Have you ever developed a financial model for a client or your organization and later found out that the spreadsheet had errors? What did you do? Did you go to your supervisor or the client and tell them …?

Person 1: “Oh, by the way, do you know the model we built for Project Y had some minor mistakes, but it’s nothing to worry about” or

Person 2: “I would like to bring to your attention that I found some mistakes in the model we built for Project Y. I have assessed the potential financial impact of the mistake and would like to bring you up to speed and brainstorm some possible remedies at the earliest possible opportunity” or

Person 3: Are you the type that ignored it and hoped that nobody would ever find out? In this scenario, I’m right on the money that you dreaded hearing these words from your supervisor, “please come to my office and close the door or from the client, “Something’s not adding up. We need to talk.”

Whoever you are, these costly mistakes can be minimized by getting someone else to review and audit your model.

This article will answer some Frequently Asked Questions on financial model review and why it is important for anyone making financial and non-financial decisions to ensure their financial model has been reviewed before adoption. This article is NOT about financial model audit.

What is a financial model?

A financial model is a forward-looking abstract representation of real-world financial situations for use in decision making. Financial models can be built for businesses, projects, and portfolio of assets, among other uses. A financial model is built in spreadsheet software such as Excel.

Why should you review your financial model before adoption?

According to Ruth McKeever, around 95% of spreadsheets contain actual or potential errors. Isn’t this enough reason to review your model?

What are some common mistakes found in financial models?

Common mistakes may be categorized as below:

1. Integrity errors – these arise from inconsistencies with accounting, tax, and business principles.
2. Logical errors – these come from inconsistent operational, financial, and economic assumptions made in the model.
3. Model build errors – these are errors that interfere with the flexibility, transparency, and structure of the model.
4. Subject matter knowledge – these errors occur when the modeller lacks knowledge around specific calculations that affect the correctness of the output.

How can a modeller minimize mistakes in financial models?

1. Understanding the task at hand and developing a conceptual model before starting the model build.
2. Using a financial model standard. At InVhestia, we use the FAST Standard.
3. Conducting sufficient research in the field of the business or project being modelled.
4. Using checks and alerts in the financial model.
5. Conducting a financial model review – this is a review of a financial model which provides added confidence to users about the financial model. Comprehensive model reviews will identify errors, so they can be corrected.
6. Conducting a full financial model audit – this is a cell-by-cell review of a financial model to give full confidence in the reliance on the financial model. It checks the assumptions made, flow of data and calculation blocks, model structure, logical thinking, adherence to accounting and tax rules, and presence of external links, among other checks.

What is the difference between financial model review and financial model audit?

Financial model review is a process that focuses on certain aspects of the model (such as formula inconsistency, external links, hardcoding in calculations) as per agreed terms with the model owner while a financial model audit is a cell-by-cell review of the financial model and encompasses conducting logical, integrity, model build, and commercial checks. A model audit often takes longer than a model review because it is a more detailed exercise.

What are some similarities between financial model review and financial model audit?

1. Both result in a report that can be used to correct the errors identified in the model.
2. Both increase the level of confidence for users using the model.
3. Both require an understanding of financial modelling to complete successfully.
4. Both can be done manually or using a software or a mix of both.

How can a modeller conduct a financial model review?

A modeller can do a quick financial model review by:

1. Reviewing the logic and integrity of the model and checking whether the calculations are reasonable and consistent with the operational, financial, and economic assumptions contained in the model.
2. Reviewing whether the composition of key financial indicators is reasonable in the model.
3. Reviewing formulas in key calculation blocks.
4. Creating error checks and alerts for key items such as balance sheet and cashflow statement.
5. Checking whether the model follows all accounting rules, tax, and business principles.
6. Using Excel functions such as trace dependents and precedents, Ctrl+\, error checking, show formulas, among other functions.
7. Stress testing to check whether the output is consistent with the expected changes after changing key assumptions.

Who needs financial model review services?

1. Small and medium-sized businesses
2. Private equity and venture capital firms
3. Startups
4. Multinational companies
5. Project companies
6. Governments
7. Institutions such as banks, NGOs, learning institutions, DFIs etc

In conclusion, it is advisable to review your financial models to avoid making costly financial and non-financial mistakes. Remember, as Stephen Gugu, Principal at InVhestia Africa, says, “there is no Excel money. Any mistake in a financial model leads to a loss in real money.”

InVhestia Africa has built capabilities around financial model review over the years. We would be delighted to help you increase the confidence level in your financial model before making any financial or non-financial decisions. Please check our website for more information on the financial model review product.

Written by Keziah Njeri, Associate Principal, InVhestia Africa Limited.