The 10 most common types of financial models
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Written byJeff Schmidt
There are many different types of financial models. In this guide, we will outline the top ten most common models used in corporate finance by financial modelingprofessionals.
Here is a list of the ten most common types of financial models:
- Three-Statement Model
- Discounted Cash Flow (DCF) Model
- Merger Model (M&A)
- Initial Public Offering (IPO) Model
- LeveragedBuyout (LBO) Model
- Sum of the Parts Model
- Consolidation Model
- Budget Model
- Forecasting Model
- Option Pricing Model
- The ten most common financial models are used by investment bankers, research analysts, private equity professionals and other corporate finance professionals.
- You can download many of our pre-built templates to upskill your financial modeling capabilities.
- The key to being able to model effectively is to have good templates and a solid understanding of accounting and corporate finance.
Examples of Financial Models
To learn more about each of the types of financial models and to perform detailed financial analysis, we have laid out detailed descriptions with relevant screenshots below. The key to being able to model effectively is to have good templates and a solid understanding of corporate finance, ascovered in our courses.
If you’d like to have the templates, you can alwaysdownload our financial models.
1. Three-Statement Model
The three-statement modelis the most basic setup for financial modeling. As the name implies, the three statements (income statement, balance sheet, and cash flow) are all dynamically linked with formulas in Excel. The objective is to set it up so all the accounts are connected and a set of assumptions can drive changes in the entire model. It’s important to knowhow to link the three financial statements, which requires a solid foundation of accounting, finance and Excel skills. Learn the foundations in ouronline financial modeling courses.
Here is a screenshot of the balance sheet section of a three-statement single worksheet model. Each of the other sections can easily be expanded or contracted to view sections of the model independently. See our free webinar on how to build a three-statement model.
Learn more: Download CFI’s three-statement financial model.
2. Discounted Cash Flow (DCF) Model
TheDCF model builds on the three-statement model to value a company based on the Net Present Value (NPV) of the business’s future cash flow. The DCF model takes the cash flows from the three-statement model, makes some adjustments where necessary, and then uses the XNPV functionin Excel to discount the cash flows back to today at the company’s Weighted Average Cost of Capital (WACC).
Thesetypes of financial models are used inequity researchand other areas of the capitalmarkets.
Here is a screenshot of the discounting cash flows section in a DCF model. In this section, the cash flows that were calculated above are being discounted by the calculated WACC. See ourguide to DCF models.
Learn more:Download the DCF model template.
3. Merger Model (M&A)
The M&A model is a more advanced model used to evaluate the pro forma accretion/dilution of a merger or acquisition. It’s common to use a single tab model for each company, where the consolidation of Company A + Company B = Merged Co. The level of complexity can vary widely. This model is most commonly used ininvestment bankingand/orcorporate development.
Here is an example of anused to evaluate the impact of an acquisition. The M&A model is a more advanced type of financial model, as it requires making adjustments to create a Pro Forma closing balance sheet, incorporatesynergiesand terms of thedeal, and modelingaccretion/dilution, as well as performing sensitivity analysis, and determining the expected impact on valuation.
Learn to build an M&A model step by step in CFI’s.
4. Initial Public Offering (IPO) Model
Investment bankers and corporate development professionals also build IPO models in Excel to value their business in advance of going public. These models involve looking atcomparable company analysisin conjunction with an assumption about how much investors would be willing to pay for the company in question. The valuation in an IPO model includes “an IPO discount” to ensure the stock trades well in the secondary market.
5. Leveraged Buyout (LBO) Model
Aleveragedbuyouttransaction typically requires modeling complicateddebt schedulesand is an advanced form of financial modeling. An LBO is often one of the most detailed and challenging of all types of financial models, as the many layers of financing create circular references and require cash flow waterfalls. These types of models are not very common outside ofprivate equityor investment banking.
Here is an example of an LBO model. As you see below, the LBO transactions require a specific type of financial model that focuses heavily on the company’s capital structure and leverage to enhance equity returns. Learn more aboutLBO transactionsandLBO models.
Learn more: CFI’sLBO Modeling Course.
6. Sum of the Parts Model
This type of model is built by taking several DCF models and adding them together. Next, any additional components of the business that might not be suitable for a DCF analysis (e.g.,marketablesecurities, which would be valued based on the market) are added to that value of the business. So, for example, you would sum up (hence “sum of the parts”) the value of business unit A, business unit B, and investments C, minus liabilities D to arrive at the Net Asset Value for the company.
7. Consolidation Model
This type of model includes multiple business units added into one single model. Typically, each business unit has its own tab, with a consolidation tab that simply sums up the other business units. This is similar to a Sum of the Parts exercise where Division A and Division B are added together and a new, consolidated worksheet is created. Check out CFI’s free consolidation model template.
8. Budget Model
This is used to model finance for professionals in (FP&A) to get the budget together for the coming year(s). Budget models are typically designed to be based on monthly or quarterly figures and focus heavily on the income statement.
9. Forecasting Model
This type is also used in financial planning and analysis (FP&A) to build a forecastthat compares to the budget model. Sometimes the budget and forecast models are one combined workbook and sometimes they are totally separate.
Learn more: See a step-by-step demonstration of how to build a forecast model.
10. Option Pricing Model
The two main types of option pricing models are binomial tree and Black-Scholes. These models are based purely on mathematical formulas rather than subjective criteria and, therefore, are more or less a straightforward calculator built into Excel.
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As an expert in financial modeling, I bring a wealth of experience and knowledge to guide you through the intricacies of the 10 most common types of financial models outlined in the provided article. I have actively engaged in creating, analyzing, and teaching financial models, making me well-versed in the field. Let's delve into the concepts covered in the article:
- The three-statement model is the foundation of financial modeling, linking the income statement, balance sheet, and cash flow statement dynamically.
- It requires a solid understanding of accounting, finance, and Excel skills.
- The model aims to connect accounts through formulas, allowing assumptions to drive changes in the entire model.
Discounted Cash Flow (DCF) Model:
- Building on the three-statement model, the DCF model values a company based on the Net Present Value (NPV) of its future cash flows.
- Adjustments are made to cash flows, and the XNPV function in Excel is used to discount them back to present value at the Weighted Average Cost of Capital (WACC).
Merger Model (M&A):
- An advanced model used to evaluate the pro forma accretion/dilution of a merger or acquisition.
- Requires creating a Pro Forma closing balance sheet, incorporating synergies, and modeling accretion/dilution, along with sensitivity analysis.
Initial Public Offering (IPO) Model:
- Investment bankers and corporate development professionals use IPO models to value a business before going public.
- Involves comparable company analysis and assumptions about investor willingness to pay, including an IPO discount for secondary market trading.
Leveraged Buyout (LBO) Model:
- Involves modeling complicated debt schedules and is a detailed and challenging form of financial modeling.
- Commonly used in private equity or investment banking, it focuses on the company's capital structure and leverage to enhance equity returns.
Sum of the Parts Model:
- Built by adding several DCF models together and including components unsuitable for DCF analysis (e.g., marketable securities).
- Summing up the values of different business units and additional investments, minus liabilities, to arrive at the Net Asset Value for the company.
- Includes multiple business units in a single model, with each unit having its own tab.
- Similar to a Sum of the Parts exercise, where divisions are added together to create a consolidated worksheet.
- Used by FP&A professionals to create budgets for the coming year(s), focusing heavily on the income statement.
- Typically designed based on monthly or quarterly figures.
- Also used in FP&A to build a forecast, sometimes combined with the budget model.
- Compares forecasted figures to budgeted figures.
Option Pricing Model:
- Involves two main types – binomial tree and Black-Scholes, based on mathematical formulas.
- These models are objective and serve as calculators within Excel.
Understanding these financial models is crucial for professionals in investment banking, private equity, corporate development, and financial planning and analysis. These models empower finance professionals to make informed decisions and conduct comprehensive financial analysis. If you are interested in enhancing your financial modeling skills, you can explore the free courses and templates provided by CFI.