Corporate and Project Finance Modeling

Chapter 4The Structure of Alternative Financial Models

In developing a deterministic financial model it is essential to think about the architecture of a spreadsheet before you begin to enter data, write any spreadsheet formulas, or make any valuations. This notion of coming up with the model structure applies to virtually any analysis in finance, economics, or, for that matter, science and engineering. It involves carefully organizing the model inputs, understanding mathematical calculations that derive key outputs, and effectively presenting outputs. The general design of a financial model involves deciding how to organize the inputs from various information sources in a structured manner, how to formulate the mechanical calculations in a transparent way that is easy to audit and understand, and finally how to present the outputs for purposes of risk assessment and valuation. Other than these basic elements of structuring the inputs, calculations, and outputs of a model, subjects that should be considered in laying out the architecture of a model include programming of time lines, considering methods for verifying model accuracy, and the setting up of alternative scenarios for risk analysis. Much of the process of developing an effective model is understanding the starting point of the model, putting things in a sensible order, and letting the model flow in a natural manner from the inputs to the outputs.

One of the most influential and lasting ideas in finance arose from ...