Sridhar Yendamuri | What is Financial Modeling? | A Comprehensive Guide to Understanding the Basics | Sridhar Prahasith Yendamuri

Sridhar Yendamuri | Sridhar Prahasith Yendamuri: If you are trying to understand financial modeling from the basics, follow me, I would be happy to share a few key points on what it is about. How do you and where do you implement it? Further, how is corporate finance different from project finance? Many more articles to follow.

What is Financial Modeling: It is a tool to predict the financial health of a business and also helps in forecasting future decisions and outcomes.

To further share, it is li ke a tool to perform analysis of your business and yes, it is very important to have knowledge on this tool.

In small scale businesses, people make decisions based on cash, operations, purchases, sales and believe inherently that profit earned per day or week or month is what matters. But the most important point I have learnt is not starting or running a business, but managing a business long term is a difficult thing. It takes time to understand this and as a result cash flow in the business plays an important role. It is also important to look at 3-Statement financial model and understand this model for every entrepreneur or lead to forecast the business projections.

Microsoft Excel is the most widely used tool for financial modeling due to its flexibility, extensive functions, and widespread familiarity. It also offers features such as Advanced formulas, pivot tables, macros (VBA), add-ins for enhanced capabilities.

3-Statement Financial Model: It is a fundamental tool used to project a company's financial performance and structure over a given period, offering a comprehensive view of its operations and financial health. This model integrates three core financial statements: the Income statement, the Balance sheet, and the Cash Flow statement. By linking these statements together, it provides a holistic overview of the business, allowing for better analysis of profitability, liquidity, and overall financial stability. This model is essential for decision-making, as it helps businesses forecast future performance, evaluate potential risks, and assess capital needs.

Other important types of Financial Models:

Discounted Cash Flow Model : It is a most powerful tool used by businesses to estimate the value of future cash flows generated throughout the life of a business. But how does it work? The model projects a company’s Free Cash Flows—the cash generated from operations after accounting for expenses, taxes, and capital investments—and then discounts these future cash flows to their present value using a Discount Rate (typically the company's cost of capital). This approach helps determine the current value of the business by considering the time value of money, providing insights into its intrinsic worth and investment potential.

Project Finance Model: This is another critical financial model specifically used to assess the viability and structure of large-scale, capital-intensive projects, often in infrastructure, energy, and natural resources sectors. This model is centered on the project's ability to generate cash flows to repay debt and provide returns to equity investors, with the project itself typically being the sole source of repayment (non-recourse or limited-recourse financing). Most importantly it helps in understanding project’s projected cash flows and not the company’s overall financials and projects cash flow that is generated through operations plays an important role, as it helps in evaluating whether the generated cash flow can cover its debt obligations( debt raised for the project execution) .

Mergers & Acquisitions (M&A) Model: This tool has been used to evaluate the financial implications of mergers, acquisitions, or other strategic transactions. It helps in assessing if the acquisition can impact on the combined entity’s financial statements, including synergies, purchase price allocation, and accretion/dilution analysis to determine whether the deal will enhance shareholder value.

Leveraged Buyout (LBO) Model : This is another powerful tool that is used by PE firms, investors for buy out options.  Signifies on acquiring businesses using a significant amount of borrowed funds (debts-leverage). This model projects the cash flows available to service debt, evaluates the debt repayment schedule, and estimates the potential return on equity for investors.