The majority of people have a deep desire in their heart to know about something perfect in their life. Let us guess that you were completely dedicated to driving and giving it all that you have. Today, you want to hang out with your friends after a long time, but your car reduces to start! There were issues with your car for a long time, but you ignore that and doesn’t care for your car’s condition. You never maintain your car and offer it what it needs and today, it will refuse to obey you when you want it badly.
So, what really it shows? It means just learning about something is not adequate. We have to follow the ideal practices on a regular basis for maintaining the health of the tool so that it can work properly and offer the required results during the needy times in an appropriate manner.
If you talk about Financial Modelling as an analysis tool, then we can say that it has the capability to do wonders. However, it is only possible if the ideal practices are followed by the modeler for making it work properly. By ideal practices, we are talking about the major principles that are required to follow for building and maintaining the model for giving maximum functionality.
Now, we will talk about the ideal practices required to follow for excel modeling that is mentioned below in detail:
1. Standard Structure
All the companies need to follow some guidelines for the financial models and structure. In order to define a standardized structure for the financial model, the things like necessary page break pages at intervals, number of sheets, proper explanation and accurate flow of the sheets from top to bottom and left to right are considered. In addition, it is also mandatory to format cells accurately by following the standard practices.
For example, symbols like percentage values, currency, and other similar things should be consistent. If there is a lack of a standardized model, then it can result in confusion and absence of readability. That’s why it is important for ensuring that a standardized and accurate structure is used.
There is a need for protecting financial data from any type of tampering and other similar attacks. Therefore, the excel sheet is required to be password encrypted so that unauthorized access should be avoided. It is ideal to have two levels of password for having proper protection, first for accessing the file and second one for modifying it.
The read-only access will be allowed by the first password to the file, where the modifications can be made in the cell. However, you can’t save them in the original file. In case, the users want to make modifications in the original sheet, then they need to access it through the second password.
3. Accurate documentation of assumptions
There is a very important part played by the assumptions in a financial model and that’s why they need to be documented in a very systematic manner to promote easier understanding. There is a need to assign separate sheet for assumptions where one can a good reference will be offered by the inclusion of source data and calculations. In addition, every explanation related to the assumptions should be mentioned with proper details so that the users don’t face any issues while understanding the reason for the assumptions.
4. Use linking and avoid hard-coding
There are lots of numbers in the financial models and that’s why there are greater chances for omissions or errors. It is ideal to link the cells when there is the repetitive utilization of similar numbers across same sheets, different sheets or other dependent variables. The output is affected automatically when there are changes in an input of one cell. That means, there is no need to worry about anything when there are sudden modifications made and the analyst is already dealing with greater pressure. In addition to the reduction in the number of errors, linking also offer relief from the issues of final changes that can be performed by other users who are working on it.
5. Consistency in formulas
One of the perfect ways to minimize the errors in a financial model is maintaining the consistency in the formulas. However, the real question is how we can achieve it? First of all, you need to make sure that the same formula presents across the whole calculation table. In order to check that, you have to tap on the Formulas tab in Excel and then click on the show formulas. After that, you should look for the blank rows and columns in data blocks. If not, it will create a hindrance to the Data Sort and Data Filter.
6. Formatting Charts
In financial models, the formatting of the charts should be easy on the eyes with axes label, scaling, uniform font size, legend, color coding, etc. One of the frequently reported mistakes in financial modeling is not labeling the charts accurately. You should make sure that accurate units and measures like headcount, MWh, liters, kms, and ‘000 are mentioned in both the data tables as well as the axes. Furthermore, it is perfect for noticing that the row headings as well as column should have currency headings or unit. Also, they should include a single type of currency or unit.
Simplicity is one of the most vital parts of the financial modeling. If this aspect lacks in a model, then it will be difficult to read. Instead of adding complex templates, you should keep your model completely organized by utilizing the simple templates that focus on the main functionality. The sheets added should the ones that are really needed and the cells are required to be grouped in case. Also, you should try to make the navigation as seamless as possible.
8. Futuristic / Flexibility
Financial modeling is a wonderful tool that needs to be flexible as well as futuristic. While creating a model, you must make sure that it is adaptable and responsive according to the changes within and outside the organization. The modifications within the organization should be made on the basis of technological innovation, sales, profit, product launch, organizational restructuring, etc. When we talk about the external changes, it means modifications in interest rate regime, any type of macroeconomic development, etc. Each of these things has the ability for affecting the operating cost, profits and sales. There will be a lesser requirement for making changes manually if you consider more number of factors in the assumptions.
For example, you shouldn’t mention that the revenue of the car will increase from $10 million to $12 million. Here, there is a need for mentioning the revenue = unit sales * price per unit in a precise way. You should also offer input on whether the rise in revenue is because of constant price, increase in unit sales or vice versa.
9. Reader Focused
A financial model has the capability to deal with the readers of different segments. The model can be used by a Financial Manager, A Senior Management official, A Chief Accountant or even a Business Analyst. Having different types of users, it is your huge duty to make sure that the model is able to cater the needs of every stakeholder involved in this model.
10. Integrity Checks
It is pretty common that the models have lots of errors. However, the important thing is how easy it is to figure out the errors for the user and eliminate them at the right time. The best approach to get rid of this situation is to work towards minimizing the errors. One method to reduce the errors is by including integrity and error checks in your models. It is suggested that you should add all the important checks throughout the model on a separate sheet that allow the model builder for checking the model and its section in a correct way.
Ensuring the ideal practices results in increasing authenticity and usability
What is the reason behind creating financial models? So that you can tell about the trends accurately over a certain period of time. So, we can say that you should spend more time and eliminate the issues so that its functionality can be promoted. If you follow the above-mentioned practices, then your model will be foolproof. All the analyst wants a non-complex, accurate and adaptable model that can be useful for them.
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