You then use these numbers to forecast the company’s financial statements, i.e., its Income Statement, Balance Sheet, and Cash Flow Statement, over several years. In these financial models, you project a company’s revenue, expenses, and cash flow-related line items, such as the Change in Working Capital and Capital Expenditures. It can help persuade others that you are correct, but a spreadsheet by itself doesn’t solve the case or convince everyone on the jury. Or, perhaps you do further research into the company and its market, become more skeptical, and decide against investing.Ī financial model is just a PART OF the investment process it’s like a piece of evidence in a courtroom murder trial. And the other outcomes here, especially the last one, are more plausible.ĭoubling or quintupling your money over 5 years is still a great result, so you might take your uncle’s advice and invest some amount.If the company does achieve this performance, it will likely take more than 5 years. ![]() We can’t assign a specific probability to this outcome, but we can say that no food & beverage company in history has ever achieved this performance in this time frame. ![]() It’s unlikely that your uncle’s $100,000 investment will turn into $1 million within 5 years because the required pricing and market share are unrealistic. $200,000 in 5 Years: This would require 3% market share within 5 years or tequila sold for 2x the normal price and 1% of the market (the same as the current share).$500,000 in 5 Years: This would require the company to win 5% market share within 5 years or sell its tequila at 2x the normal price while capturing 2% of the market.Alternatively, the company could also get there by selling its tequila at 3x the normal price and capturing 3% of the market. $1 million in 5 Years: This would require the tequila company to grow from 1% to 10% market share in a very crowded market within 5 years.Returning to this tequila company example, perhaps your model produces the following results for your uncle’s $100,000 investment: If a financial model tells you that a company is undervalued by 5% or 10%, that is a meaningless result because the margin of error is so high.īut if the model tells you that the company is undervalued by 90% or overvalued by 200%, those are much more useful results.Įven if you’re wrong about the percentages, you can still make money if you are directionally correct. ![]() The goal is to be “roughly correct” rather than “precisely wrong.” Will your crazy uncle’s idea pay off? Financial modeling to the rescue!Ī robust financial model lets you input these parameters, project the company’s future cash flows, and assess the likelihood of your uncle’s $100,000 investment turning into $1 million in 5 years.įinancial models cannot predict any outcome with a high degree of certainty. He then gently encourages you to put your life savings into this tequila company. He shares data about the company’s sales, employee count, and market share, and then he claims that his $100,000 investment will be worth $1 million in 5 years. Suppose that your crazy rich uncle calls you and tells you about his latest investment: a tequila company into which he just “poured” $100,000. ![]() So, let’s start with the basic definition:įinancial Modeling Definition: A financial model is a spreadsheet-based abstraction of a real company that helps you estimate the company’s future cash flows, financing requirements, valuation, and whether or not you should invest in the company models are also used to assess the viability of acquisitions and the development of new assets. We get many questions about what “financial modeling” means, how important it is in the finance industry, and why so many students and professionals are obsessed with learning it.
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