Week 6

How to build a robust model?

- Modelling Best Practices

UTS CRICOS 00099F

Model Types

• Three-way Statement forecast

• Discounted Cash Flow (DCF)
• Merger Model (M&A)
• Leveraged Buyout (LBO)
• Portfolio tracking
• Budgeting
• Operational performance tracking
FINANCIAL MODELLING
BEST PRACTICES

UTS CRICOS 00099F

Financial Modelling Best Practices

• Flexible

• Appropriate

• Structured

• Transparent

The FAST Standard - https://www.fast-standard.org/

Appropriate

• It is a good representation of reality, not

reality itself
• It reflects key business characteristics and
relations truthfully
• It is not built with unnecessary detail
• Different components are specified
consistently and with balance
Appropriate | Model Design
• Model audience
• Personal use
• Internal business use
• External client

• Model purpose
• Set data size
• Rolling window
• Growing data set

• Time series
• Which frequency? Annual, Quarterly, Monthly, Weekly, Daily, Hourly

• Data collection
Appropriate | Steps to building a model

• Design the high-level structure

Document as you go
• Design outputs: summaries, charts, and reports

• Design inputs

• Plan calculations by breaking larger problems into smaller ones

• Finalise outputs

• Design sensitivities and scenario analysis

Structure

• Overall workbook design

• Layout of individual worksheets
• Writing formulas that help to link different
parts of the model
Structure | Workbook Layout

• Single-purpose worksheets
• Separate Inputs, Calculations, and Outputs

• Group worksheets by type

• Left-to-right Inputs Calculations Outputs

• Right-to-left Outputs Calculations Inputs

• Model-user-friendly Outputs Inputs Calculations

Structure | Workbook Layout

• Structural consistency

• Same column structure and

time ruler across sheets

• Re-usable templates

Source: Financial Modelling Institute - https://fminstitute.com/learning-resources-afm/

Structure | Worksheet Design

Inputs
• Organising inputs worksheets
• Constant inputs and series inputs
• Historical inputs vs forecasting assumptions
• By business units, asset type, company, debt instrument, etc.
• Source data should be entered only once
• Use direct links to reference inputs in other worksheets
Structure | Worksheet Design

Calculations
• Logical on-sheet flow
• Formulas should reference only the cells above and to the left
• Calculate only once | Then drag horizontally or vertically
• Consistent formula blocks | Re-usable
• Minimise calculation dependency trees | Direct link inputs
Structure | Worksheet Design

Dedicated sections for flags and factors

• Time
• Actuals / Forecast
• Pre-production/Production/Post-production
• Escalation factors
• Inflation
• Discount factors
Transparent

• A clear logic structure and a layout that

enables the model logic
• Separate worksheets with a clear purpose
• Separating calculations by their nature –
monetary, timing, escalation
• Formulas that are short, simple and easy
to understand and review by other model
builders, reviewers and users
Transparent | Formats

• Formatting using cell styles

• Create your own template
• Format types
• Inputs
• Input cells linked to dashboard
• Imported line items
• Exported line items
• Calculations Source: The IGF Financial Model - https://www.igfmining.org/beps/resources/igf-financial-model/
Transparent | Formats

• Format and label clearly

• Format cells appropriately
• Include a dedicated column for units
(e.g., $, ‘000s, MWh, litres, headcount)
• Don’t hide rows and columns
• Use Data/Outline to Group/Ungroup
rows and columns

Source: The IGF Financial Model - https://www.igfmining.org/beps/resources/igf-financial-model/

Transparent | Formulas

• Formula simplicity
• Having shorter formulas (less than 1 line) is preferred
• If longer, split into two or more steps
• It makes it easier to review and understand formula content
• Limit hard-coded values
• Only standard values that will not change: 24 hours in a day, etc
• Best to have an input
• Same worksheet reference
• Remove sheet name
• Relative, absolute and mixed referencing
Transparent | Validation and Error Checking

• Error Types
• Formula mistakes
• Incorrect assumptions
• Logic errors

• Data Validation
• Helps prevent errors
• Drop-down menus
Flexible

• Users to update the model content as new

information arrives
• Other model builders to modify and adapt
the model as required
• Users to be able to run scenarios and
sensitivities
Flexible | Sensitivities and Optimisations
• Goal Seek and Solver
• Optimisations
• Static
• Lacks transparency

• Data Table
• Sensitivities
• Very useful to build charts
• One or Two-Way tables
Flexible | Scenarios
• Scenario Manager
• The built-in tool has limitations

• Build your own Scenarios

• Build multiple scenarios
• Include all relevant assumptions
• Drop-down menu to select a scenario
• Limitation: you can only see one live scenario at a time
DECISION-MAKING
BIASES

UTS CRICOS 00099F

Poll

What would you prefer to receive:

• Option 1: $50 twelve months from now
• Option 2: $100 eighteen months from now
Poll

What would you prefer to receive:

• Option 1: $50 now
• Option 2: $100 six months from now
Hyperbolic Discounting

▪ Tendency to choose smaller, immediate

rewards rather than larger, later
rewards.
▪ This occurs more when the delay is
closer to the present than the future
Hyperbolic Discounting

$50 ≻ $100 $50 ≺ $100

Now 6 12 18

▪ Short-term: we are impatient and prefer immediate rewards

▪ Long-term: we are more patient and wait for better rewards

IN-CLASS ACTIVITY

UTS CRICOS 00099F