Outlining the top 10 most common models used in corporate finance

There are many different types of financial models.  Here, we outline the top 10 most common models used in corporate finance by financial modelling professionals.

Here is a list of the 10 most common types of financial models:

  • Three Statement Model
  • Discounted Cash Flow (DCF) Model
  • Merger Model (M&A)
  • Initial Public Offering (IPO) Model
  • Leveraged Buyout (LBO) Model
  • Sum of the Parts Model
  • Consolidation Model
  • Budget Model
  • Forecasting Model
  • Option Pricing Model

More detail about each type of financial model
To learn more about each of the types of financial models and to perform detailed financial analysis, we have laid out detailed descriptions below. The key to being able to model finance effectively is to have good templates and a solid understanding of corporate finance.

#1 Three Statement Model
The 3 statement model is the most basic setup for financial modelling. As the name implies, in this model the three statements (income statement, balance sheet, and cash flow) are all dynamically linked with formulas in Excel. The objective is to set it up so all the accounts are connected, and a set of assumptions can drive changes in the entire model. It’s important to know how to link the 3 financial statements, which requires a solid foundation of accounting, finance, and Excel skills.

#2 Discounted Cash Flow (DCF) Model
The DCF model builds on the 3 statement model to value a company based on the Net Present Value (NPV) of the business’ future cash flow. The DCF model takes the cash flows from the 3 statement model, makes some adjustments where necessary, and then uses the XNPV function in Excel to discount them back to today at the company’s Weighted Average Cost of Capital (WACC).
These types of financial models are used in equity research and other areas of the capital markets.

#3 Merger Model (M&A)
The M&A model is a more advanced model used to evaluate the pro forma accretion/dilution of a merger or acquisition. It’s common to use a single tab model for each company, where the consolidation of Company A + Company B = Merged Co. The level of complexity can vary widely and is most commonly used in investment banking and/or corporate development.

#4 Initial Public Offering (IPO) Model
Investment bankers and corporate development professionals will also build IPO models in Excel to value their business in advance of going public. These models involve looking at comparable company analysis in conjunction with an assumption about how much investors would be willing to pay for the company in question. The valuation in an IPO model includes “an IPO discount” to ensure the stock trades well in the secondary market.

#5 Leveraged Buyout (LBO) Model
A leveraged buyout transaction typically requires modelling complicated debt schedules and is an advanced form of financial modelling. An LBO is often one of the most detailed and challenging of all types of financial models as the many layers of financing create circular references and require cash flow waterfalls. These types of models are not very common outside of private equity or investment banking.

#6 Sum of the Parts Model
This type of model is built by taking several DCF models and adding them together. Next, any additional components of the business that might not be suitable for a DCF analysis (i.e. marketable securities, which would be valued based on the market) are added to that value of the business. So, for example, you would sum up (hence “Sum of the Parts”) the value of business unit A, business unit B, and investments C, minus liabilities D to arrive at the Net Asset Value for the company.

#7 Consolidation Model
This type of model includes multiple business units added into one single model. Typically each business unit is its own tab, with a consolidation tab that simply sums up the other business units. This is similar to a Sum of the Parts exercise where Division A and Division B are added together and a new, consolidated worksheet is created. Check out CFI’s free consolidation model template.

#8 Budget Model
This is used to model finance for professionals in financial planning & analysis (FP&A) to get the budget together for the coming year(s). Budget models are typically designed to be based on monthly or quarterly figures and focus heavily on the income statement.

#9 Forecasting Model
This type is also used in financial planning and analysis (FP&A) to build a forecast that compares to the budget model. Sometimes the budget and forecast models are one combined workbook and sometimes they are totally separate.
Learn more: see a step-by-step demonstration of how to build a forecast model.

#10 Option Pricing Model
The two main types of models are binomial tree and Black-Scholes. These models are based purely on mathematical models rather than subjective criteria and therefore are more or less a straightforward calculator built into Excel.

3 Statement Model
Here is a screenshot of the balance sheet section of a 3 statement single worksheet model. Each of the other sections can easily be expanded or contracted to view sections of the model independently.

DCF Model
Here is a screenshot of the valuation section in a DCF model. In this section, the cash flows that were calculated above are being placed in sequence along with the purchase prices of the business to arrive at the internal rate of return (IRR) and Net Present Value (NPV).

LBO Model
Here is an example of an LBO model. As you see below, the LBO transactions require a specific type of financial model that focuses heavily on the company’s capital structure and leverage to enhance equity returns.

M&A Model
Here is an example of an M&A model used to evaluate the impact of an acquisition. The M&A model is a more advanced type of financial modeling, as it requires making adjustments to create a Pro Forma closing balance sheet, incorporate synergies and terms of the deal, modeling accretion/dilution, as well as performing sensitivity analysis, and determining the expected impact on valuation.

Learn to build an M&A model step by step in CFI’s M&A Modelling Course.

More Learning
We hope this has been a helpful guide. To learn more about financial modelling and valuation you may want to check out from Corporate Finance Institute:

  • What is financial modelling
  • Financial modelling for dummies
  • Excel shortcuts
  • Why investment banking
  • How to a great financial analyst
  • DCF model infographic

How digital winners think

Digital winners are thinking broadly about whom to collaborate with. In some cases, that may include collaborating with firms that would have been considered competitors historically—or, at the very least, collaborating with firms that can share data.

Digital winners are creating the right scale of investment in their IT infrastructure. It’s very hard to keep up with the pace of evolution in the digital world unless one has a flexible IT infrastructure and one that can plug and play products and services from other places.

Making key decisions
A key decision around digital is whether to attack or defend. For many incumbents who are in a high-margin business, it can be hard to imagine the need to set up a low-cost, innovative proposition, to target your customers, because it can destroy value in the short term. On the other hand, defending for too long can lead to a long-term problem if those attackers are sufficiently more attractive to customers or have a lower cost base. So companies need to think carefully about the right balance of attack and defend.

It’s important early on to understand what, really, is the value from digital. There’s an awful lot of hype around digital, from many sources. One way of cutting through that is to understand the potential upside and downside to the P&L in the medium term.

In many industries, there are opportunities that come from new channels or low-cost entry into new markets. But there are also threats that come from improved price transparency that leads to margin compression. Understanding the relative weight of those opportunities and threats is a good way of understanding the amount of investment that digital warrants and the speed at which action is needed.

Incumbents have many strengths that they can play on as they defend against digital attackers. They have, for example, a customer base. They have a brand. And they have data. The trick, however, is to make sure that all of those assets are leveraged and used equally well in the digital world. For example, making sure that the data they do have is used in an effective way for insight and for your presentation of the right marketing and offers in the digital space.

Deciding who drives
Many CEOs are choosing to lead the digital transformation themselves. That’s particularly true in the industries that are being heavily disrupted. Because, in that case, it’s a do-or-die situation. The other reason why CEOs often need to be personally involved is because digital impacts many of the different functions at an organization. It’s very hard to delegate it to one person because it impacts most of the organization.

The challenge for CEOs is carving out enough time. On the whole, they’ll have very full agendas and digital is just another thing to be added to a long list, typically. One solution is for a CEO to delegate the digital agenda to a chief digital officer. That can be very effective. But it has its challenges. Specifically, it can be difficult for a chief digital officer to have enough influence to make the changes they need across the whole organization.

To give an example: a bank wanting to create a seamless customer experience needs to change marketing, needs to make changes to the products, needs to make changes to distribution, and needs to make changes to operations and to technology. It can be hard for a chief digital officer to have the mandate and the impact across all of those functions.

In some sectors, it’s easier for the CEO to delegate the digital agenda. For example, in a consumer goods company, often the main impact of digital is in the marketing function. Therefore it can make sense for the chief marketing officer to take control of the digital agenda.

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