What are the different types of financial models?

Comparative Company Analysis

Discounted Cash Flow

Leveraged Buy Out

Merger & Acquisition

Sum-of-the-parts

Cash flow model

pricing analysis model

merger and acquisition 

here are various kinds of financial models that are used according to the purpose and need of doing it. Different financial models solve different problems. While majority of the financial models concentrate on valuation, some are created to calculate and predict risk, performance of portfolio, or economic trends within an industry or a region. The following are the different types of financial models:

1) Discounted Cash Flow model

Among different types of Financial model, DCF Model is the most important. It is based upon the theory that the value of a business is the sum of its expected future free cash flows, discounted at an appropriate rate. In simple words this is a valuation method uses projected free cash flow and discounts them to arrive at a present value which helps in evaluating the potential of an investment. Investors particularly use this method in order to estimate the absolute value of a company. If may want to learn more about Financial Modeling here

2) Comparative Company Analysis model

Also referred to as the “Comparable” or “Comps”, it is the one of the major company valuation analyses that is used in the investment banking industry. In this method we undertake a peer group analysis under which we compare the financial metrics of a company against similar firms in industry. It is based on an assumption that similar companies would have similar valuations multiples, such as EV/EBITDA. The process would involve selecting the peer group of companies, compiling statistics on the company under review, calculation of valuation multiples and then comparing them with the peer group.

3) Sum-of-the-parts model

It is also referred to as the break-up analysis. This modeling involves valuation of a company by determining the value of its divisions if they were broken down and spun off or they were acquired by another company.

4) Leveraged Buy Out (LBO) model

Included in the types of Financial model is the LBO Model. It involves acquiring another company using a significant amount of borrowed funds to meet the acquisition cost. This kind of model is being used majorly in leveraged finance at bulge-bracket investment banks and sponsors like the Private Equity firms who want to acquire companies with an objective of selling them in the future at a profit. Hence it helps in determining if the sponsor can afford to shell out the huge chunk of money and still get back an adequate return on its investment.

5) Merger & Acquisition (M&A) model

Merger & Acquisitions type of financial Model includes the accretion and dilution analysis. The entire objective of merger modeling is to show clients the impact of an acquisition to the acquirer’s EPS and how the new EPS compares with the status quo. In simple words we could say that in the scenario of the new EPS being higher, the transaction will be called “accretive” while the opposite would be called “dilutive.”

6) Option pricing model

As it is defined “Options are Derivative contracts that give the holder the right, but not the obligation, to buy or sell the underlying instrument at a specified price on or before a specified future date”. Option traders tend to utilize different option price models to set a current theoretical value. Option Price Models use certain fixed knowns in the present (factors such as underlying price, strike and days till expiration) and also forecasts (or assumptions) for factors like implied volatility, to compute the theoretical value for a specific option at a certain point in time. Variables will fluctuate over the life of the option, and the option position’s theoretical value will adapt to reflect these changes.