What does the term "modeling" exactly mean?

LevFinGS:

Sometimes I feel like Yahoo Answers would be better than this.

or a simple 2 second Google fucking search

manbearpig:

It's not that stupid a question people. Modeling has different meanings in finance. For example, when I hear modeling, I immediately think of building stochastic models for the purpose of pricing derivatives (i.e. geometric brownian motions for equity derivatives or jump-diffusion models for energy prices). I don't think of coming up with simplistic models for how to value a company based on discounted cash flows etc.

I don't know what all them there fancy words mean, so I'm gonna take what you said as an insult! Step outside and I'll model some haymakers for ya!

manbearpig:

It's not that stupid a question people. Modeling has different meanings in finance. For example, when I hear modeling, I immediately think of building stochastic models for the purpose of pricing derivatives (i.e. geometric brownian motions for equity derivatives or jump-diffusion models for energy prices). I don't think of coming up with simplistic models for how to value a company based on discounted cash flows etc.

Do you use every post on this forum to show how smart you are?

MBP Love how you clarified the various asset class applications of stochastic models. Thank you for doing that dude, mad crucial.

manbearpig:

..I immediately think of building stochastic models for the purpose of pricing derivatives (i.e. geometric brownian motions for equity derivatives or jump-diffusion models for energy prices).

blastoise:

i thought models were little airplance?

Why was this so funny...

In the most general sense of the word, it would be three-statement financial modeling. You need to understand how to project the income statement, balance sheet, and cash flow statement, as well as understand how the three are linked together.

Financial modeling is mostly used for projections and valuations, i.e., pro-forma. Accounting is typically just recording current period expenses and revenues, i.e., preparing actual financial statements. However, it should be noted that budgeting can be considered using projections, and it is an accounting function. However, I don't have experience in that area. I'm not an accountant.

CMore is incorrect in the context of this question. Financial modeling is an incredibly broad term that encompasses a vast collection of analyses. Conducting a valuation of a company, security, asset, etc. could utilize a certain analysis that would fall under the realm of financial modeling - e.g. a DCF analysis is a type of financial model. At the same time, there are a variety of financial models that are outside of the scope of a typical M&A banker - e.g. Black-Scholes (albeit this is still a valuation model).

If someone tells you they "know financial modeling," they are likely referring to a DCF. As CMore was saying though, if you want to work in banking, the critical components of financial modeling you need to know are forecasting/accounting (for Operating/3-Statement Models), valuation modeling (DCF, also understand Trading Comps and precedent transactions), LBO and M&A modeling.

The term “Financial Modeling” encompasses anything related to finance on excel. A financial model is a living and breathing calculation with multiple historical financial values, mixed with prospective inputs to get you to the answer. Using excel you could create a financial budget, forecasting a project cost, developing an option pricing model or simply valuing a company, among nearly anything else. It is all considered “financial modeling” and it all requires the user to identify the project, scope out the inputs/calculations necessary to reach the conclusion and build the model.

Financial models can be used by many different parties for many different goals. Investment bankers use models for transactions involving capital structure or ownership, accountants and valuation advisors use financial models for valuation projections, credit analysts use financial models to determine ability to repay debt, buy/sell side research analysts use financial models to determine a buy or sell rating on a particular security and management uses financial models to determine internal budgets for various reasons.

Hi,

I think people already have well explained about financial modeling. But in case if you need more in-depth knowledge and want to learn creating financial models, you can rely on iBanking Training video tutorials. They have explained step by step about financial modeling. Hope it helps!

Cheers!

I see financial modeling as a way to represent how an asset(s) and/or a liability(s) will perform in the future based on certain set of assumptions, logic and math. Excel is a tool to help build these models (LBO, M&A, whatever), and each one uses one or a blend of financial and accounting theories to determine valuation and rates of return to quantify performance

copy/paste pics of hot models and based on age, DCF (instead of yrs, based on # of hrs hired ->> present to MD ->> win

I created a few automated models during the summer and the MDs freaked when I presented it to them. Needless to say, I used the automated models; using the models streamlined my work and cut countless hours of bullshit.

A little knowledge of VBA goes a long way as well. Best way to streamline most work...especially stuff that is repetitive.

The bankers do this only to make them look important and busy :D

That's because you are right. The modelling skills aren't that intensive. And you can have it automated and streamlined as is mentioned in the above post about VBA. And data service providers do this for you.

Because it's not about the model you idiot, its how you arrive at those assumptions that take the most time. I had to travel for 2 weeks going around to all the management sites and take notes and come back and put that into my model.

Haha, I felt the same coming from a quant background. The so called LBO models and M&A model are just a bunch of tabs with a few hundred rows each. It's basically making sure info from one flows well into others and they all 'tie out'. On the other hand a banker would freak the eff out if he had to do a problem as simple as constrained portfolio optimization from scratch not using any packages.

Also every S&T kid i know is a complete idiot who spent 2 years getting coffee and getting fired. I think that's a really good skillset to have. I never knew how hard coffee was to get until I made a food order at mcdonalds and they f'd it up.

1. Agree that assumptions are the most difficult part of the model

2. As a non-banker trying to break in, a lot of the things one takes for granted when looking over a model can be tricky. I suppose if you have internal templates to leverage things could be a lot easier.

Modeling does tend to get a large focus here since it's an important part of the Analyst job and it's pretty difficult to get legitimate modeling experience outside of some very specific finance roles.

Financial modeling is often just a one semester course in business school and it isn't amazingly complex by any means. Most firms have templates anyway that make it real easy to switch out companies, and change assumptions.

The important thing to remember is that banking is a RELATIONS business. Hence the MD who interacts with clients gets paid a ton more than the Analyst who does all the modeling. At the end of the day these models are presented to insert random industrials executive and he's not gonna know how to interpret some some crazy statistical model. Hence making sound dependable assumptions is the most important aspect.

It's also a principal-agent problem. The bankers who churn out the models have no personal capital at risk, hence they don't care much how accurate it is as long as it makes the client and internal risk happy.

If you're at a hedge fund and are trying to extract alpha from the markets, your modeling combined with the qualitative inputs (for L/S funds) determine how sound your investment is going to be. For the quant funds, the modeling alone is the key determinant of how profitable your fund is and how much alpha you can produce.

its not about modeling. its about how good your assumptions are about the drivers of the company's sales growth, profitability, and FCF generation. Which isn't easy. the mechanics behind a model are easy; coming up with a way to defend your forecast and/or valuation isn't.

but u guys know what is really hard? being in S&T and getting coffee. that shit is nerve wracking. i dunno how u guys do it.

Thanks guys. That's good to know.

I felt like the kid who said the emperor had no clothes. Everyone makes such a fuss about 'running the model' when I was like, but, all you did was add together a bunch of numbers, what's the issue...

i know what u mean bro. i was all like "omg S&T rules" and then i got coffee for 2 years and was like omfgggggg this is so much harder than i thought.

but then spreads got thinner and i got fired and i was like damnnn that was an awesome job i just had getting mcdonalds for everyone. now i'm a stripper.