Using Excel for Business Analysis: A Guide to Financial Modelling Fundamentals, + Website

CHAPTER 4

Financial Modelling Techniques

In this chapter, we’ll take a look at some of the more frequently used techniques, as well as some of the common errors (and avoidance strategies), issues, and decisions a financial modeller encounters when building models in Excel.

As discussed in Chapter 1 in “Tool Selection,” Excel is by far the most commonly used tool for financial modelling due to its wide acceptance and ubiquity in the market. However, it most certainly has its flaws, mostly to do with the prevalence of undetected mistakes in Excel-built models. Astute financial modellers need to understand the dangers of a poorly built financial model and the ease with which mistakes can be made.

THE PROBLEM WITH EXCEL

A well-built financial model or piece of analysis is an invaluable tool in decision making and financial management, but all too often a wrong calculation can have disastrous consequences. Many executives and decision makers rely far too heavily on Excel models—probably because they don’t fully understand the risks involved.

There are many well-documented cases of high-profile Excel model blunders. Some of those documented by EuSpRiG, the European Spreadsheets Risks Interest Group, include1:

• The auditor’s office that divided the growth from one year to the next by the second year, rather than the first year, specifically, calculated it using (Year 2 – Year 1)/Year 2 instead of (Year 2 – Year 1)/Year 1.
• Aspiring police officers were told they passed an exam only to ...