Financial model

A financial model is anything that is used to calculate, forecast or estimate financial numbers. Models can therefore range from simple formulae to complex computer programs that may take hours to run.

At the simple end a valuation ratio, such as the PE, is a simple valuation model. Although the term model is rarely used for something quite as simple as a straightforward, commonly used ratio, it is commonly used for slightly more complex formulae of a similar nature.

Specific methods of calculating numbers are often called models: for example, application of a DCF to dividends to value a share would be called a dividend discount model.

Spreadsheets used for budgeting and for forecasting profit and cashflow are also financial models.

More specialist computer software is used for more complex models, especially those that require a more complex application of statistics and financial mathematics.

In areas such as risk management and economic forecasting, the models used are extremely complex. Models such as value at risk are implemented using specially written computer programs. Investment banks employ quantitative analysts and computer programmers who specialise in devising and implementing financial models.

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