Financial Management

4Developing Predictive and Analytical Models

One of the greatest tools in the business partner's bag is the ability to create a “model” of future business results. Models are typically used to evaluate business decisions, analyze alternatives, or predict future business results. If you turned to this chapter hoping to find the latest and greatest spreadsheet tricks, you will be disappointed. Instead, in this chapter, we will define models, highlight typical applications, review best practices, discuss best ways to present the results of a model, and explain how to establish a portfolio of models.

WHAT IS A FINANCIAL MODEL?

A model is essentially a mathematical representation of a transaction, event, or business, and typically involves the use of assumptions and relationships of various factors to predict an outcome. Most models rely heavily on historical results and past experience to project future outcomes.

A financial model allows us to project and test the dynamics of a business, project, or program. Developing an effective model of a business or significant project requires a sophisticated understanding of the business or opportunity at hand. The analyst will almost always need input from other business disciplines such as sales and marketing, operations, and research and development.

Several challenges arise in developing effective models. The first challenge is to create a model that will fully satisfy its primary objective. Second, almost all models include ...