Financial modeling is the task of building a financial model, a tool designed to forecast the performance of a business, project, or any other form of financial investment. A financial model uses relationships among macro-economic, operating, investing, tax, accounting, and financing variables to predict performance. The central aim of financial modeling is to forecast under uncertainty, and a financial model must allow multiple scenarios to be run efficiently, known as deterministic modeling. It will also ideally support probabilistic, or stochastic, risk modeling.
There is considerable debate amongst experts in the industry as to the nature of financial modeling, whether it is a tradecraft, such as welding, or a science, such as metallurgy. The task of financial modeling is seldom taught within MBA programs, which suggests a strong lean amongst academic institutions to the former position, and a clear distinction with the academic pursuit of financial analysis. From this an alternative, less formal definition would be:
Financial modeling is the trade skill required to produce a tool for financial analysis.
This definition also focuses the topic on aspects of financial modeling that relate to craft experience: the importance of simplicity for a durable design; learning as much from the experience and lessons-learned of predecessors in the craft more than academic works, rigorous attention to mind-numbing detail that adds up in the ultimate product, etc.
There are non-spreadsheet software platforms available on which to build financial models. However, the vast proportion of the market is spreadsheet-based, and within this market Microsoft Excel now has by far the dominant position, having usurped Lotus 1-2-3. From this it is easy to see how the uninformed can equate Financial modeling competency with 'learning Excel'. However, the fallacy in this contention is the one area on which professionals and experts in the financial modeling industry agree.
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