Introduction

Like many computer programmers, people who build nancial models can get quite opinionated about the "right
way" to do it.

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 Tabs versus Spaces
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 In fact, there is surprisingly little consistency across Wall Street around the structure of nancial models. One
reason is that models can vary widely in purpose. For example, if your task was to build a discounted cash ow
(DCF) model to be used in a preliminary pitch book as a valuation for one of 5 potential acquisition targets, it would
likely be a waste of time to build a highly complex and feature-rich model. The time required to build a super
complex DCF model isn't justi ed given the model's purpose.

On the other hand, a leveraged nance model used to make thousands of loan approval decisions for a variety of
loan types under a variety of scenarios necessitates a great deal of complexity.

Understanding the purpose of the model is key to determining its optimal structure. There are two primary
determinants of a model's ideal structure: granularity and exibility. Let's consider the following 5 common
nancial models:

Model Purpose Granularity Flexibility

One page DCF Used in a buy side pitch book to Low. Ball-park Low. Not reusable without structural
provide a valuation range for valuation range is modi cations. Will be used in a speci c pitch and
one of several potential su cient) / Small. circulated between just 1-3 deal team members.
acquisition targets. Entire analysis can t
on one worksheet <
300 rows)

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 Model Purpose Granularity Flexibility

Fully Used to value target company in Medium Low. Not reusable without structural
integrated a fairness opinion presented to modi cations. Will be tailored for use in the
DCF the acquiring company board of fairness opinion and circulated between deal
directors time members.

Comps model Used as the standard model by Medium High. Reusable without structural modi cations.
template the entire industrials team at a A template to be used for a variety of pitches and
bulge bracket bank deals by many analysts and associates, possibly
other stakeholders. Will be used by people with
varying levels of Excel skill.

Restructuring Built speci cally for a High Medium. Some re-usability but not quite a
model multinational corporation to template. Will be used by both the deal team and
stress test the impact of selling 1 counterparts at the client rm.
or more businesses as part of a
restructuring advisory
engagement

Leveraged Used in the loan approval High High. Reusable without structural modi cations.
nance process to analyze loan A template to be used group wide.
model performance under various
operating scenarios and credit
events

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 Financial model granularity

A critical determinant of the model's structure is granularity. Granularity refers to how detailed a model needs to
be. For example, imagine you are tasked with performing an LBO analysis for Disney. If the purpose is to provide a
back-of-the-envelope oor valuation range to be used in a preliminary pitch book, it might be perfectly appropriate
to perform a "high level" LBO analysis, using consolidated data and making very simple assumptions for nancing.

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 If, however, your model is a key decision making tool for nancing requirements in a potential recapitalization of
Disney, a far higher degree of accuracy is incredibly important. The di erences in these two examples might
involve things like:

Forecasting revenue and cost of goods segment by segment and using price-per-unit and #-units-sold
drivers instead of aggregate forecasts

Forecasting nancials across di erent business units as opposed to looking only at consolidated nancials

Analyzing assets and liabilities in more detail (i.e. leases, pensions, PP&E, etc.)

Breaking out nancing into various tranches with more realistic pricing

Looking at quarterly or monthly results instead of annual results

Practically speaking, the more granular a model, the longer and more di cult it will be to understand. In addition,
the likelihood of errors grows exponentially by virtue of having more data. Therefore, thinking about the model's
structure — from the layout of the worksheets to the layout of individual sections, formulas, rows and columns —
is critical for granular models. In addition, integrating formal error and "integrity" checks can mitigate errors.

Financial model exibility

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 The other main determinant for how to structure a model is its required exibility. A model's exibility stems from
how often it will be used, by how many users, and for how many di erent uses. A model designed for a speci c
transaction or for a particular company requires far less exibility than one designed for heavy reuse (often called
a template).

As you can imagine, a template must be far more exible than a company speci c or "transaction speci c model.
For example, say that you are tasked with building a merger model. If the purpose of the model is to analyze the
potential acquisition of Disney by Apple, you would build in far less functionality than if its purpose was to build a
merger model that can handle any two companies. Speci cally, a merger model template might require the
following items that are not required in the deal-speci c model:

1. Adjustments to acquirer currency

2. Dynamic calendarization (to set target's nancials to acquirer's scal year)

3. Placeholders for a variety of income statement, balance sheet and cash ow statement line items that don't
appear on Disney or Apple nancials

4. Net operating loss analysis (neither Disney or Apple have NOLs)

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 Together, granularity and exibility largely determine the structural requirements of a model. Structural
requirements for models with low granularity and a limited user base are quite low. Remember, there is a trade-
o to building a highly structured model: time. If you don't need to build in bells and whistles, don't. As you add
granularity and exibility, structure and error proo ng becomes critical.

The table below shows the granularity/ exibility levels of common investment banking models.

High exibility Low exibility

High granularity

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 Leveraged nance credit model Integrated LBO model

Merger model template "one size ts all" Integrated DCF model

Integrated Merger Model

Integrated operating model

Trading comps template "Back of the envelope" accretion/dilution model

Transaction comps template DCF "one pager"

Low granularity
LBO "one pager"

Simple operating model

Financial model present-ability

Regardless of granularity and exibility, a nancial model is a tool designed to aid decision making. Therefore, all
models must have clearly presented outputs and conclusions. Since virtually all nancial models will aid in
decision-making within a variety of assumptions and forecasts, an e ective model will allow users to easily modify
and sensitize a variety of scenarios and present information in a variety of ways.

Now that we have established a simple framework for structuring models, it's time to discuss speci c features of
model architecture, error proo ng, exibility and presentation.

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 Financial model structure
Below, we lay out the key elements of an e ectively structured model, most of which will go a long to way to
improve the model's transparency. As a model becomes more complex (due to higher granularity and exibility),
it naturally becomes less transparent. The best practices below will help to x this.

Formatting

Color coding

Just about everyone agrees that color coding cells based on whether it holds a hard coded number or a formula is
critical. Without color coding, it is extremely di cult to visually distinguish between cells that should be modi ed
and cells that should not ( i.e. formulas). Well built models will further distinguish between formulas that link to
other worksheets and workbooks as well as cells that link to data services.

While di erent investment banks have di erent house styles, blue is typically used to color inputs and black is
used for formulas. The table below shows our recommended color coding scheme.

Type of cells Excel formula Color

Hard-coded numbers (inputs) =1234 Blue

Formulas (calculations) =A1*A2 Black

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 Links to other worksheets =Sheet2!A1 Green

Links to other les =[Book2]Sheet1!$A$1 Red

Links to data providers (i.e. CIQ, Factset) =CIQ(IQ_TOTAL_REV) Dark Red

While everyone agrees that color coding is very important, keeping up with it can be a pain in native Excel. It's
not easy to format cells based on whether they are inputs or formulas, but it can be done. One option is to
use Excel's "Go To Special" (covered in our Excel Crash Course, which you can enroll in here). Alternatively, color
coding is dramatically simpli ed with a third party Excel add-in like Macabacus (which is bundled with Wall Street
Prep self-study products and boot camp enrollments), Capital IQ or Factset. These tools allow you to "autocolor" an
entire worksheet in one click.

Comments

Inserting comments (Shortcut Shift F2, see our Essential Excel Shortcuts List) in cells is critical for footnoting
sources and adding clarity to data in a model.

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 For example, a cell containing an assumption on revenue growth that came from an equity research report should
include a comment with a reference to the research report. So how much commenting do you need? Always err
on the side of over commenting. No managing director will ever complain that a model has too many comments.
Additionally, if you're on a conference call and someone asks how you came up with the number in cell AC1238
and you blank, you'll regret not commenting.

Sign convention

The decision on whether to use positive or negative sign conventions must be made before the model is built.
Models in practice are all over the place on this one. The modeler should choose from and clearly identify one of
the following 3 approaches:

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 Convention 1: All income positive, all expenses negative.

Advantage: logical, consistent, makes subtotal calculations less error-prone

Disadvantage: Doesn't align with conventions used by public lings, % margin calculations appear negative

Convention 2: All expenses positive; non-operating income negative.

Advantage: Consistent with public lings, % margin calculations appear positive

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 Disadvantage: Negative non-operating income is confusing, subtotal calculations are error-prone, proper
labeling is critical

Convention 3: All expenses positive except non-operating expenses.

Advantage: Avoids negative non-operating income presentation; margins evaluate to positive

Disadvantage: Presentation not internally consistent. Proper labeling is critical.

Our recommendation is Convention 1. The reduced likelihood of error from easier subtotaling alone makes
this our clear choice. In addition, one of the most common mistakes in modeling is forgetting to switch the sign
from positive to negative or vice versa when linking data across nancial statements. Convention 1, by virtue of
being the most visibly transparent approach, makes it easier to track down sign-related mistakes.

Formulas

Avoid partial inputs (all models)

Hard coded numbers (constants) should never be embedded into a cell reference. The danger here is that you'll
likely forget there is an assumption inside a formula. Inputs must be clearly separated from calculations (see
below).

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 One row, one calculation

Most investment banking models, like the 3-statement model, rely on historical data to drive forecasts. Data
should be presented from left to right. The right of the historical columns are the forecast columns. The formulas
in the forecast columns should be consistent across the row.

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 Use roll-forward ("BASE" or "cork-screw") calculations

Roll-forwards refers to a forecasting approach that connects the current period forecast to the prior period.

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 This approach is very useful in adding transparency to how schedules are constructed. Maintaining strict
adherence to the roll-forward approach improves a user's ability to audit the model and reduces the likelihood of
linking errors.

Write good (and simple) formulas

There is a temptation when working in Excel to create complicated formulas. While it may feel good to craft a
super complex formula, the obvious disadvantage is that no one (including the author after being away from the
model for a bit) will understand it. Because transparency should drive structure, complicated formulas should be
avoided at all cost. A complicated formula can often be broken down into multiple cells and simpli ed. Remember,
Microsoft doesn't charge you extra for using more cells! So take advantage of that. Below are some common traps
to avoid:

1. Simplify IF statements and avoid nested IFs

2. Consider using ags

Simplify IF statements

IF statements, while intuitive and well understood by most Excel users, can become long and di cult to audit.
There are several excellent alternatives to IF that top-notch modelers frequently use. They include using Boolean
logic along with a variety of reference functions, including MAX, MIN, AND, OR, VLOOKUP, HLOOKUP, OFFSET.

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 Below is a real-world example of how an IF statement can be simpli ed. Cell F298 uses any surplus cash generated
during the year to pay down the revolver, up until the revolver is fully paid down. However, if de cits
are generated during the year, we want the revolver to grow. While an IF statement accomplishes this, a MIN
function does it more elegantly:

Revolver formula using IF statement

Revolver formula using MIN

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 The revolver formula using MIN as an alternative to IF also holds up better when additional complexity is required.
Imagine that there's a limit on annual revolver draw of $50,000. Look at how we have to modify both formulas to
accommodate this:

Revolver formula using IF statement

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 Revolver formula using MIN

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 While both formulas are challenging to audit, the formula using IF statements is more di cult to audit and is more
vulnerable to getting completely out of hand with additional modi cations. It uses nested (or embedded) IF
statements, which our feeble human brains have a hard time with once there's more than one or two.

Fortunately, Excel has made this a bit easier in 2016 with the introduction of the IFS function, but our preference
for relying on more elegant functions remains. We spend a lot of time in our Excel Crash Course going over the
many ways "IF alternative" functions can be used to power-charge Excel.

Reduce date-related formula complexity using ags

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 Flags refer to a modeling technique most useful for modeling transitions across phases of a company, project or
transaction over time without violating the "one row/one calculation" consistency rule. Imagine you're building a
model for a company that's contemplating bankruptcy. Each phase of the restructuring process has its own
distinct borrowing and operating characteristics.

In our example below, the company's revolver "freezes" once it goes into bankruptcy and a new type of borrowing
("DIP") acts as the new revolver until the company emerges from bankruptcy. Additionally, a new "Exit" facility
replaces the DIP. We insert 3 " ags" in rows 8-10 to output "TRUE/FALSE" based on the phase we're in. This
enables us to build very simple, consistent formulas for each revolver without having to embed IF statements into
each calculation.

In cell F16 the formula is =F13*F8. Whenever you apply an operator (like multiplication) on a TRUE, the TRUE is
treated like a "1" while a FALSE is treated like a "0." This means that the pre-bankruptcy revolver is the de facto
revolver when the pre-bankruptcy ag evaluates to TRUE and becomes 0 once the ag evaluates to FALSE (starting
in column I in our example below).

The main bene t is that with the use of just an extra 3 rows, we've avoided having to insert any sort of conditional
tests within the calculations. The same applies to the formulas in rows 20 and 204 — the ags have prevented a lot
of extra code.

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 Names and named ranges

Another way many modelers reduce formula complexity is by using names and named ranges. We strongly
caution against using names and named ranges. As you're probably beginning to sense, there is always some
kind of tradeo with Excel. In the case of names, the tradeo is that when you name a cell, you no longer know
exactly where it is without going to the name manager. In addition, unless you are proactively deleting names (you
aren't), Excel will retain these names even when you delete the named cell. The result is that a le you're using
today to build a DCF contains dozens of phantom names from prior versions of the model, leading to warning
messages and confusion.

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 Don't calculate on the balance sheet — link from supporting schedules.

In investment banking, your nancial models will frequently involve nancial statements. Ideally, your calculations
are done in schedules separate from the output you're working towards. For example, it's preferable that you
don't perform any calculations on the model's balance sheet. Instead, balance sheet forecasts should be
determined in separate schedules and linked into the balance sheet as illustrated below. This consistency helps in
the transparency and auditing of a model.

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 How to reference cells

Never re-enter the same input in di erent places

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 For example, if you've inputted a company name in the rst worksheet of the model, reference that worksheet
name — don't re-type it into the other worksheets. The same goes for years and dates entered into a column
header or a discount rate assumption used in a variety of di erent places in the model. A more subtle example of
this is hard coding subtotals or EPS when you can calculate it. In other words, calculate whenever possible.

Always link directly to a source cell as it is more di cult to audit "daisy chained" data

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 The one major exception to this is when "straight-lining" base period assumptions. For this, go ahead and daisy
chain. The reason is that straight-lining base period assumptions is an implicit assumption, which can change, thus
making it possible for certain years in the forecast to ultimately end of with di erent assumptions than other
years.

Avoid formulas that contain references to multiple worksheets

Compare the two images below. It is more di cult to audit the formula in the rst image because you'll need to
bounce around to di erent worksheets to view the precedent cells. Whenever possible, bring the data from other
worksheets into the active worksheet where the calculation is made.

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 Link assumptions into standalone cells in the calculation and output sheets

If you're working with larger models and you have assumptions that need to be referenced from a separate
worksheet, consider linking assumptions directly into the worksheet where you're using them, and color code
them as a distinct worksheet reference link. In other words, don't have an input reference embedded into a
calculation (i.e. =D13*input!C7). Instead, use a clean reference =input!C7 and a separate cell for the
calculation. While this creates a redundant cell reference, it preserves the visual audit-ability of the model tab
and reduces the likelihood of error.

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 Avoid linking les

Excel allows you to link to other Excel les, but others might not have access to the linked-to les, or these les
may get inadvertently moved. Therefore, avoid linking to other les whenever possible. If linking to other les is a
must, be vigilant about color coding all cell references to other les.

Worksheets

One long sheet beats many short sheets

A long worksheet means a lot of scrolling and less visual compartmentalizing of sections. On the other hand,
multiple worksheets signi cantly increases the likelihood of linking errors. There's no hard and fast rule about this,
but the general bias should be toward a longer sheet over multiple, shorter worksheets. The dangers of mis-linking
across worksheets is quite real and hard to mitigate, while the issues of cumbersome scrolling and lack of
compartmentalization associated with long worksheets can be drastically mitigated with Excel's split screen
functionality, clear headers and links from a cover sheet or table of contents.

Don't 'hide' rows — 'group' them (and do it sparingly)

A model often has rows with data and calculations that you do not want to show when the model is printed or
when you paste the data into a presentation. In this situation, it's often tempting to hide rows and columns for a
"cleaner" presentation of results. The danger is that when the model is passed around, it is very easy to miss (and
potentially paste over) the hidden data.

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 Keeping inputs (assumptions) together (for high-granularity models)

Nearly every nancial modeling expert recommends a standard that isolates all of the model's hard-coded
assumptions (things like revenue growth, WACC, operating margin, interest rates, etc...) in one clearly de ned
section of a model — typically on a dedicated tab called 'inputs.' These should never be commingled with the
model's calculations (i.e. balance sheet schedules, the nancial statements) or outputs (i.e. credit and nancial
ratios, charts and summary tables). In other words, think of a model as comprised of three clearly identi ed and
physically separated components:

Assumptions → Calculations → Output

Advantages:

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 Consistent, reliable architecture: Once a model is built, the user has only one place they need to go to change
any assumptions. This creates a consistent distinction between areas in the model that the user works in vs.
areas the computer works in.

Error mitigation: Storing all assumptions in one place makes it far less likely that you'll forget to remove old
assumptions from a prior analysis and inadvertently bring them into a new analysis.

Yet despite these advantages, this practice has never been widely adopted in investment banking.

One reason is simply poor practice. Some models would clearly bene t from an input/calculation/output
separation, but are often built with no forethought given to structure. Imagine building a house without any pre-
planning. Sure, you'll avoid the pain of all that planning, but you'll encounter unforeseen problems and end
up redoing work or adding complexity by working around what's already been done. This problem is rampant in
investment banking models.

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 Another reason is that many investment banking models are simply not granular enough to merit the additional
audit trail and legwork. The analyses bankers perform are often broader than they are deep. For example, a pitch
book might present a valuation using 4 di erent valuation models, but none of them will be overly granular.
Common investment banking analyses like accretion dilution models, LBO models, operating models and DCF
models usually don't delve into detail beyond the limits of public lings and basic forecasting. In this case, moving
back and forth from input to calculation to output tabs is unnecessarily cumbersome. As long as you're diligent
about color coding, placing assumptions on the same sheet and right below calculations is preferable in smaller
models because your assumptions are visually right next to the output, making it easy to see what's driving what.

The other consideration is the number of a model's users. The advantages of the "inputs together" approach grow
with the number of a model's intended users. When you have many users, your model will inevitably be used by
people with a wide range of modeling pro ciency. In this case, a consistent and reliable structure that prevents
users from getting into the guts of the model will reduce error. In addition, it will also reduce the amount of time a
user has to spend in the model — a user can simply locate the area for inputs, ll them in, and the model (in
theory) will work. That said, despite attempts by IB teams to standardize models, many investment banking
models are essentially "one-o s" that get materially modi ed for each new use. Aside from comps models
which lend themselves to becoming templates, most models are used primarily by their original authors (usually
an analyst and associate) who understand the model well.

The bottom line on keeping inputs all together

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 Unfortunately, there's no established benchmark for when it makes sense to separate out assumptions. The ideal
approach depends on the scope and goal of the model. For a simple 1-page discounted cash ow analysis not
intended for frequent reuse, it is preferable to embed inputs throughout the page. However, for a large fully-
integrated LBO model with many debt tranches to be used a group-wide template, the bene ts of keeping all
inputs together will outweigh the costs.

No spacer columns between data

Elevator jumps

In long worksheets, dedicating the leftmost column for placing an "x" or another character at the start of schedules
will make it easy to quickly navigate from section to section.

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 Annual vs quarterly data (periodicity)

Most investment banking models are either quarterly or annual. For example, a U.S. equity research earnings
model will always be a quarterly model because one of its key purposes is to forecast upcoming earnings, which
are reported by rms quarterly. Similarly, a restructuring model is usually a quarterly model (or even a monthly or
weekly model) because a key purpose of this model is to understand the cash ow impact of operational and
nancing changes over the next 1-2 years. On the other hand, a DCF valuation is a long term analysis, with at least
4-5 years of explicit forecasts required. In this case, an annual model is appropriate.

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 There are also models for which both quarterly and annual periods are useful. For example, a merger model
usually needs a quarterly period because a key goal is to understand the impact of the acquisition on the
acquirer's nancial statements over the next 2 years. However, attaching a DCF valuation to the combined merged
companies may also be desired. In this case, a possible solution is to roll up the quarters into an annual model and
extend those annual forecasts further out.

When determining a model's periodicity, keep in mind the following:

1. The model must be set up with the smallest unit of time desired, with longer time periods being aggregated
(rolled up) from those shorter time periods. If you're building an integrated nancial statement model in
which you want to see quarterly and annual data, forecast the quarterly data rst.

2. Keep the quarterly and annual data in separate worksheets. It is easier to audit what's going on when periods
aren't commingled. Additionally, commingling quarterly and annual data in one worksheet will either A) force
you to violate the one row/one formula consistency best practice or B) you will have to jump through some
crazy hoops to maintain the consistency.

Circularity

Circularity refers to a cell referring to itself (directly or indirectly). Usually, this is an unintentional mistake. In the
simple example below, the user has accidentally included the sum total (D5) in the sum formula. Notice how Excel
becomes confused:

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 But sometimes a circularity is intentional. For example, if a model calculates a company's interest expense based
on a cell that calculates the company's revolving debt balance, but that revolving debt balance is itself determined
by (among other things) the company's expenses (including interest expense), then we have a circularity:

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 The logic of such a calculation is sound: A company's borrowing needs should take into account the interest
expense. As such, many investment banking models contain intentional circularities like these.

Since unintentional circularity is a mistake to avoid, the usage of intentional circularity in nancial models is
controversial. The problem with intentional circularity is that a special setting must be selected within 'Excel
Options' to prevent Excel from misbehaving when a circularity exists:

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 Even with these settings selected, Excel can become unstable when handling circularity and often leads to a model
"blowing up" (i.e. the model short-circuits and populates the spreadsheet with errors), requiring manual
intervention to zero out the cells containing the source of circularity:

While the underlying logic for wanting to incorporate a circularity into a model may be valid, circularity problems
can lead to minutes, if not hours, of wasted auditing time trying to locate the source(s) of circularity to zero them
out. There are several things modelers can do to better cope with circularity, most notably the creation of a simple
circuit breaker, which creates a central place in the model that "resets" any cell containing a circularity or
wrapping an error-trap formula (IFERROR) around the formula that is the source of the circularity.

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 Circuit breaker or an IFERROR error-trap

When building an intentional circularity, you MUST build a circuit breaker and clearly identify all the circularities in
your model. In our simple example, we placed a circuit breaker in D17 and altered the formula in D8 so the
circularity is zeroed out when the user switches the breaker to "ON":

Approach 1: Adding a circuit breaker toggle

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 An alternative approach is to simply wrap an IFERROR function around the source of the circuilarity. When the
model short circuits, the IFERROR function evaluates to the FALSE condition and populates the model with 0s
automatically. The primary downside to this approach is that they make nding unintentional circularities harder.
That's because you can never explicitly turn the breaker on or o - the IFERROR does it automatically. That said, as
long as all circs are handled with an IFERROR function, the model will never blow up.

Approach 2: Adding an error trap using the IFERROR function

Bottom line: To circ or not to circ?

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 Despite the circuit breaker and error trap solutions, many believe it is preferable to simply outlaw all circularity
from nancial models. For example, the way to altogether avoid the intentional circularity in the example above is
to calculate interest expense using beginning debt balance. For quarterly and monthly models with minor debt
uctuations, this is desirable, but for an annual model with a large forecasted change in debt, the " x" can lead to
a materially di erent result. Therefore, we do not believe in a blanket "ban." Instead, we provide the following
simple guideline:

A circularity is only OK if all the following conditions are met.

1. It is intentional: At risk of stating the obvious, you must understand exactly why, where, and how the circularity
exists. The example described above is the most common source of circularity in nancial models.

2. You have “enable iterative calculation” selected in your Excel settings: This tells Excel the circularity is
intentional and ensures Excel doesn't throw up an error and populate the entire model with random zeros
everywhere.

3. You have a circuit breaker or error trap formula: A circuit breaker or error trap formula ensures that if the le
gets unstable and #DIV/0!s start populating the model, there is an easy and clear way to x it.

4. The model will not be shared with Excel novices: Circularities, even with a circuit breaker, can create confusion
for Excel users not familiar with it. If the model you are building will be shared with clients (or a managing
director) that like to get into the model but are generally unfamiliar with Excel, avoid the circularity and save
yourself the headache.

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 Don't use macros

Keep macros to an absolute minimum. Very few people know how macros work, and some users cannot open les
that use macros. Every additional macro is a step closer to making your model a "black box." In investment
banking, this is never a good thing. The only macros regularly tolerated in banking models are print macros.

Error checking

Excel is an amazing tool. Unlike software speci cally designed to perform a particular set of tasks (i.e. real estate
investment software, bookkeeping software), Excel is a blank canvas, which makes it easy to perform extremely
complicated analyses and quickly develop invaluable tools to help in nancial decision making. The downside here
is that Excel analyses are only as good as the model builder (i.e. "Garbage in = garbage"). Model error is absolutely
rampant and has serious consequences. Let's break up the most common modeling errors:

1. Bad assumptions: If your assumptions are faulty, the model's output will be incorrect regardless of how well
it is structured.

2. Bad structure: Even if your model's assumptions are great, mistakes in calculations and structure will lead to
incorrect conclusions.

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 The key to mitigating #1 is to present results with clearly de ned ranges of assumptions (scenarios and
sensitivities) and make the assumptions clearly de ned and transparent. Breaking models out into
inputs→calculation→output helps others quickly identify and challenge your assumptions (Addressed in detail in
the "Presentation" section above). The far more pernicious modeling error is #2 because it's much more di cult to
nd. As you might imagine, the problem grows exponentially as the model's granularity increases. This is why
building error checks into your model is a critical part of model building.

Build in error checks

The most common error check in a nancial model is the balance check — a formula testing that assets =
liabilities + equity:

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 Anyone who has built an integrated nancial statement model knows it is quite easy to make a simple mistake that
prevents the model from balancing. The balance check clearly identi es to the user that a mistake has been made
and further investigation is required. However, there are many other areas of models that are prone to error and
thus could merit error checks. While every model will need its own checks, some of the more common ones
include:

Ensuring sources of funds = uses of funds

Ensuring the quarterly results add up to annual results

Total forecast depreciation expense does not exceed PP&E

Debt pay-down does not exceed outstanding principal

Favor direct calculations over "plugs"

Below we show two common ways that users set up a sources & uses of funds table in nancial models. In both
approaches, the user accidentally references intangible assets. In approach 1, the incorrect data is linked into D37.
The model notices that sources do not equal uses and throws an error message in D41. The second (and equally
common) approach structurally sets D52 equal to D47 and uses D49 as a plug to ensure sources and uses always
equal. Which approach do you think is preferable? If you guessed the rst approach, you are correct. The problem
the second ("plug") approach is that because of the mis-linking in D50, the model incorrectly calculates the amount
of secured loans required for the transaction, and no error is identi ed.

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 Whenever a direct calculation is possible, use it, along with an error check (i.e. "do sources equal uses?") instead of
building plugs.

Aggregate error checks into one area

Place error checks close to where the relevant calculation is taking place, but aggregate all error checks into a
central easy to see "error dashboard" that clearly show any errors in the model.

Error trapping

Models that require a lot of exibility (templates) often contain areas that a user may not need now, but will need
down the road. This includes extra line items, extra functionality, etc. This creates room for error because Excel is
dealing with blank values. Formulas like IFERROR (and ISERROR), ISNUMBER, ISTEXT, ISBLANK are all useful
functions for trapping errors, especially in templates.

Present-ability

Cover Page and TOC

When a model is designed for use by more than just the model builder, include a cover page. Cover page should
include:

1. Company and/or project name

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 2. Description of the model

3. Modeler and team contact information

Include a table of contents when the model is su ciently large to merit it (a good rule of thumb is more than 5
worksheets).

Worksheet design

Label worksheets by the nature of the analysis (i.e. DCF, LBO, FinStatements, etc...). Tabs should ow logically from
left to right. When following the inputs→calculations→output approach, color the worksheet tabs based on this
division:

1. Include the company name on top left of every sheet

2. Include the sheet purpose, scenario selected (when relevant), scale and currency prominently below the
company name on each sheet

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 3. Page setup for printing: When a sheet is too long to t in one page, the top rows containing company name,
purpose of the page, currency and scale should be displayed on top of each page (select "rows to repeat at top"
(Page Layout>Page Setup>Sheet)

4. Include le path, page number and date in footer

Scenarios and sensitivities

The purpose of building a model is to provide actionable insight that wasn't otherwise readily visible. Financial
models shed light on variety of critical business decisions:

How does an acquisition change the nancial statements of an acquirer (accretion/dilution)?

What is a company's intrinsic value?

How much should an investor contribute to a project given speci ed return requirements and risk tolerances?

Virtually all investment banking models rely on forecasting and assumptions to arrive at the outputs presented to
clients. Because assumptions are by de nition uncertain, presenting the nancial model's output in ranges and
based on a variety of di erent scenarios and sensitivities is critical. In this post about scenario analysis and this
post about using data tables for sensitivity analysis, we address the two most e ective ways to present nancial
outputs in nancial models.

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 Conclusion and further reading

We wrote this guide to provide a framework applicable to investment banking models. For those that want to
dive deeper into building speci c investment banking models, consider enrolling in our agship nancial modeling
program. For those that want to get into the weeds of modeling theory, I recommend the following texts:

Building Financial Models by John Tjia

Financial Modeling by Simon Benninga

Master nancial modeling!

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