling, along with Financial Planning, have become the new tools of the smart financing bandwagon. Financial Planning is done to simulate an actual financial event. How would you act if you were faced with such a financial situation? What would be the appropriate mode of action in such a case? How can cash-flow of an imaginary financial situation be calculated theoretically? Financial Modelling involves all this and more. Companies require financial modelling all the time. Financial modelling has now become a major element of all top-rung managerial decisions. An accountant possessing sufficient knowledge of financial modelling has now become indispensable to the company.

Simple discounted cash flow models alone are not sufficient for financial analysis. A number of studies have shown that the simple discounted cash flow models are, more often than not, riddled with errors. This has paved the way for the introduction and widespread adoption of financial modelling. One of the primary requisites involved in financial modelling is that one has to determine the model objective. Models can created on any number of things, for instance, financial modelling can be done to compare between two investment options, two loan schemes, and the like. After determining the objective of the model, we must now fill in the requisite inputs. The extent of accuracy or precision of the data that is entered must also be determined from before. Models which are clearly documented and complete unambiguous are very rare to find. If a person follows the proper steps, then creation of a spreadsheet based model becomes very easy. The trick is to follow each step rigorously. For every element that we enter into a financial model; all the implications of profit and loss, cash-flow and balance-sheet need to be considered.

The general technique of financial modelling can be applied for a number of other calculations as well. When it comes to financial models, it is very important that the test phase is properly performed. The success of a financial model depends entirely on this phase, as an unnoticed error in calculation in this phase renders the model useless. The level of testing of a financial model obviously depends on the ultimate objective of the model. If the financial model is being developed for business worth millions of dollars, then the financial model should be meticulously tested, a simple error in calculation, or mathematical formulation would result in huge losses to the company.

Now after reviewing the various uses of financial modelling, it occurs to us: Why is financial modelling so important? The answer to the simple query is also simple: All important managerial decisions are a direct consequence of financial modelling. Financial modelling, business plan modelling, financial planning, integrated business planning, enterprise modelling, business process modelling, business reference modelling- all these have assumed a lot of importance in the present day because directly or indirectly, they have a direct connection to all the decision-making processes of a company.

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