Types of Financial Models

Financial models are essential tools in financial management.

They help you analyze historical data, forecast future performance, and make strategic decisions.

Here are the key types of financial models used in business and investment analysis:

1. Three-Statement Model

The three-statement model is the foundation of all financial modeling.

It integrates a company’s income statement, balance sheet, and cash flow statement using Excel formulas, supporting schedules, and assumptions.

Purpose:

• Analyze historical financial results.

• Set up a financial forecast.

• Serve as a basis for more advanced models.

2. Discounted Cash Flow (DCF) Model

The DCF model builds on the three-statement model by adding a valuation component.

It calculates free cash flow and discounts it to present value using the weighted average cost of capital (WACC). It also includes internal rate of return (IRR) analysis.

Purpose:

• Value businesses, investments, or projects.

• Determine acquisition prices.

• Assess strategic initiatives and raise funds.

3. Budgeting and Forecasting Model

This model supports internal business planning by detailing revenue, expenses, and operational forecasts on a monthly or quarterly basis.

It continuously updates with new data.

Purpose:

• Internal planning and budgeting.

• Performance evaluation.

• Strategic business planning.

4. Valuation Model

Valuation models incorporate various valuation methods, including DCF, comparable company analysis, and precedent transactions.

A summary “football field” chart is often used to display valuation ranges.

Purpose:

• Display business valuation ranges.

• Summarize valuation methods.

• Create presentations for investment banking and private equity deals.

5. Mergers & Acquisitions (M&A) Model

The M&A model integrates the three-statement and DCF models while adding assumptions about deal structure, consolidation, and per-share metrics. It includes accretion/dilution and sensitivity analysis.

Purpose:

• Evaluate M&A transactions.

• Determine acquisition prices and deal structures.

• Assess synergies and financial impact.

6. Leveraged Buyout (LBO) Model

The LBO model is an advanced tool that includes debt and interest modeling, investor returns, and sensitivity analysis. It is used to structure buyouts funded primarily through debt.

Purpose:

• Value target businesses.

• Determine purchase prices and equity returns.

• Evaluate financing scenarios.