Think financial modeling has nothing to do with you? Think again!
Before you go out somewhere nice, you might try on a few different clothes to see what looks good. If I wear this blue shirt and these brown boots, will that work? Maybe the suede shoes instead. You try a number of scenarios until it clicks. Then you decide what to wear.
That’s what financial modeling allows you to do for your business. It’s a scientific way of asking “what if” several times, getting the hypothetical answers and comparing them. Then you can decide what to do. Invest, sell, hold, borrow, pay back, grow, etc.
If you have 5,000 dollars and you’re trying to work out whether to pay off credit card debt or buy some shares, a small model will allow you to run some scenarios. You know the interest rate on your credit card, but the return your shares could make is unknown. So you could easily work out how much your shares would need to go up in order to make buying them a better alternative than paying off your credit card. If you think that’s likely, you might invest. Otherwise, pay down that debt.
At the other end of the spectrum, companies buy and sell assets and raise capital. They need to compare a multitude of alternatives, each with several variables. So, you’ll likely need to build a large, multi-sheet Excel model with complex formulae.
But the principles are the same. At the end of the day you want to be able to ask “if X happens, what’s the outcome?”. And then compare the range of outcomes so that you can decide how to proceed. Modeling allows us to make decisions every day at work and at home. Otherwise we’d be guessing.
For simple tasks you can probably get away with a few lines in Excel and work it out yourself. But when companies or governments make big decisions they usually need to do a lot of analysis. It takes a little while to get to the right answer.
So what does it take to be a good modeler and how hard is it? Like many things, it’s not difficult to learn the basics, but it takes quite a bit of effort to develop strong financial modeling skills.
Here is a summary of what to look for.
The Top Three Attributes of Great Financial Modelers
- They love Excel: Most modeling is done using spreadsheets. Excel has endless functionality but it’s only as good as the data you enter. And the bigger the model gets, the harder it is to keep track and the easier it is to make a mistake. Learning Excel isn’t difficult but you need to be prepared to make Excel your friend. Good modelers are extremely confident with Excel.
- They have financial acumen and understand accounting: Knowing how to use Excel is one thing but knowing which logic to use is another. Which questions are we trying to answer? How do we design the structure? What are the right variables? Which scenarios should you run? Which items balance each other out? Strong modelers know a lot about double entry accounting and financial statements, they know how financial instruments work and they are always teaching themselves new things about finance.
- They never give up and they are industrious: Modeling is about resilience. Without fail, building a model comes with mistakes. Lots and lots of them. It doesn’t balance. Things don’t make sense. The computations aren’t working. And often the error is buried somewhere so deep it feels like a needle in a haystack. But it’s often about patience and fortitude. Good modelers keep trying until it works. And importantly, they figure out new ways to avoid making the same mistake again.
The key ingredients are Excel, finance and grit. The best modelers know how to use the right tools, have shrewd commercial skills and don’t give up until they get it right.
How to Hire a Financial Modeler
There are a number of proven methods to hire financial modelers. The common theme across all these methods is “show, don’t tell”.
Ask your candidate to send a previous model they worked on and talk you through it.
Pros: it’s evidence of the candidate’s ability.
Cons: the candidate may not have built all the components and confidentiality may prevent you from seeing the candidate’s best work.
Live modeling test in the office
Bring the candidate in for a modeling test and see what they can do.
Pros: candidates can’t fake it so you’ll know what you’re getting.
Cons: very time consuming and limited to local candidates.
Design a modeling challenge that is delivered online via an automated interview. Candidates complete the challenge in their own time.
Pros: quick and efficient, can assess candidates from anywhere, and can test multiple scenarios.
Cons: candidates could seek assistance.
Case study interview
Have a discussion about a number of modeling scenarios.
Pros: can use live case studies and can modify questions based on candidate’s responses.
Cons: can be too theoretical.
Timed modeling competition
Ask candidates in to perform the same task at exactly the same time. This can be done in the room or online.
Pros: great way of assessing relative performance.
Cons: logistically harder to organize.
Note: drinking shots every three minutes only happens in the movies.
The key is to get as close as possible to a practical assessment in order to see what candidates can actually do and how they think through different situations. Don’t rely on what you hear, ask the candidate to prove it.
Having a good modeler in your business is a sound investment. It helps you make evidence-based decisions. And learning a little bit of modeling yourself will allow you to be more considered and give you confidence in your own decisions.