Which Are The Important Financial Modeling Techniques That Makes A Model Flexible?

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Which Are The Important Financial Modeling Techniques That Makes A Model Flexible?

Flexibility or rather, variability and simulation of a scenario under different conditions is the end goal of a model. Here are some of the various techniques you can use to make a model more adaptable.

Model assumptions clearly- the first step to creating a workable model is to always document the delta assumption. What does that mean? As discussed earlier, if you want to say that you forecast sales of firecrackers during Diwali to up by 15 percent from 2015, then you model in the assumption.

The origin value is, let's say, 1000 crackers sold in 2015. The result would be (1000 *0.15) + 1000 which would equal 1150 crackers sold in 2016. But you have to document the 0.15 clearly so that if someone wanted to change that assumption to 20 %, then they would just need to key 20% in instead of 15 and the entire model would change.

Created more detailed assumptions – While complex models are generally less robust due to higher chances of linkage issues etc, there needs to be some amount of complexity for a model to be useful. For instance, we want to forecast revenue from the sale of fireworks from 2015 to 2016.

The first would be to break the Rs 1000 up into the various products like sparklers, (30% of 1000) flowerpots, and the like.

Once that happens you need to break sales into its component. Sales equal price into quantity. So instead of saying, arbitrarily, that the total sales of sparklers go up from Rs 300 to Rs 345 (a jump of 15%) in 2016, you would say that the number of sparklers would go from 100 sparklers to 115 (model in the 15%) sparklers while the price of the sparkler (Rs 3 per piece ) did not increase at all. (the model in the 0%) The flexibility comes in when I change the cell that holes from 0% to 10%.

This would make the price of the sparkler go up from Rs 3 to Rs 3.30 which would lead to a total sales of Rs 379.5.

Use a spin button- A spinner helps model variability especially as it relates to stepping costs. So let’s say that for every extra Rs 200 I make in sales, I need to add one extra salesperson. That is not a variable cost. That is a steep cost. So when my sales go up 15% from Rs 1000 to Rs 1150, I don’t need an extra salesperson.

But what if I want to sell 1250. I need to add one more salesperson. A spin button does the job for you. Every time increment sales go up by Rs 200, one extra person at a salary of Rs x a month will be added to that cell, thereby making your model more adaptable and robust.

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