Quick Answer
Financial modelling is the process of building a mathematical representation of a company's financial performance to support planning and decision-making. Models typically project the P&L, balance sheet, and cash flow using assumptions about revenue drivers, costs, and working capital. Good financial models are transparent, auditable, flexible, and clearly separate inputs from calculations and outputs.
Three-statement model. Links the P&L, balance sheet, and cash flow statement through shared assumptions. The gold standard for comprehensive financial planning.
Budget model. Detailed revenue and cost projections by department, typically at monthly granularity for a 12-month period. Forms the basis of the annual budget.
Rolling forecast model. Extends beyond the budget period, typically 12-18 months ahead, updated monthly with the latest actuals and revised assumptions.
Scenario model. Tests the financial impact of different assumptions — growth rates, pricing changes, market conditions. Usually built as an overlay on the base model.
Valuation model. DCF (discounted cash flow) or comparable company analysis used for investment decisions, fundraising, and M&A.
Working capital model. Projects receivables, payables, and inventory to forecast cash conversion and funding requirements.
1. Structure clearly. Follow a logical flow: assumptions → calculations → outputs. Use separate sheets or sections for each. Colour-code cells: blue for inputs, black for calculations, green for links to other sheets.
2. Use driver-based assumptions. Model revenue as [customers x ARPU] rather than a single growth percentage. Model costs as [headcount x average salary x employer cost multiplier] rather than a lump sum. Driver-based models are easier to understand, challenge, and update.
3. Build for scenarios. Include a scenario toggle from the start. Even a simple dropdown that switches between base, upside, and downside assumptions saves hours when leadership requests scenario analysis.
4. Document everything. Every assumption should have a source or rationale. Use a dedicated assumptions sheet with comments explaining where each number comes from.
5. Error-check obsessively. Build in validation checks: does the balance sheet balance? Does cash flow tie to the balance sheet? Do revenue components sum to total revenue? Flag errors prominently.
6. Keep it as simple as possible. Complexity is the enemy of usability. If a model is so complex that only one person can maintain it, it is a risk, not an asset. Simplify where possible and add complexity only when it materially improves accuracy.
Excel remains the most common modelling tool, particularly for bespoke or one-off models. For recurring FP&A models (budgets, forecasts, scenarios), purpose-built platforms like Grove FP provide better collaboration, version control, and automation while maintaining the flexibility finance teams need.
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FAQ
Use Excel for one-off models (valuation, investment case, ad hoc analysis). Use FP&A software for recurring models (monthly forecasts, annual budgets, management reporting) where collaboration, data integration, and version control matter. Many finance teams use both.
Match the detail to the decision being made. A fundraising model needs high-level, long-range projections. An annual budget needs monthly, department-level detail. A pricing analysis needs granular unit economics. More detail is not always better — it increases maintenance cost and error risk.
Hard-coding numbers instead of linking to assumptions. When revenue is typed as "£500,000" rather than calculated as "1,000 customers x £500 ARPU," the model becomes impossible to update, challenge, or scenario-test. Always trace every number back to an explicit assumption.
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