Types of Financial Modelling

Financial modelling is the backbone of strategic corporate decision-making. It turns raw data into meaningful insights, offering a roadmap for businesses as they navigate critical choices.

Whether you’re a founder charting a startup's path to growth or a CFO preparing for a merger, solid forecasting model capabilities are essential for success.

Each scenario calls for a tailored approach, which is why there are different types of financial modelling, tools, and levels of specificity.

The Three-Statement Model

Every robust financial model starts with three essential components. Think of these as the anatomy of your spreadsheet:

• Income Statement: Reports revenues, expenses, and net income over a period, tracking a company's profitability.
  

• Balance Sheet: Provides a snapshot of assets, liabilities, and equity at a specific point in time.
  

• Cash Flow Statement: Reveals how cash moves in and out from operations, investing, and financing.

These statements are interdependent, modifications in one ripple across the others.

For instance, adjusting operating expenses on the income statement will flow through to retained earnings and impact operating cash flow.

This dynamic linkage creates a foundation for consistent, mathematically reliable forecasting.

This system enables a robust analysis of a company’s financial health, covering everything from revenue growth and cost drivers to operating expenses and cash flow projections.

It often serves as the backbone of a budget model used for planning and monitoring company finances.

Model Building and the 3-Phase Approach

Model building relies on historical data, market trends, and external variables like cost drivers, headcount, and unit economics to estimate future performance.

Clear detailing of these variables helps stakeholders understand the "why" behind the numbers and lays the foundation for effective sensitivity analysis.

Financial experts often use a three-phase approach to structure these models:

1. Phase I: Detailed Historical Performance

   Capture 3–5 years of historical data to ground forward-looking assumptions.
   

2. Phase II: Near-Term Forecasts

   Project the next 3–5 years using detailed, data-driven inputs, think revenue drivers, margin improvements, and capital expenditures.
   

3. Phase III: Terminal Value Period

   As you peer further into the future, shift to generalized assumptions to calculate terminal value, the present value of all future cash flows beyond the explicit forecast period.

Discounted Cash Flow (DCF) and Leveraged Buyout (LBO) Models

For valuation and scenario analysis, two frameworks stand out:

1. Discounted Cash Flow model: The DCF model is the premier method for estimating a company’s intrinsic value. It projects future free cash flows and discount future cash flows to the present using the Weighted Average Cost of Capital (WACC). This pure, data-driven approach lets you strip away market noise to understand a firm’s true worth.
   

2. Leveraged Buyout model: LBO modelling assesses whether a leveraged acquisition can deliver a targeted Internal Rate of Return (IRR) on exit. It’s especially critical in private equity, where firms need to ensure that the company’s cash flows can support substantial debt repayment.

Key Elements: WACC, Debt, and Terminal Value

• WACC in DCF: The DCF model’s accuracy hinges on a carefully calculated WACC, a blend of the cost of equity and debt that factors in business risk.
  

• Debt Servicing in LBOs: In LBO models, managing debt schedules and ensuring ongoing financial stability are paramount. You'll need to account for multiple tranches of financing, each with unique repayment terms.
  

• Terminal Value: Both DCF and LBO models use formulas to determine terminal value, capturing the business’s value beyond the forecast period.

These methods bolster business valuation, enable thorough scenario analysis, and support strategic planning for investment banking, corporate finance, and beyond.

Comparative and Merger & Acquisition (M&A) Analysis

Sometimes, benchmarking against peers or evaluating potential deals provides more actionable insight than intrinsic valuation alone.

Comparable company analysis and M&A models excel here.

Relative Valuation and Deal Mechanics

• Comparable Company Analysis (Comps): By assembling a peer group and examining their valuation multiples (such as Price/Earnings or EV/EBITDA), analysts can estimate a company's market value relative to competitors.
  

• Precedent Transactions: Reviewing past M&A deals in the industry provides a reference point for acquisition premiums and deal structures.

Merger and Acquisition Models

• M&A Impact: M&A models help predict how a merger or acquisition will affect financial performance. The merger model estimates whether the deal will be accretive (increasing earnings per share) or dilutive for shareholders.
  

• Statement Consolidation: Analysts must consolidate financial statements of merging companies, account for synergies and transaction costs, and map out the combined entity’s future.

These tools help analysts and investors understand not only the financial performance and future growth prospects of a target, but also the broader strategic implications of a deal.

Financial Modelling for Actionable Insights

No matter which financial model you use, the ultimate goal remains the same: empowering data-driven decision-making.

Strong models help estimate future growth, maintain financial stability, and communicate the "why" behind every number, enabling teams to adapt, invest, and innovate with confidence.

Yet, building and maintaining effective financial models is both vital and time-consuming. That’s where Actomate's financial analysis comes in.

By automating the data-gathering, reconciliation, and reporting processes, Actomate frees your finance team to focus on what matters most, strategic thinking and driving performance.