F-Cube Series – Finance Fundamentals for Founders – Financial Modeling (Part 4) – Types of models in finance

In Part-3 we looked into the construction of a financial model and the typical approaches used – either a top-down or a bottom up approach. The financial models you use to make decisions for your business will vary depending on the objective of the model, and who it is being built for.

There are different types of financial models that businesses can use. The most common ones include business plans, financial planning and analysis, and cash flow forecasting. Each type has its own purpose and it’s important to understand which one is right for your business.

• Business Plan Model: This model outlines the business’s goals and how they will be achieved. It is generally used to back a data story that is to be communicated to Investors or Stakeholders. Here, emphasis may be on arriving at Unit Economics Analysis and Discounted Cashflow valuation. These models contain a Pro-forma Cap Table to facilitate better visibility for investors with respect to business dilution, value of holding through different fund raising rounds and exit returns.
• Financial planning and analysis (FP&A) Model:  This type of model is typically used by the CFO and FP&A teams for budgeting purposes at the start of the financial year. It helps track the company’s actual performance against its targets and offers a Budget vs. Actuals Variance Analysis.
• Cashflow Analysis Model for Loans: Banks and Financing Firms analyze cashflows of businesses in order to understand the ability of the business to repay principal and pay interest on those loans throughout the loan tenure.
• Project Finance Model: For project financings (like infrastructure), this type of model helps forecast the Internal Rate of Return (IRR) to understand the returns against the initial project investments made by investors. This also acts as a feasibility analysis for management decisions on ‘go or no-go’

If you are looking to build a financial model, you have to cover all phases of modeling including data collection, analysis and interpretation, inputting assumptions into models where appropriate, evaluating various scenarios based on probabilities set forth in each financial plan (e.g., economic conditions) and calculating returns to investors.

To reiterate, financial models vary by the end objective of the user and for whom it is being built. Driving this idea into the model you build is critical for making an effective tool for actionable decision-making. To do this, identify what your financial goals are and then construct a model that best fits your needs, goals, and objectives. Connect with us for help, if need be!

F-Cube Series: This is part 4 of 5-part series of blog posts

1. What is a Financial Model
2. Why use a financial model
3. How to create a financial model
4. Types of models in finance
5. Use-cases of financial models