Creating a Revenue Model
February 12, 2025
A central bank is an institution that is mandated by constitutional decree to function along certain principles and entrusted with managing the fiscal side of the country’s economy. The Fed Reserve and Bank of England are examples of central banks. These banks have many functions, some of which are listed below. The central bank manages […]
Merger modeling requires creating many sub-models which enable decision making. The accretion/dilution analysis is one such sub-model. It is one of the most sought after skills in junior investment bankers who have commonly entrusted the task of creating financial models in major investment banking firms. In this article, we will have a closer look at […]
Wells Fargo is one of the largest banks in the United States. However, of late, it has also become one of the most infamous banks. A couple of years back Wells Fargo was in the news since its sales executives opened up fake accounts without the knowledge of the customers simply to meet the sales […]
In the articles on present value, we learnt that the value of a dollar today is not the same as it will be 10 years from now. Then, we came across annuities which are a powerful mechanism that ensure that the nominal value of the payments remain the same throughout the years whereas its internal […]
The gist of optimism bias is often expressed by using the popular saying “rose-tinted glasses.” In real life, it is helpful to be an optimist. Optimists often live happier and healthier lives. However, when it comes to financial markets, a healthy dose of skepticism is not only necessary but also recommended by many experts. In […]
Planning is the cornerstone around which business empires are built. Businesses which survive and thrive in the long run are often businesses which have diligently kept track of their external environment and continued to plan ahead. In many ways, planning is intuitive to human beings.
Every salaried individual plan how they are going to pay the bill every month. Every housewife plans how they are going to source the various products required for household consumption in the most cost-effective manner. This household planning is often easily accomplished with the help of the back of the envelope calculations.
Planning done by large businesses is also similar in many ways. The only difference is that the number of variables which impact large businesses is much larger.
For instance, large businesses have to take into account the impact of price changes in several markets, possible changes in taxation policies, increase or decrease in consumer demand, and many more things. Therefore, simple back of the envelope calculations which suffice for household needs are not sufficient for these companies.
Instead, these companies require a complex mathematical model where the effect of several variables can be considered. Simply put, a financial model is nothing but a more advanced form of calculation which helps companies plan and make appropriate financial decisions. These decisions then enable them to increase their profit margins, market share, or meet other pre-determined business goals.
The defining feature of financial modeling is that it is forward-looking. Financial statements like Balance Sheet and Income Statements are considered to be financial models if they created for a future date based on certain underlying assumptions.
As mentioned above, the world modeling refers to complex mathematical calculations. Financial models, therefore, refer to the creation of abstract representations of a company’s financial statements. The idea behind the creation of these models is that decision-makers can simulate their decisions and finally see the impact on the company’s finances.
A financial model allows a company to simulate their revenues and expenses under various situations. This is the reason why financial models are extensively used when companies are about to make big decisions like launching a new product line, entering a new market, or acquiring a competitor.
There are two common approaches which are used during financial modeling. Both of them have their own advantages and disadvantages. The exact approach is chosen depending upon the budget and technical sophistication of the company undertaking the process. The two approaches have been explained in detail in the article below:
Once the size and characteristics of the market are ascertained, the firm tries to determine its position vis-a-vis the competition. Finally, the sales, revenues, and expense figures and derived based on these calculations. The strengths and shortcomings of the company are viewed in the light of the macro-market.
Since this approach to financial modeling pays a lot of attention to external variables, the numbers derived from this model are often very accurate. Also, this model works very well for companies on a budget. This is because volumes of point of sales data are not required to make this model work. Also, this approach forces firms to view the trends in the entire market. This helps them better appraise the long term profitability potential of the firm given the external environment.
Bottoms up approach provides a forecast on a line by line basis. As a result, businesses are able to decide on their product mix and align their resources internally. Also, the data in the bottoms-up approach is collected by lower-level employees who have a better understanding of the process. Hence, if there are any discrepancies or wrong assumptions being made in the planning process, they are brought to the fore and corrected immediately.
However, many companies cannot afford the bottoms-up approach since it means that the point of sales data needs to be collated and analyzed. This is what makes it an expensive proposition.
Hence, it would be fair to say that financial modeling refers to a wide variety of tasks and methods which are used for planning by companies depending upon their own capabilities and financial position. It would also be fair to say that financial modeling is the cornerstone of diligent decision making and hence, is extensively used by businesses today.
Your email address will not be published. Required fields are marked *