Sit in on a finance internship for a week and you will hear the phrase constantly. Someone is "building a model." Someone else is "updating the model." A managing director wants "the model" by Friday. For a term that gets thrown around as though everyone was born knowing it, a financial model is remarkably rarely explained, which leaves a lot of capable students assuming it is far more mysterious than it is.
At its simplest, a financial model is a spreadsheet that represents how a business, project or investment is expected to perform financially over time. You feed it assumptions, how fast sales will grow, what costs will be, how many staff get hired, and it calculates the consequences: profit, cash flow, how much funding is needed, what the business might be worth. It is, in essence, a company translated into numbers so people can ask "what if?" and see the answer.
The idea behind it
Think of a model as a set of connected calculations. Change one number at the top, and everything downstream updates automatically. If you increase the sales-growth assumption from 5 per cent to 10 per cent, the revenue line rises, profit shifts, the tax bill changes, and the cash balance at the end of the year moves with it. That linking is the whole point. A model is not a static picture of a business; it is a living machine that lets you test decisions before anyone commits real money to them.
That is why models sit behind so many of the big moments in finance. When a company decides whether to build a new factory, someone models the returns. When an investor weighs up buying shares, they model what the company might earn. When a start-up raises money, it hands investors a model showing how the cash will be spent and when the business turns a profit. The specific purpose changes, but the job is always the same: make an uncertain future something you can reason about.
What actually goes into one
Most models are built on the three core financial statements, which work together to describe a company's finances. If those are new to you, our guide to understanding company reports is a good place to start, but here is the short version.
The income statement (or profit and loss) shows revenue, costs and the profit left over. The balance sheet shows what the company owns and owes at a point in time. The cash flow statement tracks the actual cash moving in and out, which is not the same as profit, a genuinely important distinction that catches a lot of people out, and one reason working capital matters so much. A good model builds all three and links them, so a change in one flows sensibly through the others.
Around those statements sit two things worth naming. The first is assumptions, the inputs the modeller chooses, such as growth rates, margins and hiring plans. These are usually kept together and colour-coded (blue text is a common convention for "this is an input you can change"). The second is outputs, the answers the model produces, often summarised on a single front page: projected profit, cash position, a valuation, or a return figure.
A worked example, in words
Imagine a small café planning to open a second location. A model for that decision might start with assumptions: how many customers a day, average spend, rent, wages, the cost of the fit-out. From there it calculates monthly revenue and costs, then profit, then the cash the business has left after paying for everything. It might show that the new café loses money for the first eight months, then turns cash-positive, and pays back the fit-out cost within two years.
Now the owner can play with it. What if rent is 15 per cent higher than expected? What if it takes twelve months to get busy instead of eight? Each answer appears in seconds. The café has not spent a cent, but the owner has already lived through a dozen versions of the future and can make a far calmer decision. That is the quiet power of a model, and it scales all the way up to billion-dollar deals.
One idea that separates the good from the messy
The best models are built so that assumptions live in one clearly marked place, and every other cell is a formula that refers back to them. Nothing important is typed twice. That sounds like a small housekeeping point, but it is the difference between a model people trust and one that quietly breaks. When the only things you change are the labelled inputs, anyone can follow your logic, stress-test it, and rely on the result. Learning to build that way early is a genuine advantage.
Why this matters for your career
Financial modelling is one of the most transferable and sought-after skills in the industry. Investment banking analysts build models for deals. Equity analysts model the companies they cover. Corporate finance teams model budgets and business cases. Private equity and venture capital investors model the companies they back. Even roles that never touch a full model benefit hugely from understanding how one works, because it means you understand how the business itself hangs together.
The reassuring part is that modelling is a craft, not a talent you are born with. It rewards clear thinking and tidy logic far more than mathematical genius, if you can reason step by step and you are willing to be careful, you can learn it. Plenty of the most capable modellers in the country started exactly where you are, opening a blank spreadsheet and feeling slightly intimidated. And with spreadsheet and AI tools now doing more of the mechanical work, the real value is shifting towards understanding what the numbers mean, which is something you can start building long before your first job. If you want to get ahead of that curve, our piece on AI tools for a finance career is worth a read.
You do not need to build a perfect model tomorrow. You just need to understand what one is and what it is for, and now you do. The rest is practice, and every expert you will ever meet started with their own first clumsy spreadsheet. Yours is allowed to be clumsy too. You belong in the room where the models get built.
F3 shares this as general education about finance skills and careers. It is not financial advice.