what is financial modelling

FINANCIAL MODELLING; makes every finance aspirant’s eyes light up.

What is it? And what does a career in financial modelling actually mean? This blog will give you crystal clear insights; and a guide to starting off a career in it.

What is Financial Modelling?

A financial model is a simulation, or replica, of a financial scenario. The scenario can be, for example, working out the share price of a company, given a set of financial situations; or what the enterprise value of a company can be, given again, a set of financial situations – such as sales, growth, costs, etc.

Therefore, financial modelling is the process of understanding and building such scenarios; a good model is one which is as close to real life, as possible.

But financial modelling is not a career in itself! It is a technique, which is used in different roles. These roles require modelling to be done, in order to analyse and arrive at financial decisions.

For example, in order to arrive at the share price of a company:

1. Financial modelling of its financials needs to be done. That is, based on its past performance and current market situation – competition, costs, growth, etc. – the financials for the next few years will be modelled.

2. Then, the share price is estimated, using various techniques.

Similarly, to estimate the enterprise value of a company to be bought or sold, financial models will need to be designed, built and tested. For all models, once the model is built, an analysis of what it tells you needs to be done.

what is financial modelling

Financial Modelling in Excel

It is important to understand, that while Excel is the key tool to build a financial model, it is just that: a tool. Many people think that putting data into Excel and building formulae is what financial modelling is about. That’s not so. What is critical is the ability to understand a business, the factors which drive the financials, and build them accurately into the model. Excel is just the tool which enables this.

Let me give you a small example. For an e-commerce company, how would you model revenues?

Well, the first input is traffic to the website/app– that too, organic (unpaid) traffic, which is regular or consistent and hence can be modelled. Next, is what percentage of that traffic, expresses interest – the ‘leads’. Third, is what percentage of these leads convert to sales.  And then, of course, the price per sale. But wait! Is that all? Won’t these figures change over time? Yes, so we need the growth/change for each period, as well. Here’s what a snapshot of the modelled revenue will look like:

financial model example

That’s it? Financial modelling is easy, you’ll say.

But what is critical here, is on what basis have the growth numbers been arrived at. What will impact them? And how? Is there seasonality, for example?

So, while inputting numbers and building an Excel model is one thing, ensuring that the data which goes in is realistic and validated; and the factors that drive the financials are correctly estimated – is the key skill. For that, as mentioned, understanding an industry, the drivers that impact it, and how to model them – is vital.

Job roles where financial modelling is used

Financial models can be used in many situations – from an internal corporate finance projection to understand how much cash the business is going to generate – to arriving at enterprise value, to sell the company.

So we see that the tool of financial modelling can be used in different roles; you need to have the skill for that role, along with an understanding of modelling, specific to that role.

What, therefore, are these roles? And where are the opportunities, especially for freshers? We also see that about 30% of campus placed students look to switch in the first year. So, this information is critical to junior professionals – say, 0-3 years – as well.

The main roles where financial modelling is used, are:

I. Equity Research Associate/Analyst

Equity Research Analysts (the entry-level designation is ‘Associate’) model share price valuations, to arrive at a buy/sell/hold recommendation. They are usually recruited in the following organizations:

a. Buy-side companies are those, that use the model, for their own internal use – they have funds, which they invest. A Mutual Fund would be an example, of a buy-side entity. Typically, buy-side entities hire experienced professionals, who will be able to take investment decisions from the beginning. Very few junior/fresh people are hired here.

b. Sell-side companies are those which sell advice or research analysis to buy-side companies. Brokerage/Securities companies such as IIFL, Motilal Oswal, Anand Rathi are examples of sell-side companies. Brokerages do hire freshers/junior professionals, in equity research.

c. KPOs: Global buy or sell side companies outsource their research; either to self-owned captive KPOs or third party KPOs. Moody’s Analytics or Evalueserve are examples of third-party KPOs. JPMC, Deutsche Shared Services, Nomura, are examples of captive KPOs. All such KPOs too, hire 0-2 years’ professionals.

CTCs here for a fresher, would range from INR 4-5 LPA for a Moody’s analytics fresher role, to INR 8-10 LPA for a brokerage/securities firm.

II. Investment Banking/M&A Associate/Analyst:

Investment banking companies model enterprise valuations, to present to their clients – who may be the entity buying another company, or the entity being bought. The roles here will either be directly in the I-banking company itself; or more commonly, in KPOs which service the main I-Banks. The larger KPOs are again, JPMC, Deutsche, Morgan Stanley, etc.

Investment banking companies in India are Avendus, Equirus, Axis Capital, etc. Consulting firms like Ernst and Young also have large M&A practices. Note that, both the I-banks and consulting firms typically hire CFAs, MBAs or CAs with strong academics.

It’s an extremely competitive market here. Typical entry-level salaries will range from INR 8-10 LPA for a KPO, to INR 15-20 LPA for the I-bank.

job roles where financial modelling is used

So, how do you get into one of these roles?

It’s extremely competitive. That being said, there are people who get in – so how do you ensure you are one of them?

First, let’s order them, in increasing order of difficulty of getting in:

1. Sell-side KPOs
2. Sell-side brokerage houses
3. Buy-side KPOs
4. Investment banking KPOs
5. Investment banks

So, while you can try to get into the I-banks/I-banking KPOs, it’s easier to work in a sell-side KPO or Brokerage for a couple of years and then look to move.

To score an interview, you can identify the Head of Research for the Sell side Brokerages on LinkedIn and write to them directly, expressing your interest. You can, of course, apply directly on a job site as well – but it’s not effective though.

To increase your chances of getting interviewed, if you do not have the relevant experience, it is critical to have a relevant and good certification on your CV. Make sure that the certification is a known one – and is not just a ‘financial modelling certification’, but a role relevant – ‘Equity Research with Financial Modelling certification’, for example.

And to ensure success in your interview, absolutely make sure, that the certification program teaches you how to understand the drivers of a business, and then model it. Ensure that it is a practical program written by a practitioner who has worked in Equity Research; who knows how to make a good model and more importantly, how to analyse it. That’s the functional skill your interviewer will seek. If you have it, then you’re well on your way to a rewarding career.

All the best!

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