Financial models and its real importance...
Hi everyone,
I've been enjoying the discussions on this forum for the past 3 months and felt it was time to bring up some topic that i guess everyone in finance has wonder at least once in their career.
I'm a senior associate at one of LATAM's largest alternative asset manager. I'm relatively young (the youngest person on my position at my firm's history) and one of the skills that got me early promotions a couple of times was my modeling/excel abilities (hopefully among others)
Nevertheless, as i advance on my career and have the opportunity to interact more directly with MDs from my firm or other firms, with CEOs, CFOs, entrepreneurs, etc. i have been doubting about the real importance of financial modeling and what do a firm really get from it.
Don't get me wrong, i know its a great skill and a must if you want to develop a career in PE or IB but seems that some times junior people focus too much on this subject and forget to think outside the box and generate ideas that would really bring value to portfolio companies and ultimately, more money for our investors.
The most successful investors i've met and had the opportunity to work for, never gave importance to the financial model and projections. They just focus on the "3 things" that would make the investment a 3.0x (e.g. industry tendencies, management team track record, historical cash flows)
Other not that outstanding investors I've work with, always ask to see financial projections with every posible detail on revenues, COGs, expenses, considering all account policies, etc, etc... ultimately, excel would give you the IRRs you are searching for, and if you're good at modeling, it would be without any "dramatic" growth or margin increase on one year and rather YoY "minor" improvements.
When i was an analyst, i was really focus on my modeling skills, some times even forgetting the skills that now I know are more important.. Now, I see other analysts at firm on the same position.. they are experts on excel but they don't the ability to present to a investment committee.
What are your experiences regarding financial modeling and it's importance as your career advance?
I've sort of always kept in mind George Box's saying that all models are wrong, but some are useful.
I think a model is important in having a set of numbers that are useful for bringing "in-the-air" concepts down to earth. With a model, you are able to tweak certain parameters to get a quantitative feel of results, and the accompanying comfort is what makes people get behind it I suppose. At the end of the day, a financial model is only as useful as the information you put into it; if you don't have high quality inputs, chances are the outputs are going to be garbage as well.
Like you rightly pointed out, it's important to recognise ideas and opportunities that would add value to portcos, but a financial model allows you to embed these initiatives inside and obtain a measurable output which you can then use to decide if it's worth pursuing, especially if there's other considerations like financing. Your LPs would also be interested to know what sort of returns they can look forward to, and this isn't a figure you can pluck from the air. Or rather, it shouldn't be.
At the end of the day, the model only reflects the trajectory that the business or project you believe will follow. Growing the business is still dependent on the management team's ability to deliver results, the market's ability to support growth, the competitive landscape's effect on sales, and the resilience of the business in its operating environment.
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