Principles of Financial Modelling

CHAPTER 3Core Competencies and Best Practices: Meta-themes

INTRODUCTION

This chapter discusses the foundation of modelling best practices and the core competencies required to build good models. The discussion here is at a high level, since the rest of this text is essentially a more detailed discussion of these topics.

KEY THEMES

It is probably fair to say that many models built in practice are of mediocre quality, especially larger ones. Typical weakness that often arise include:

• They are hard to understand, to audit or validate. They require an over-dependence on the original modeller to use, maintain or modify, with even minor changes requiring significant rework.
• They are either excessively complex for a given functionality, or lack key functionality. For example, it may be cumbersome to run sensitivity or scenario analysis for important cases (such as changing multiple items simultaneously, or delaying the start date of part of a project), the granularity of the data or time axis may be inappropriate, and it may be cumbersome to include new data, or replace forecasted items with actual figures as they become available, and so on. Additionally, the choice of functions used in Excel may limit the ability to modify the model, or be computationally inefficient.
• They are likely to contain errors, or assumptions which are implicit but which may have unintended consequences (such as being invalid in certain circumstances, and which are overlooked even when such circumstances ...