Financial Modeling is so much more than one or two spreadsheets with numbers. It is the mathematical representation of key financial and operational relationships. Comprising of one or several sets of equations, it is used in analyzing how a business will react to different economic situations or events, and in estimating the outcome of financial and/or operational decisions before committing any funds.
A financial model generally includes the profit and loss, balance sheet, cash flow projections, depreciation schedules, debt service, inventory levels, rate of inflation, all interlinked for true “what if” simulations.
It may also quantify the financial impact of the firm’s policies, and of restrictions or covenants imposed by investors and/or lenders. A cash budget spreadsheet is the most basic and limited form of a financial model.