Fimodo speaks to four financial modelling experts to understand how they see the benefits of financial modelling standards.
This is a tough question – as it will annoy people in it! I will step back and qualify the sectors as ‘financial’ and the typical industries that use financial models to procure finance. I can’t comment on say decision making models in the R&D of a pharmaceutical or aero engineering company for example. I would also say that to improve standards you need to have standards in the first place, the industry as a whole doesn’t. It would be remiss of me not mention BPM’s efforts through the Spreadsheet Standards Review Board which definitely deserves a mention but is not widely known about in my experience globally even though they have been available since 2003. Awareness is critical step to be taken on the way to acceptance.
I see a lot of financial models prepared by analysts, both banking and corporate, large accounting firms and one-man bands seeking to raise or advise on a project finance transaction. The upshot is that it never ceases to amaze me of the truly terrible average standards of modelling, understanding of basic principles of finance, presentation of important information and care that is taken with most projects involving some pretty big numbers! If you can’t spell principal then you shouldn’t be modelling it! – is that unfair?! I don’t think so.
The flow of models that would benefit from improved standards are the models we see prepared by corporate (and banking) analysts and engineers in the core industrial sectors (mining, power, oil and gas, renewable fuels etc). These models generally fail on most of the benchmarks for assessing a model. This might sound harsh but it is through no real fault of their own – I think it is an awareness issue and probably due to the path that executives in those industries follow to get where they are combined with a lack of ‘corporate memory’. My experience is in these cases responsible people have generally been engineers, geologists or accountants rather than bankers or consultants focused on presentation and flexibility.
Proper standards, let alone their improvement, require an official body, such as
- Ethical lending
- Quantity surveying
- Petroleum / Geology reporting
….the world of financial modelling hasn’t got one and without wanting to sound pessimistic I don’t think it is likely to have a meaningfully accepted one.
The reason, in my opinion, is because on the whole, financial modelling is at the moment seen as a task rather than a profession. An official body would need to be
- Marketed properly
- Accepted by a fragmented market across a wide range of industries with different challenges.
- Regulate the practice of the standards
- Train the industry
Where standards do exist owners are not incentivised to adapt, each probably thinking they have cracked the nut. In my mind this makes it even more important for project companies to invest in the services of consultancies who have an refined their own methodology and have had them battle tested and constantly being challenged and refined.
This is a very interesting question as it goes to the core of Excel financial modelling standards (or dare I say the complete lack of financial modelling standards in certain sectors).
How to define industry sectors of financial modelling?
When discussing financial modelling standards, we often assume that we are relating the discussion to the sophisticated end of the spectrum. This segment of the world typically involves people from the
- financial sector
- large corporates
- research agencies
There is however another way of looking at the world when it comes to ‘financial modelling’, even though this specific sector would probably relate to this skills set as ‘spreadsheeting’.
The large ugly world of consumer Excel spreadsheets
To understand the extent of the problems with lack of standards in consumer spreadsheets, try this at him. Ask you mum(!) to tell you a bit more about her approach to financial modelling standards. This is unlikely to more of a reply than a frustrated look from your mum. Even simplifying the question to ‘how do you build spreadsheets’ is not going to get a structured answer.
In my view the ‘sector’ that would benefit the most from improved standards is the general public! I am in no way suggesting aiming for the high standards of Corality of any other professional financial modelling consultants but a couple of hours of training would go a long way.
Financial Modelling Professional
Hard to generalise here about specific industries, because one company may have, due to the arrival of a financial modelling professional from a reputable firm or with fantastic modelling experience, may implement best practice financial modelling across the company. This company may be one of the few in its industry, which is an industry that is not renowned for its financial modelling sophistication.
Less financially literate industries, where the finance or accounting function traditionally just reported historical, actual, differences, and performed vanilla budgeting, without more complex forecasting or sensitivity analysis
Some sectors use historical cost to form the basis of future investment decisions rather doing sophisticated financial modelling via forecasting and sensitivity analysis
Proprietary companies who haven’t had the resources and ability in the past to perform best practice financial modelling
Aviation, while although I saw some good financial models, overall it was lacking error free, value-adding and auditable financial models.
One of the things I love so much about Financial Modelling is the fact that it is so easily applicable across different industries. I think any sector could really benefit from improved standards. Over the years I’ve become a “general specialist”. I specialise in Financial Modelling in Excel, but am not industry specific. I know a little bit about a lot of different industries and that’s why communicating with the client and really “getting inside their head” is really important, and assumptions documentation is absolutely critical. Working out the purpose of the model, what the required inputs and outputs are and what industry-specific information is relevant to the model is a skill in itself!
The people that come on my courses are from many different backgrounds and it’s fascinating to see how people that come from very different industries can all benefit from implementing Financial Modelling principles of best practice to their models.
Financial Modelling in Excel is, by and large, still a rather unregulated discipline and one that could hugely benefit from improved standards. There are so many different ways to model exactly the same thing which makes models difficult to follow, audit and validate.
Recently I’ve seen some larger companies starting to put some guidelines and standards around their models rather than just letting their analysts go off and create their own ad hoc models. Not only are they standardising their assumptions, but also the look and feel, as well as modelling methodology; for example having standard guidelines on how to include escalation, or how to calculate a payback period. This is a great start, and a practice that I think many companies would benefit from.