A financial model is a quantitative representation of a company's financial performance, built in spreadsheets or specialised software, that projects future results based on assumptions about key business drivers. Financial models are the primary tool FP&A teams use for planning, analysis, valuation, and decision support.
In Depth
Financial models translate business assumptions into numbers. They range from simple revenue projections to complex, integrated three-statement models with scenario analysis. The model is only as good as its assumptions and structure, making model design and maintenance a core FP&A competency.
Common types of financial models include: operating models (annual budgets and forecasts), three-statement models (integrated P&L, BS, CF), DCF models (discounted cash flow for valuation), LBO models (leveraged buyout analysis), and M&A models (merger and acquisition analysis).
Best practices for financial modelling include: separate inputs from calculations from outputs, use consistent formatting and colour coding, document all assumptions, build error checks and balances, keep formulas simple and consistent, use named ranges for key assumptions, and version control.
FP&A teams maintain the operating model as a living document, updating it with actuals monthly and refreshing assumptions quarterly. The model should be structured so that key assumptions can be changed easily and their impact traced through all financial statements.
For UK businesses, financial models should incorporate UK-specific elements: corporation tax rates and reliefs, employer NI calculations, pension auto-enrolment costs, VAT timing, and any applicable government incentives (R&D tax credits, capital allowances, regional grants).
Real-World Example
A UK SaaS company maintains a financial model with three linked sections: a driver-based operating model (headcount, revenue per rep, churn rate, ARPU), a three-statement output (monthly P&L, quarterly BS and CF), and a valuation section (DCF and comparable multiples). The model runs 36 months of monthly detail and 5 years of annual projections. Key outputs include cash runway, break-even date, and implied valuation at various multiples.
Related Terms
A three-statement model is an integrated financial model that links the income statement (P&L), bala...
Driver-based planning is a financial planning methodology that links key operational and business dr...
Scenario analysis is a financial modelling technique that evaluates the impact of different future c...
Due diligence is the comprehensive investigation and analysis of a business conducted before a major...
A DCF (Discounted Cash Flow) model values a company or project by projecting future free cash flows ...
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