Professional Modeling

Some thoughts on learning to build models. Keep in mind that I still have a ton to learn on my own, but these are some ideas that have helped me to get where I am today.

I. Financial Knowledge

If you are going to build a financial model, it just makes sense that you need to have some basic knowledge of finance in order for it to be a functioning model. The goal of a good model is to be fully integrated and dynamic, meaning that changes flow through the entire model and everything still balances. Models also need to be flexible enough to test different scenarios and to make changes according to management projections and the projections of your associates who sometimes like to "massage" the numbers.

If you just want to build a basic DCF model, then read the Vault Guide and you will be ready to go. If you're going to be interviewing, you should be able to "walk somebody through a DCF" anyway, since you WILL get this question in most interviews you will have.

For more complex models, you might need to study up on accretion/dilution, purchase accounting, and other more in-depth accounting and finance issues in order to conceptually understand what is going on in your model. There are a ton of good valuation books out there, so grab one and learn something!

II. Start with somebody else's model

Before you just start from a blank screen, get a hold of another model (preferably a simple model so it's easier to follow) and begin by working your way through. Go line-by-line and make sure you understand not only how the model works, but why the functions are set up the way they are, and what happens when you change inputs.

You need to understand the "flow" of a model before you can build one. As you go through a model, try to see how the different financial statements link and fit together. Notice how changes on one statement flow through the model and affect your outputs.

Once you've gone through the entire model and feel like you understand what is going on, it's time for the hard(er) work to begin.

III. Re-build the model

At this point it's good to either pull the 10-K and 10-Qs from the company of the model you've already worked through, or you can just copy the numbers out of the original model. I think it's better to pull the SEC docs because that's how it is when you make your own model.

Work through building a model that's just like the one you already looked at. You are basically just rebuilding the exact model that you are familiar with so that you can say you've done it yourself. Hopefully as you go through this you will start to learn better how to use Excel and how to save time using shortcuts.

As a side note, most firms have some kind of coloring system in their models. I like to make inputs (numbers that I get from 10-Ks and -Qs) blue and calculated numbers black. I've also seen people putting numbers pulled from other tabs/sheets in green and negative numbers in red, but whatever is easiest for you.

Once you've completed the model, making sure that everything works just as well as the original, then do it a few more times! Each time try to rely less and less on the original and more and more on your own intuition and understanding.

IV. Build your own model

Now that you feel comfortable re-building a model, pick a company that you would like to model out. Go to http://www.sec.gov/ and find their 10-K and most recent 10-Q. Build a model with their numbers, reflecting all of the nuances of a different company. You can still refer to the original model if you get stuck, but hopefully by now you are figuring out how to build a basic operational model with all three statements (and a debt schedule and depreciation schedule if you're getting a lot better).

Building models for various companies is good practice and really causes you to learn the more nuanced parts of a model.

The final test will be to see if you can open Excel, pull some SEC docs, and build a dynamic operational model. Once you have mastered the operational model, you can move on to more complex models like LBO models or merger models. They all require the basic understanding of how financial statements fit together and how changes in one place flow through the rest of the model.

There are lots of training programs out there that can teach you modeling skills. I personally think the best learning comes when you just figure things out on your own, especially since you will get formal training when you start at a bank. But I can also see great benefits in learning things the correct way the first time, instead of teaching yourself incorrectly.

Like I said at the beginning, this is just a BASIC overview of a process, and there are a lot more things I could have mentioned about modeling. I'll probably continue to post about modeling as I get farther along in the model I'm building, just because that's what's on my mind these days.

As a personal goal, I want to be able to build solid LBO and merger models before I start. I figure that if I build a model a week, I'll get there by next summer. Who wouldn't want an analyst to come in already feeling comfortable building models. From the various types of models I saw over the summer, it's obvious that no matter what preparation I do there will still be tons to learn, but I figure the more I can come up the learning curve on my own, the faster I'll be able to take in the more advanced stuff on a real deal.

Good luck, and good modeling!

And congrats to President Obama.