10 Types of Financial Models Every FP&A Analyst Needs To Know

Financial modeling helps organizations forecast their financial performance using historical data and projections. 

FP&A analysts use these models to explore different "what-if" scenarios, like assessing how a sudden increase in material costs might impact profit margins in a given industry. This way, they can identify potential risks and opportunities and prepare for unexpected changes. 

Financial modeling also lets you conduct sensitivity analysis, budget for capital expenditures and evaluate the worth of a business or investment opportunity in the event of a potential merger or acquisition.

Below, we cover 10 of the most common types of financial models. You’ll find this list useful if you’re an FP&A professional looking to gain a holistic understanding of the business, think more strategically or improve decision making processes.

Key Takeaways

• Financial models help organizations forecast their financial performance using historical performance data and projections.
• Commonly used financial models include the three-statement, discounted cash flow and initial public offering models.
• Methods of financial modeling rely on a basic set of assumptions. These assumptions depend on your purpose for the financial model—for instance, a model evaluating sales growth naturally assumes revenue will increase.
• Templates work well with most types of financial models. Consider creating Excel templates or using software to help you manage your financial modeling processes.

10 Types of Financial Models 

Financial models help you: 

• Estimate your company’s future revenues, expenses and cash flows
• Test various situations to prepare for different market conditions and decisions
• Spot areas that need improvement and adjust your strategies accordingly

However, creating these models can be difficult because it involves gathering data from various sources like financial statements and multiple software systems. Doing this manually can lead to mistakes in data entry, misinterpretations and wrong decisions. That’s where standardizing your financial modeling templates and using dedicated financial modeling software can help.

We’ve divided the different types of financial models we’ll cover into two categories: internal and external financial models. 

Models For Internal Planning

Internal financial models are used for internal planning, budgeting and forecasting. Some examples include:

• Three-Statement Model
• Sum of the Parts Model
• Discounted Cash Flow Model
• Consolidation Model
• Budget Model
• Forecasting Model

External Financial Models

External financial models demonstrate a company's valuation, financial health or regulatory compliance to external stakeholders. Some examples include:

• Option Pricing Model
• Leveraged Buyout Model
• Merger Model (M&A)
• Initial Public Offering Model

We'll cover all these models in detail below.

1. Three-Statement Model

A three-statement model links your company's main financial statements through a series of formulas in Excel:

• Income Statement: shows the company's revenues, expenses and net income over a specific period, typically a quarter or a year
• Balance Sheet: provides a snapshot of the company's financial position at the end of the reporting period, detailing its assets, liabilities and equity
• Cash Flow Statement: outlines the company's cash inflows and outflows across operating, investing and financing activities during the same period

Financial analysts use the three-statement model to see how different business activities, such as revenue growth and expenses, affect performance. 

Source: Wall Street Prep

How the Three-Statement Model Works

The three-statement model links the income statement to the balance sheet and the balance sheet to the cash flow statement.

Source: A Simple Model

If the net income from the income statement shows a profit, it adds to the total equity on the balance sheet. If it shows a loss, the equity decreases. Revenue increases assets such as cash, while expenses increase liabilities or decrease cash.

Changes in the income statement affect certain assets and liabilities on the balance sheet, such as accounts receivable and accounts payable. They also affect the cash flow statement. 

For example, if you borrow money (a liability), it adds cash to the financing activities section of the cash flow statement. If you invest in new equipment (an asset), it decreases cash in the investing activities section.

The final cash balance from the cash flow statement is used in the balance sheet to update the company's cash position. 

These interconnections let you track the ripple effects of changes across all three statements, which is useful for forecasting, scenario analysis, cash flow analysis, capital budgeting etc.

Pro Tip: Use financial modeling software to speed up scenario planning and make better decisions. Vena integrates natively with Excel, giving you a familiar interface to work with. It’s bolstered by a centralized database to unify all your source systems, letting you create three-statement financial models to run daily, weekly, monthly, quarterly and annually. 

2. Sum of the Parts Model

The sum of the parts model helps you understand the total value of a business that has multiple divisions or operates in different industries, like Amazon or General Electric for example.

The SOTP model breaks down the company into its individual components, valuing each one separately and then adding them up to get the total value.

Valuing each part individually gives a clearer picture of the business's overall value and identifies potential areas of strength or weakness.

This financial modeling and valuation technique is also useful for:

• Assessing the potential value of splitting parts of a business into independent entities
• Deciding whether it's worth buying or selling a part of a diversified business
• Helping investors understand the underlying value of a diversified business
  
  

Source: Wall Street Prep

How the Sum of the Parts Model Works

Say you run a conglomerate called ABC Corporation, which has three major divisions: technology, retail and manufacturing.

First, list the major parts of ABC Corporation that you want to value. In this case, it's the Manufacturing, Retail and Technology divisions. Then, choose the most suitable valuation method for each division and calculate its value separately.

Based on the valuation method used, let’s say the Manufacturing Division is valued at $300 million, and Retail and Technology are valued at $200 million and $150 million, respectively.

Add the individual values to get ABC Corporation's total estimated value ($300 million + $200 million + $150 million = $650 million).

Then, adjust for debt and other liabilities. If ABC Corporation has $100 million in debt, you'd subtract that from the total to get the net value: $650 million - $100 million = $550 million.

Finally, check if there are any potential synergies (additional value from combining operations) or corporate overheads (centralized costs). If there are significant synergies, you might add their estimated value. If there are overheads, subtract them.

3. Discounted Cash Flow Model

The Discounted Cash Flow (DCF) model estimates the intrinsic value of a business, asset or investment by discounting its expected future cash flows to the present value. 

This approach is based on the principle that a dollar today is worth more than a dollar in the future, due to factors like inflation, risk and the opportunity cost of capital.

The DCF model is popular for valuing companies, projects, or assets. It helps investors and analysts assess investment opportunities. This includes: 

• Evaluating the potential return on investment (ROI) for various opportunities
• Deciding whether to proceed with capital projects, like expanding operations
• Using cash flow projections from different sources to inform strategic decisions
• Creating forecasts and presentations that explain the company's value to investors
• Testing "what-if" scenarios to understand how changes in key factors affect valuation
• Preparing financial disclosures that comply with regulatory requirements
  
  

Source: Breaking Into Wall Street

How the Discounted Cash Flow Model Works

The DCF model estimates the worth of an investment, business or project using these steps:

Step 1: Forecast Future Cash Flows

Consider how much money the business will earn over the next 5-10 years. This includes revenue, expenses, taxes and other factors that affect cash flow.

Step 2: Calculate the Terminal Value

After you've forecasted those initial years, estimate how much the business could be worth when it stops growing or at some point in the future (the terminal value) using:

• Perpetuity Growth Model: Assumes cash flows grow at a steady rate forever or
• Exit Multiples: Uses metrics from similar companies to estimate a future selling price

Step 3: Determine the Discount Rate

The discount rate is a percentage that reflects the cost of capital and the risk of the business. It's used to convert future cash flows into today's dollars. Calculate this rate using the Weighted Average Cost of Capital (WACC), which considers both equity and debt.

Step 4: Discount Future Cash Flows

Once you have the discount rate, apply it to each year's cash flow and the terminal value to bring them to their present value. This is done by dividing the future cash flow by (1 + discount rate) ^ n, where n is the number of years in the future.

Step 5: Calculate the Total Present Value

Add up all the present values of the forecasted cash flows and the terminal value. This total is the estimated value of the business or investment in today's terms.

The DCF model has some flexibility, but it's sensitive to changes in assumptions. 

For example, if you adjust the discount rate or change the expected cash flow, it can significantly affect the final valuation. Sensitivity analysis helps test different scenarios to see how these changes impact the results.

Pro Tip: DCF relies on accurate forecasting, and even small changes in assumptions can lead to big differences in value. To create an accurate DCF model, you need reliable cash flow forecasts and a carefully chosen discount rate. Using cash flow planning software can help with this. 

4. Consolidation Model

The Consolidation Model combines a parent company's financial statements with those of its subsidiaries into a single set of statements. 

These consolidated financial statements give a 360-degree view of the financial health and performance of the parent company and its subsidiaries as if they were a single entity. 

Publicly traded companies, conglomerates or companies with significant ownership stakes in other entities use this method to:

• Prepare financial reports, tax filings and regulatory compliance
• Give investors and creditors a complete view of the entire business group
• Help management understand the company’s performance and make strategic decisions

Source: Corporate Finance Institute

How the Consolidation Model Works

This model works by: 

• Determining the subsidiaries over which the parent company has control (e.g., owning more than 50% of the subsidiary’s voting shares)
• Consolidating all entities using the same accounting policies and reporting on the same financial periods to create consistency in the consolidated statements

There are also other parts of the process, like eliminating intercompany transactions and consolidating balance sheets, income statements, cash flow statements, etc.

But manually performing these consolidations is tedious, time-consuming, and error-prone. You spend too much time gathering data from different sources and statement version control can be unruly. 

Automating the process with financial consolidation software is a more reliable way to gather and analyze accurate data quickly in real time. 

You can leverage Vena’s pre-built logic for the most challenging calculations during the financial consolidations process, including accurately accounting for and reporting non-controlling interests and cumulative translation adjustments.

5. Budget Model

A budget model helps FP&A analysts estimate the company’s revenues and expenses, allocate resources, and set realistic financial goals. It outlines how resources will be allocated over a certain period to meet financial goals and operational requirements.

This financial modeling tool is used for:

• Corporate Budgeting: For businesses planning their annual budgets
• Project Budgeting: For projects with specific timelines and financial constraints (like construction projects, for instance)
  
  

An example of a dashboard created in Vena to summarize revenue and cost of goods sold (COGS).

How the Budgeting Model Works

The budgeting model varies depending on the context, but the core principles remain consistent: planning, tracking, adjusting and evaluating spend. It includes key components like:

• Budgeted balance sheet (assets, liabilities and equity)
• Income statement (projected revenues, expenses forecasts and net income)
• Cash flow projections (the expected flow of cash in and out of the organization)
• Contingencies and reserves (extra funds set aside for miscellaneous and emergencies)

The budgeting process requires you to identify all sources of income, categorize expenses, establish your budget structure and track your spending.

To avoid any errors and speed up the process, use this free operating expense budget for Excel. The template lets you create a budget that aligns with your financial goals and consistently track spending across your accounts to ensure you're sticking to it. 

6. Forecasting Model

A forecasting model predicts future trends, outcomes or events based on historical data, trends, and assumptions. It helps financial planning and analysis professionals compare future projections with present budget estimations.

This way, they can:

• Determine where actual or forecasted results differ from budgeted figures, which often reveals unexpected revenue shortfalls, cost overruns, or other discrepancies
• Evaluate how well the organization is performing against its budgeted goals to highlight areas of strength and those needing improvement
• Use insights from the comparison to make strategic adjustments 
  
  

An example of a rolling forecast for operating expenses created with Vena.

How the Forecasting Model Works

Before creating a forecast, identify what you're trying to predict and why it's important. 

The purpose could be to project sales for the next quarter, estimate future cash flows, forecast inventory needs or predict economic trends.

Then, gather historical data—forecasting relies on historical data to identify trends and patterns. You’ll need to collect relevant data like:

• Financial Data: Revenue, expenses, profits and cash flow
• Operational Data: Production output, inventory levels and customer orders

Complete planning software like Vena brings together both your financial and operational data from your ERP, CRM, HRIS, Excel and other systems. It also includes pre-built but customizable templates for planning revenues, operating expenses and more.

ATB Financial, for example, used Vena to build a custom forecasting model that let them:

• Plan compensation, employment insurance and pension contributions 18 months ahead
• Review actual vs. budget during the team’s monthly analysis to see if variances are due to their margins or due to price/volume variances
• Update plans monthly and keep the business on track with agile scenario modeling
• Audit back to see who made any changes to the data and why

7. Option Pricing Model

An option pricing model is a mathematical framework used to determine the fair value or theoretical price of options. Corporate finance teams often use this model to: 

• Value employee stock options
• Make informed capital budgeting decisions
• Ensure transparent and compliant financial reporting
• Estimate the fair value of options granted to executives
• Manage risks associated with currency fluctuations, interest rates, and commodity prices

How the Option Pricing Model Works

There are three main types of option pricing models:

• The Binomial model (for American options): uses a step-by-step approach, considering various possible outcomes in a tree-like structure
• The Black-Scholes model (for European options): assumes constant volatility and risk-free rates and doesn’t consider other factors that might affect the underlying asset
• Monte Carlo Simulation (for pricing exotic options or those with complicated features): uses random sampling to simulate a range of possible outcomes for the option's underlying asset

To use this model, determine the underlying asset price, strike price, time to expiry, volatility, risk-free rate and type of option (call or put). 

Then, choose the appropriate option pricing model based on the type of option and other characteristics. F

or example, the Black-Scholes model is suitable for European-style options, while the binomial model is commonly used for American-style options.

8. Leveraged Buyout Model

The Leveraged Buyout (LBO) model is an Excel-based tool for evaluating the viability and profitability of acquiring a company using a significant amount of borrowed money. 

The model helps monitor the acquired company's performance, ensuring that it generates sufficient cash flows to service the debt and deliver the expected returns. 

FP&A professionals can use the LBO model to run various scenarios, such as changes in interest rates, operating performance or market conditions to understand how these factors might impact the buyout's success. 

This way, you can:

• Recognize risks related to debt servicing and operational performance
• Develop strategies to mitigate these risks and ensure financial stability

Source: Corporate Finance Institute

How the Leveraged Buyout Model Works

An LBO model typically follows these steps:

• Determine the acquisition price
• Decide how much equity the acquirer will invest and the amount and type of debt
• Forecast the target company's future revenues, costs, EBITDA and cash flows to assess its ability to service the debt
• Estimate interest expenses and principal repayments to ensure the company's cash flow is sufficient to cover them
• Consider possible exit strategies and calculate the expected internal rate of return (IRR) and equity value at the end of the investment period

Creating a reliable LBO model improves your ability to assess risk, predict future ROI,  plan for multiple potential outcomes and successfully navigate uncertainty.

But to identify the right opportunities for a potential acquisition, you need a budgeting and planning process that helps you easily make smarter business decisions faster. 

For example, First Majestic Silver Corp., one of North America’s leading miners of silver, is always looking for acquisition opportunities and constantly adding new sites to its portfolio. 

Before Vena, their finance team struggled to build a coherent budget, as everything was done using offline Excel spreadsheets. As a result, the team couldn’t empower leadership with a reliable long-term business outlook, making it difficult to plan confidently for future capital investments and growth opportunities.

But with an Excel-based financial planning software like Vena, the team now presents management with the most reliable business plan possible, with budgets done 50% faster.

9. Merger Model (M&A)

A Merger Model analyzes and evaluates the potential impact of a merger or acquisition. 

Also called an M&A (Mergers and Acquisitions) model, it helps stakeholders understand the financial and strategic effects of combining two companies, including cost synergies, revenue synergies, financing needs and the impact on shareholders.

Source: Street of Walls

How the Merger Model (M&A) Works

This financial modeling tool is used to determine the potential benefits and risks of combining two companies. To do this, it analyzes the effects on earnings per share (EPS), debt levels, cash flows and other critical metrics.

Generally, a merger model follows these steps:

• Determine the Transaction Structure: Define the type of deal, form of consideration, and other transaction details.
• Value the Target Company: Estimate the target company's worth to determine an appropriate purchase price and premium.
• Develop Financing Plans: Decide how the transaction will be financed and calculate the cost of financing.
• Identify Synergies: Determine potential cost and revenue synergies, as well as integration costs.
• Create Pro Forma Financial Statements: Combine the financial statements of the acquiring and target companies to create a pro forma view of the merged entity (pro forma is used to present a hypothetical scenario to illustrate the financial impact of specific events, such as mergers, acquisitions or divestitures).
• Analyze the Financial Impact: Calculate key metrics like EPS impact, ROI and debt ratios to understand the deal's financial implications.
• Conduct Accretion/Dilution Analysis: Determine whether the deal is accretive (meaning it increases the acquiring company's earnings per share) or dilutive (meaning it decreases the acquiring company's earnings per share) to assess the transaction's impact on the company's profitability and shareholder value.

10. Initial Public Offering Model

An Initial Public Offering (IPO) model estimates the value of a company preparing to go public and helps stakeholders understand the potential outcomes of this move. 

Financial analysts use the IPO model to conduct valuation analyses. They compare the company to its industry peers and provide recommendations regarding the IPO investment opportunity. 

The insights from the analysis help the company:

• Set the IPO price
• Determine the number of shares to be offered
• Evaluate the effects of going public on the company's financial structure

Source: Macabus

How the Initial Public Offering Model Works

An IPO model typically follows these steps:

• Valuation of the company using various valuation methods
• Deciding how many shares to offer, individual stock price, and whether to include additional provisions like a greenshoe option (which allows the underwriters to issue more shares than originally planned by the issuer)
• Estimating the company's post-IPO financial performance, including revenues and profits
• Analyzing how the IPO will affect existing shareholders' ownership and determine the impact of new shareholders on overall equity
• Assessing current market trends, investor sentiment, and the competitive landscape to determine the optimal timing for the IPO.

The most critical part of an IPO is ensuring all regulatory requirements are met. This includes filing accurate documents with securities authorities and adhering to listing rules.

To streamline the IPO process, consider transitioning from manual copy-and-paste spreadsheet methods to using complete planning software. This software automates financial reporting, ensuring accurate reports and timely completion of regulatory filings.

Shift4 Payments made the switch two years before their IPO. 

The team automated the flow of data from Shift4’s Oracle ERP Suite (and other systems) into a central database, providing a unified platform for their budgeting and forecasting, reporting and scenario modeling activities. As a result, they produced accurate reports with insights cross-functional stakeholders could rely on. 

The reporting structure Shift4 developed in Vena made the IPO process smoother. For example, they could input topside adjustments via the Excel-based templates and generate historical results under PCAOB audit standards. 

Build Custom Financial Models with Excel-Based FP&A Software

Excel is still arguably the best financial modeling tool out there—its flexibility is unmatched. 

With Vena’s Complete Planning platform natively integrated with Microsoft 365, you get to keep the best of Excel while scaling its capabilities. 

Vena’s centralized database automates the process of gathering data from the various systems you already use, saving you time and improving data accuracy. With Vena, you can also create multiple scenarios and perform sensitivity analysis, providing insights into how different factors affect financial outcomes. 

Our software includes a Power BI integration, ad-hoc reporting tools and executive-level reporting templates to help you create detailed real-time reports and facilitate clear communication with stakeholders and decision makers.

Use Vena to build models that accurately reflect your business's goals and unlock powerful insights to make smarter choices for the future.

FAQs About Financial Modeling

What Is Financial Modeling?

Financial modeling is the process of creating a mathematical representation of a company's financial situation using tools such as Excel. Businesses, investors, analysts and finance professionals use these models to analyze their financial performance, evaluate investment opportunities, assess risks, forecast future outcomes and support strategic planning. 

What Is Financial Modeling Used For?

Financial modeling is used for a wide range of purposes, including

• Creating budgets and financial plans for companies
• Forecasting future financial performance
• Evaluating investment opportunities, such as mergers and acquisitions
• Estimating the value of companies, assets, or projects
• Creating what-if scenarios to understand how changes (such as fluctuations in market demand, or variations in production costs) can affect financial outcomes
• Identifying potential business risks and quantifying their impact
• Evaluating strategic decisions, such as entering new markets
• Creating financial reports and presentations for stakeholders

What Are the Types of Financial Models?

There are 10 common types of financial models:

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