Whether for sorting out finances, setting prices, or foreseeing risks, spreadsheet models in Excel help us understand and manage processes by breaking them down. It’s like working on interactive worksheets where we get to use math and knowledge to make sense of real data. We can see how different things are connected, conclude, and take action.
Lots of companies rely on spreadsheet models to make sense of tricky situations without breaking the bank or dealing with complicated setups. Financial models are the go-to, but there’s a whole bunch of other types out there too.
What is the use of an Excel Model?
Excel serves as the top tool for modeling because it lets you dive deep into real-life scenarios using math, finance, and statistics. You can play around with econometric models, and regression analysis, and even get your hands dirty with VBA programming for more complex or large-scale modeling.
Sure, there are other software options for modeling, but they shine when it comes to focusing on specific industries and dishing out benchmarking data. The big guns in the business world use these systems to whip up tailor-made solutions, like helping retailers figure out how product placement impacts sales.
Some modeling software tackles manufacturing challenges linked to production materials. But, Excel still holds its ground as a solid testing area for kicking off more advanced models before advanced software entered the picture.
Excel models strike a sweet spot with their mix of flexibility, ease, and control. They let you break down calculations and prediction systems into bits that you can tweak and test without breaking a sweat.
Key Functions to Master for Excel Modeling
Creating Reports
One key aspect of a modeler’s job is transforming data into meaningful insights. This often involves crafting charts and tables from a dataset. When it comes to this task, SUMIFS is your go-to function! It calculates the total value for rows in a dataset that match the set criteria.
- The SUMIFS function is part of Excel’s math and trig functions.
- It calculates the total value for rows in a dataset that match specified criteria.
- SUMIFS is highly valuable for gathering the values needed in your reports.
Data Mapping
In modeling, we often have to beef up our main dataset by grabbing details from a reference table. That’s where the XLOOKUP function comes in handy – it shifts data from one table to another using a unique reference. XLOOKUP kicks it up a notch compared to the traditional lookup methods like VLOOKUP, HLOOKUP, and INDEX MATCH.
However, there are some factors to keep in mind when you’re using the XLOOKUP function in your financial model.
- An optional argument in the function allows specifying what to return if no match is found, eliminating the need for separate error management functions.
- Similar to other reference functions, we can select an exact or approximate match using the match mode argument.
- XLOOKUP now offers the option to specify the direction of the search – either top to bottom or bottom to top – by using the search mode argument.
- Leveraging the dynamic array engine, the function can return multiple entries for a single formula.
- It’s important to note that the XLOOKUP function is exclusive to Office 365 users, posing a notable compatibility risk.
Date Operations
As modelers, we often have to tweak dates in our Excel models. A typical need is to change a date to the last day of the month for reporting purposes. That’s where the EOMONTH function comes in handy!
- The EOMONTH Function is part of Excel’s Date/Time functions.
- It gives you the serial number of the last day of the current month, adjusted by the number of months you specify.
- Financial modeling frequently uses EOMONTH to switch dates between the beginning and end of a month or to move to the next month.
- In data analytics and reporting, EOMONTH is commonly used to mark rows with the end-of-month date or period.
How to create a formula using the EOMONTH function?
=EOMONTH(Start Date, Months)
Start Date – The date you wish to set as the starting point for your reference.
Months – The number of months before (-ve) or after (+ve) the start date.
Working with Text
When it comes to modeling, being able to transform text is a crucial skill. You often find yourself cleaning up text, pulling out specific parts, or merging text pieces. The main functions to get the hang of for playing around with text are TEXTSPLIT and TEXTJOIN.
Just a heads-up, TEXTSPLIT works a bit differently as it “spills” the results into multiple cells instead of just one.
What does Excel’s TEXTSPLIT Function Do?
- The TEXTSPLIT function operates similarly to the text-to-columns feature in Excel or the split-by function in PowerQuery. It lets you divide values from a cell into rows and columns using a specified delimiter.
- This function utilizes Excel’s dynamic array feature to spread the results across rows and columns.
- TEXTSPLIT is a significant advancement over using other text functions like LEFT, RIGHT, and MID to extract text from a cell.
What does Excel’s TEXTJOIN Function Do?
- It concatenates (or joins) values together from cells or ranges of cells.
- This function is an improvement on the CONCAT and CONCATENATE functions as it allows you to include a delimiter and choose whether or not to ignore empty cells.
IF Function
The IF function gives back a value depending on the outcome of a True/False test. For instance, if we want to see if the value in cell A1 equals 1, and if it does, it will show “Yes”; if not, it will show “No.”
Here’s how the formula looks:
=IF(A1 = 1, “Yes”, “No”)
What are the things to consider when using the IF function in your financial model?
- Excel allows nesting up to 64 different IF functions.
- It’s strongly advised to avoid nesting IFs whenever possible because formulas with nested IF functions can become very difficult to understand, audit, and maintain.
- Avoid nesting IF functions by breaking down formula logic into multiple rows. Utilize the IF function to establish 1 or 0 flags instead.
- XLOOKUP or INDEX MATCH can often offer a clearer and simpler solution to challenges often tackled with nested IFs.
- The SWITCH function (introduced in 2016) provides a simpler alternative to nested IFs.
- The IFS function (introduced in 2019) was developed to eliminate the need for nested IFs.
Commonly Used Excel Models by Industry
These models are tailored to use data from selected market segments or company departments. They might use business intelligence to forecast sales or market insights to boost investment ROI or lower risk exposure.
Here are a few industry-specific Excel models that people often find handy:
Financial Models in Excel
We listed down 3 Commonly Used Financial Models in Excel:
Three-Statement Model
The three-statement model is like the foundation of financial modeling. It’s all about connecting the income statement, balance sheet, and cash flow using Excel formulas. The goal? To have everything linked up so that assumptions can shape the whole model. Understanding how to tie these three financial statements together calls for a good grasp of accounting, finance, and Excel skills.
Discounted Cash Flow (DCF) Model
The Discounted Cash Flow commonly called the DCF model extends the three-statement model by valuing a company through the Net Present Value (NPV) of its future cash flows. It involves taking the cash flows from the three-statement model, making adjustments as needed, and applying the XNPV function in Excel to discount these cash flows back to present value at the company’s Weighted Average Cost of Capital (WACC).
These financial models, such as the DCF model, play crucial roles in equity research and various segments of the capital markets.
Merger and Acquisition Model (M&A)
The Merger and Acquisition usually referred to as the M&A model is a modified tool for checking if a merger or acquisition will boost or dilute earnings. Imagine it as combining Company A with Company B to form AB Co. in a single tab. It’s got different levels of complexity depending on the deal. Typically, you’ll see this model in investment banking or corporate development.
Banking & Financial Risk Models
Banks rely on models to keep things running smoothly. When it comes to handling money and making connections, having a solid plan and understanding the landscape is key. In addition to predicting demand, managing banking risks is becoming increasingly crucial. Having precise risk models in place allows traditional banking services to adjust their risk exposure actively and meet their capital requirements while complying with the frameworks.
On another note, probing into investment and stock market risks can also benefit from using models. Although banks can develop their in-house systems, it’s not always the most practical solution.
Financial Risk Modeling Process
Although techniques may vary, the financial risk modeling process typically encompasses the following key steps:
- Clearly define the risks to be assessed and understand their importance in achieving model objectives and managing risks effectively.
- Collect data that reflects the behavior of risk factors across different market conditions and over extended periods.
- Select an appropriate modeling methodology based on the model’s objectives, available data, and resources.
- Construct the model using mathematical and statistical techniques to generate simulations based on the chosen methodology.
- Validate the model by rigorously back-testing it using out-of-sample data and ensuring that the outputs match real-world observations.
- Analyze the model outputs and results to assess potential risks under various conditions and identify key factors that could influence outcomes.
- Continuously monitor and update the model to incorporate new information and adapt to changing market dynamics.
Manufacturing or Production Models
Improving the production of any product can get pretty tricky. The costs of materials and energy can fluctuate in unexpected ways, just like the demand for the product. Add in the limited flexibility of the production pipeline bandwidth and the unique properties of the goods being made, and you might find yourself needing production planning models to keep everything running smoothly. These models often use catalogs of parts that could be stored in Excel or an external database.
Here are some easy steps on how to build a financial model for a manufacturing business.
1. Production Forecast
When creating a financial model for a manufacturing company, start by projecting production. Production refers to the quantity of units manufactured over a period.
2. Estimate Revenue
Once production forecasts are in place, determining revenue becomes straightforward. To calculate revenue for each product line, the formula is simple: Revenue = Sales Volume x Unit Price.
Two crucial steps are required:
Step 1 – Assign a unit price to each product line.
Step 2 – Incorporate a percentage increase in price (annually, for example). This adjustment is necessary to counter cost inflation in the future and enhance profitability.
3. Cost of Goods Sold Forecast
Our next task is to project the Cost of Goods Sold (COGS) and it may encompass various elements depending on the product:
Unit Costs – These are the overall expenses involved in providing the parts, ingredients, and inputs for the final product. Unit costs can be established per product line, either as a total unit cost or broken down into different components such as windshield, wheels, motor, and more.
Packaging – Packaging costs can be allocated per product line or as an average cost per product (e.g., $40 per product).
Shipping – Shipping plays a crucial role in COGS. For manufacturers, shipping costs typically cover the transportation of products from suppliers. However, the shipping cost to deliver products to clients or resellers is typically the client’s responsibility.
4. Compute Expenses
After calculating the COGS, the next step is to project operating expenses. These expenses include many aspects like marketing, rent, janitorial services, logistics, office supplies, salaries, and more.
5. Build your Profit and Loss Report and Cash flow
Once you’ve figured out the expected revenues and expenses, put together the profit and loss (P&L) statement. This will clearly show important financial numbers like Gross Profit and EBITDA margin.
The cash flow statement, on the other hand, should cover all cash items from the P&L and other cash movements like capital expenditures (also known as “Capex”), fundraising, debt, and so on.
Understanding your cash flow is crucial because it gives you insights into how much funding you need to kickstart and sustain your manufacturing business, whether it’s from investors or the bank.
