Types of
Financial Models
~ By edu CBA
What is a Financial Model?
• A financial model is a mathematical representation of the financial operations and financial statements of a company. It is used to forecast future financial performance of the company by making relevant assumptions of how the company would fair in the coming financial years.
• It is a risk management tool for analyzing various financial and
economic scenarios and also provided valuations of assets. • These models involve calculations, analyzing them and then
provide recommendations based on the information gathered.
Types of Financial Models
Discounted Cash Flow Model
Comparative Company Analysis model
Sum-of-the-parts model
Leveraged Buy Out (LBO) model
Merger & Acquisition (M&A) model
Option pricing model
Discounted Cash Flow model
• DCF is based upon the theory that the value of a business is the sum of its expected future free cash flows, discounted at an appropriate rate.
• Investors particularly use this method in order to evaluate
the potential of an investment and estimate the absolute value of a company.
Merger & Acquisition (M&A) model
• The entire objective of merger modeling is to show clients the impact of an acquisition to the acquirer’s EPS and how the new EPS compares with the status quo.
• In simple words we could say if the new EPS is higher,
the transaction will be called “accretive” while the opposite would be called “dilutive.”
Comparative Company Analysis model
• Also referred to as the
“Comparable” or “Comps”, it is the one of the major company valuation analyses that is used in the investment banking industry.
• In this method we undertake
a peer group analysis under which we compare the financial metrics of a company against similar firms in industry.
Leveraged Buy Out (LBO) model
• Leverage buy out deal involves
acquiring another company using a significant amount of borrowed funds to meet the acquisition cost.
• This kind of model is being used
majorly in leveraged finance at bulge-bracket investment banks and sponsors like the Private Equity firms who want to acquire companies with an objective of selling them in the future at a profit.
Option pricing model
• Option traders tend to utilize different option price models to set a current theoretical value.
• Option Price Models use certain fixed knowns in the present and also forecasts for factors like implied volatility, to compute the theoretical value for a specific option at a certain point in time.
Sum-of-the-parts model • It is also referred to as the break-up
analysis. • This modeling involves valuation of
a company by determining the value of its divisions if they were broken down and spun off or they were acquired by another company.
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