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Whether it’s corporate finance or market finance, managing financial information is a major challenge for decision-makers. The challenges to be addressed in these different areas range from poor control of existing tools to the need to reinforce the predictability of financial performance, and the lack of time. Financial modeling is one of the solutions that helps address this problem. What does this concept mean? What are its goals and applications? Here are some of the questions that this article aims to answer as clearly as possible.
Definition and presentation of the concept of financial modeling
Financial modeling can be defined as the process by which projections, primarily of financial flows, are made by an economic agent based on various scenarios. In other words, it is a methodology for developing financial models that allows for the development of analytical and simulation tools that contribute to well-adapted decision-making. Performing a financial modeling, as its name suggests, involves representing a given financial situation using a mathematical model taking into account different factors. Thus defined, it is a tool that enables decision-makers or executives, in the case of companies, to make decisions with full knowledge of the facts.
what are the objectives ?
Having thus defined the term of financial modeling, it is now necessary to focus on its purpose or usefulness. For its users, this method of developing financial models aims at two main objectives. As mentioned earlier, one of the goals of this process of establishing projections is to facilitate decision-making by providing means to define the level of sensitivity of the most useful variables on the one hand. On the other hand, it allows to significantly reduce the degree of uncertainty.
Financial modeling also aims to evaluate the effectiveness of decision-making by facilitating the estimation of the impact on key financial indicators, allowing for reliable identification of the level of risk associated with the most important variables. In other words, it is a way to get a better visibility of the subject of the study. That said, financial modeling constitutes a valuable aid in making decisions with relatively little room for chance or uncertainty.
To fully play its role, it must result in the development of financial models that are easy to handle and use. Furthermore, it is important that they are personalized and perfectly adapted to the needs of users. It should be noted that maximizing the use of financial modeling involves two major steps. On the one hand, its integration into decision-making processes and on the other hand, its full incorporation as a strategic planning tool.
The different applications
The applications of financial modeling are numerous. They are more widespread in two particular areas: corporate finance and market finance.
In the business world, its use is explained by the need for company leaders to have as precise as possible information regarding their organization’s financial situation. It is of crucial importance in the development of a business plan, evaluating a company, and calculating economic indicators such as the cost of equity, for example. In the field of market finance, financial modeling is a tool that allows for simulation of different market phenomena for easier asset portfolio management. Portfolio optimization, option pricing calculation, and modeling of uncertainty and risk are among the main applications of financial modeling in the world of market finance.
And financial modeling has various applications, including:
- Business plan development
- Company evaluation
- Calculation of economic indicators such as cost of equity
- Portfolio management
- Option pricing calculation
- Modeling of uncertainty and risk in market finance.
What is the future of financial modeling ?
The future of tis concept is likely to see increasing use of advanced technologies such as artificial intelligence, machine learning, and big data analytics. These advancements will likely lead to more sophisticated models, improved accuracy, and faster processing times. Additionally, the growth of digital financial services and the increasing demand for real-time data analysis will drive the continued evolution and expansion of financial modeling.
However, it is important to note that while technology will play a significant role in shaping the future of financial modeling, human expertise and judgment will remain critical in interpreting and applying the results of these models.
