Become a Financial Modeling Expert

Starting out as a novice, the challenge in becoming an expert in any field is knowing what will be relevant to your career. As it relates to financial modeling, this challenge is amplified by the scope of all that falls under “finance.” As any field grows the talented practitioners become increasingly specialized.

Financial modeling is a valuable skill set whether you work at a corporation, a long-short hedge fund, in real estate, in oil & gas, at a generalist fund or at a fund that specializes in a particular sector, to provide a few examples. But the analysis required differs by sector and strategy, and while you could spend a lifetime attempting to cover everything, your career will likely be best served by picking a strategy, industry or career path that interests you most.

The objective with the content on ASM is to introduce models in the core curriculum that are relevant across industries. For example, the Leveraged Buyout Model video series spends substantial time focused on capital structure and debt, both of which are concepts critical to any shareholder (or at least they should be). If you work through the content on this website, and keep the steps outlined below in mind, it will provide a strong foundation for most career paths in financial services.

Adopt efficient learning practices. I committed considerable time to learning about learning, and I wish I had done it sooner. My thoughts on this subject: ASM On Learning.

Focus on variables consistent across industries. For example, most privately-held companies require you focus on the following in a financial model:

Income Statement:

  1. Growth rate applied to revenue.
  2. Measures of profitability (generally measured as a percentage of sales).

On the income statement itself, the primary drivers are the growth rate applied to sales, and measures of profitability. You can go into as much detail as you want (i.e. projecting revenue by product line or Cost of Goods Sold (COGS) by line item), or you can project total revenue with a single growth rate, and Gross Margin (measure of profitability after COGS) as a percent of revenue. At the bottom of the income statement, you have net income – using the balance sheet and cash flow statement we can start working towards cash flow.

Balance Sheet:

  1. Working capital accounts.
  2. Property Plant & Equipment (capital expenditures).
  3. Debt liabilities for borrowed money.

On the balance sheet you will find that working capital accounts are often linked to the income statement. You may use historical income statement and balance sheet data to express working capital accounts as a number of days. Accounts receivable, for example is projected using Day Sales Outstanding (DSO). The assumptions you make about how these accounts are handled can have a big impact on cash. To continue with the example provided, if you assume DSO increases, Accounts Receivable will also increase and consume cash.

The PP&E balance is equal to the beginning PP&E balance less depreciation, plus capital expenditures. Depreciation is a non-cash expense, so the focus should be on capital expenditures (especially if the business is asset heavy). Generally there is some kind of link to revenue based on the assumption that greater sales in an asset heavy business will require more equipment. Capital expenditures reduce cash.

Debt obligations should be evaluated thoroughly, particularly in a Leveraged Buyout. Here the link to the income statement is less obvious, but availability of liquidity (cash flow) should influence the debt burden assumed.

Cash Flow Statement:

In most financial models the cash flow statement will take data from the income statement and balance sheet to translate the activity of the business from an accrual basis of accounting to a cash basis of accounting. Summing net cash flow for the period with the previous periods cash balance will give you the cash balance for the current period (which links back to the balance sheet). Generally no drivers found on the cash flow statement.

For a publicly-held business you should include stock-based compensation and share count (this applies to privately-held businesses that use stock-based comp. aggressively as well).

Become proficient at building the model types described in the ASM Core Curriculum Overview. In addition to being highly used exercises, much like the description above, these models all teach accounting and finance concepts that are essential regardless of the career path chosen.

Focus on vocabulary. Even at the introductory level, finance requires so much new vocabulary that learning can feel like it involves a second language. In my opinion, it should be approached the same way.

When a student is assigned a chapter for class, the objective becomes to finish the chapter. Students read it as though they were reading a language they understand, but if every other word is new comprehension will fall. A focus on vocabulary can accelerate the process even if it feels slower to stop and digest each word.

Practice with real data. Try downloading SEC filings and building your own model. The process will expose what you need to revisit. Give the model purpose. The exercise will be all the more valuable if you have an objective. For example, find an article claiming a company’s shares are mispriced, and build a model to form your own conclusion.