Types Of Financial Models

Every business, big or small, needs something that can guide it through the immensely competitive market, to attain a decent position. In order to reach to that position, it is important that the business owner understands the past, present as well as the future of his company. A financial model is the answer to that.

A financial model is a graphic and diagrammatic representation of all the investments and their respective repercussions, of any company, since its conception. This is a must have tool for all business owners, as it is the best and most reliable way of genuinely learning from your mistakes, if there were any; or even resorting to the master plans that may have given you huge profits in the past. The financial model also acts like a crystal globe of the future, wherein after analysing your present, you can easily get an idea of what the future might be. In this way it helps prevent any major ill decision or pitfall.

Emily Muhleman is a professional at preparing these financial models and that too, a detailed version of it. Depending on the purpose and need of a particular company, the financial model can be of different types. They are as follows:

  1. The Discounted Cash Flow Model – this is perhaps the most vital type of the kind. It is based on the premise that the value of any business is the total sum of cash flow in the future, that comes as free, and is discounted at the appropriate rates. In other words, the potential of an investment can be evaluated by this model by projecting the free cash flows and discounts. This is basically employed to estimate the value of any company.
  2. Comparative Company Analysis Model – the investment banking industry rampantly uses this model and also calls it the “Comps”. This is basically a comparison of the concerned company with other similar firms in the market. This model assumes that all similar companies should be having more or less similar valuations.
  3. Sum-of the-parts Model – also known as the break-up analysis, this model tries to understand the value of a company by removing its various divisions and analysing their value separately.
  4. Leveraged Buyout Model (LBO) – this is a process in which another company is acquired with funds borrowed from another firm. The bulge-bracket investment banks and private equity firms mostly use this model, as they intend to buy a company and later sell it off at higher profits.
  5. Merger and Acquisition Model – this is a model to show what the impact of an acquisition will be on the EPS of a company, and how this new EPS is, in comparison with the status quo.
  6. Option Pricing Model – in order to set the present theoretical value, the option traders use this model. This model uses specific fixed known things in the present and predicts their outcome at a certain time in the future.

The financial models are mostly created for valuation but there are many others created by experts like Emily Muhleman, which are used for the purpose of prediction of future risks, the performance of portfolio or trends of economy of any particular region.

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