From the course: Financial Modeling Foundations

Business questions and financial models

From the course: Financial Modeling Foundations

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Business questions and financial models

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- [Instructor] There are a variety of types of financial models that are out there, but I wanna talk about a few key ones that you should be familiar with and that we're gonna talk about throughout this course. First, I'm gonna talk about the corporate model, sometimes called the three-statement model. A corporation has a history, a financial history, and we assume that corporations are going to last in the future. So, the valuation of a corporation begins with historic analysis. And models must include a terminal value assumption, because our cash flows can't be projected forever. So, the three-statement model allows us to go through and understand the corporation's historic performance, where it was doing well and where it was doing poorly, and to project that performance going forward. And it sets the stage for us to understand where the corporation might be down the road. And this leads to the concept of valuing the corporation. And that takes us to the discounted cash flow model, or DCF. DCF models are commonly used either for valuing firms or for project finance. This is our second major type of model. In a DCF model, we have an investment, and that investment is characterized by different phases. We have no history, necessarily, for that particular asset, so we're focused on projected cash flows for the future and the entire defined lifetime of the project, and we wanna go through and figure out if that project makes sense to invest in or not. Our third type of model is a leveraged buyout, or LBO model. This is a merger and acquisition, M&A, style model. We have a transaction. It's defined by an entry price, a holding period, and an exit price, and some manner of financing. So, we can use a financial model to understand if this transaction makes sense and what the outcome is likely to be for the firm. We can also answer questions using this, like, what kind of alternative financing sources make sense, here? What's the return earned by the equity investor, and what are changes that we might make to the transaction to improve its outcomes? Now, in general, when we're looking at financial models, we have an integrated consolidation model where we're looking at computing earnings per share and other ratios before and after an acquisition. We can consider specific financing or accounting of the transaction, and cost savings generated by the transaction. This type of model is more generalized and can be used in a variety of different contexts. But in a nutshell, with all of these different models, Excel is the main tool that you'll be using, here. It's used by banks, corporations, and institutions to perform financial modeling because it's versatile and it's tailored to the company and the investment opportunities and situations that come up. And there's no rules or controls in place that restrict how Excel is used and the type of modeling you can do. You can model whatever scenario you think is most likely. And that allows you to create powerful models, but it also means that you have to be careful that your underlying assumptions are accurate and reasonable, so it's important to call those assumptions out. And we're gonna get into using Excel in just a minute, but next, I wanna talk about generative AI and how this can play a role before you actually start your financial modeling and as you're going through and using that model.

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