Financial Planning & Analysis and Performance Management

4DEVELOPING PREDICTIVE AND ANALYTICAL MODELS

CHAPTER INTRODUCTION

One of the greatest tools in the business analyst'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. 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.

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 satisfy its objective. Second, almost all models include or develop projections of future performance, and therefore they incorporate assumptions about future performance, which introduces uncertainty and risk. Finally, the analyst must develop a method for creating output ...