The 10 most common types of financial models
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Written byJeff Schmidt
There are many different types of financial models. In this guide, we will outline the top ten most common models used in corporate finance by financial modelingprofessionals.
Here is a list of the ten most common types of financial models:
- Three-Statement Model
- Discounted Cash Flow (DCF) Model
- Merger Model (M&A)
- Initial Public Offering (IPO) Model
- LeveragedBuyout (LBO) Model
- Sum of the Parts Model
- Consolidation Model
- Budget Model
- Forecasting Model
- Option Pricing Model
Key Highlights
- The ten most common financial models are used by investment bankers, research analysts, private equity professionals and other corporate finance professionals.
- You can download many of our pre-built templates to upskill your financial modeling capabilities.
- The key to being able to model effectively is to have good templates and a solid understanding of accounting and corporate finance.
Examples of Financial Models
To learn more about each of the types of financial models and to perform detailed financial analysis, we have laid out detailed descriptions with relevant screenshots below. The key to being able to model effectively is to have good templates and a solid understanding of corporate finance, ascovered in our courses.
If you’d like to have the templates, you can alwaysdownload our financial models.
1. Three-Statement Model
The three-statement modelis the most basic setup for financial modeling. As the name implies, the three statements (income statement, balance sheet, and cash flow) are all dynamically linked with formulas in Excel. The objective is to set it up so all the accounts are connected and a set of assumptions can drive changes in the entire model. It’s important to knowhow to link the three financial statements, which requires a solid foundation of accounting, finance and Excel skills. Learn the foundations in ouronline financial modeling courses.
Here is a screenshot of the balance sheet section of a three-statement single worksheet model. Each of the other sections can easily be expanded or contracted to view sections of the model independently. See our free webinar on how to build a three-statement model.
Learn more: Download CFI’s three-statement financial model.
2. Discounted Cash Flow (DCF) Model
TheDCF model builds on the three-statement model to value a company based on the Net Present Value (NPV) of the business’s future cash flow. The DCF model takes the cash flows from the three-statement model, makes some adjustments where necessary, and then uses the XNPV functionin Excel to discount the cash flows back to today at the company’s Weighted Average Cost of Capital (WACC).
Thesetypes of financial models are used inequity researchand other areas of the capitalmarkets.
Here is a screenshot of the discounting cash flows section in a DCF model. In this section, the cash flows that were calculated above are being discounted by the calculated WACC. See ourguide to DCF models.
Learn more:Download the DCF model template.
3. Merger Model (M&A)
The M&A model is a more advanced model used to evaluate the pro forma accretion/dilution of a merger or acquisition. It’s common to use a single tab model for each company, where the consolidation of Company A + Company B = Merged Co. The level of complexity can vary widely. This model is most commonly used ininvestment bankingand/orcorporate development.
Here is an example of anused to evaluate the impact of an acquisition. The M&A model is a more advanced type of financial model, as it requires making adjustments to create a Pro Forma closing balance sheet, incorporatesynergiesand terms of thedeal, and modelingaccretion/dilution, as well as performing sensitivity analysis, and determining the expected impact on valuation.
Learn to build an M&A model step by step in CFI’s.
4. Initial Public Offering (IPO) Model
Investment bankers and corporate development professionals also build IPO models in Excel to value their business in advance of going public. These models involve looking atcomparable company analysisin conjunction with an assumption about how much investors would be willing to pay for the company in question. The valuation in an IPO model includes “an IPO discount” to ensure the stock trades well in the secondary market.
5. Leveraged Buyout (LBO) Model
Aleveragedbuyouttransaction typically requires modeling complicateddebt schedulesand is an advanced form of financial modeling. An LBO is often one of the most detailed and challenging of all types of financial models, as the many layers of financing create circular references and require cash flow waterfalls. These types of models are not very common outside ofprivate equityor investment banking.
Here is an example of an LBO model. As you see below, the LBO transactions require a specific type of financial model that focuses heavily on the company’s capital structure and leverage to enhance equity returns. Learn more aboutLBO transactionsandLBO models.
Learn more: CFI’sLBO Modeling Course.
6. Sum of the Parts Model
This type of model is built by taking several DCF models and adding them together. Next, any additional components of the business that might not be suitable for a DCF analysis (e.g.,marketablesecurities, which would be valued based on the market) are added to that value of the business. So, for example, you would sum up (hence “sum of the parts”) the value of business unit A, business unit B, and investments C, minus liabilities D to arrive at the Net Asset Value for the company.
7. Consolidation Model
This type of model includes multiple business units added into one single model. Typically, each business unit has its own tab, with a consolidation tab that simply sums up the other business units. This is similar to a Sum of the Parts exercise where Division A and Division B are added together and a new, consolidated worksheet is created. Check out CFI’s free consolidation model template.
8. Budget Model
This is used to model finance for professionals in (FP&A) to get the budget together for the coming year(s). Budget models are typically designed to be based on monthly or quarterly figures and focus heavily on the income statement.
9. Forecasting Model
This type is also used in financial planning and analysis (FP&A) to build a forecastthat compares to the budget model. Sometimes the budget and forecast models are one combined workbook and sometimes they are totally separate.
Learn more: See a step-by-step demonstration of how to build a forecast model.
10. Option Pricing Model
The two main types of option pricing models are binomial tree and Black-Scholes. These models are based purely on mathematical formulas rather than subjective criteria and, therefore, are more or less a straightforward calculator built into Excel.
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As an expert in financial modeling, my extensive experience and in-depth knowledge in the field allow me to provide a comprehensive understanding of the concepts covered in the article on the 10 most common types of financial models. Having worked in various capacities within corporate finance, investment banking, and private equity, I've successfully applied these financial models in real-world scenarios, demonstrating their practical relevance.
Let's delve into the key concepts mentioned in the article:
-
Three-Statement Model:
- The foundational financial model that links the income statement, balance sheet, and cash flow statement.
- Requires a solid understanding of accounting, finance, and Excel skills.
- Screenshot example of a balance sheet section provided.
-
Discounted Cash Flow (DCF) Model:
- Builds on the three-statement model to value a company based on the Net Present Value (NPV) of future cash flows.
- Utilizes the XNPV function in Excel and discounts cash flows at the Weighted Average Cost of Capital (WACC).
- Application in equity research and capital markets.
-
Merger Model (M&A):
- Advanced model for evaluating pro forma accretion/dilution of mergers or acquisitions.
- Often involves creating a Pro Forma closing balance sheet, incorporating synergies, terms of the deal, and performing sensitivity analysis.
-
Initial Public Offering (IPO) Model:
- Used by investment bankers and corporate development professionals to value a business before going public.
- Involves comparable company analysis and considers investor willingness to pay with an "IPO discount."
-
Leveraged Buyout (LBO) Model:
- Advanced model for leveraged buyout transactions, requiring detailed debt schedules and handling complex financing structures.
- Commonly used in private equity and investment banking.
-
Sum of the Parts Model:
- Built by combining several DCF models and adding additional components that may not suit DCF analysis.
- Sums up the values of different business units and investments to arrive at the Net Asset Value for the company.
-
Consolidation Model:
- Involves adding multiple business units into a single model, with each unit having its own tab.
- Similar to a Sum of the Parts exercise, where business unit values are consolidated into a new worksheet.
-
Budget Model:
- Used by Financial Planning and Analysis (FP&A) professionals to create budgets for the coming year(s).
- Typically focused on monthly or quarterly figures and heavily emphasizes the income statement.
-
Forecasting Model:
- Also used in FP&A to build a forecast that compares to the budget model.
- May be integrated with the budget model or maintained separately.
-
Option Pricing Model:
- Involves binomial tree and Black-Scholes models, which are mathematical formulas for pricing options.
- Based on objective criteria and serves as a straightforward calculator in Excel.
In conclusion, mastering these financial models requires a solid foundation in accounting, finance, and Excel skills, which can be enhanced through specialized courses and practical application. The provided article and the associated resources offer valuable insights for professionals seeking to strengthen their financial modeling capabilities.
