Many finance students and professionals study theories, formulas and definitions for years in preparation for a career in finance, they do so by studying text books, memorizing the concepts from the text book, passing exams with good grades etc. While it’s important to understand theory, in general, the majority of employers want employees that can perform the job rather than simply reciting the theory behind it. Therefore, employers today are looking more for individuals that have practical financial modelling skills than pure theory. Financial modelling is not about recalling definitions; it is about constructing models to resolve and solve issues or dilemmas based upon the numbers (data). For instance, in many of the real jobs in finance such as Investment Banking, Equity Research, Corporate Finance and Consulting, practical skills outweigh theoretical knowledge. This article outlines, explains and illustrates why having practical financial modelling skills (building models to resolve issues) is more advantageous than theoretical knowledge. Using hands-on experiences will ultimately provide you with the best chance of attaining your desired success within the world of finance.
Understanding Financial Modeling in Simple Terms
To create a financial model, you must first build a framework in Excel or another similar program that will represent how a business is forecasting the future and looking at what its revenues, costs, profits, cash flow and balance sheet will look like over time. A financial model is used by management, investors, and companies to help them determine if they should invest or expand their business, acquire another company, or raise additional capital. In theory, the concept of financial modeling is overwhelming, but in reality it is about using simple mathematical logic and the right input data to create a visual representation of what a business may look like financially in the future. While having a basic understanding of key terms such as net present value (NPV), internal rate of return (IRR), or weighted average cost of capital (WACC) is helpful, their true value lies within the context of an actual working financial model built in Excel.
The Difference Between Theory and Practical Skills
Theoretical understanding reflects on the what and why; it describes the concepts, formulas, and principles associated with finance. Practical skills demonstrate how to do things; they demonstrate to you how to create, examine, and interpret financial models. For instance, while theory indicates that cash flow is a greater indicator of overall business value than profit, practical modelling indicates how an individual's income statement can be used to produce a cash flow statement. Theory describes depreciation; however, depreciation shows you how the depreciation will influence cash flow, tax liability, and business valuation in practical modelling. As a result, employers prefer to hire candidates that are immediately able to achieve results. With this in mind, employers tend to favour practical financial modelling skills over theoretical knowledge.
Why Employers Prefer Practical Financial Modeling Skills
Time is money for employers and they are usually too busy and pressed for time to train someone from scratch with basic Excel modeling. Employers expect candidates applying for an analyst position to have already learned how to build models, analyze financial statements, and present insights when they are being interviewed. A candidate who possesses practical Financial Modeling skills has demonstrated their ability to perform under real-world work pressures. An individual who has acquired only theoretical knowledge may grasp concepts but find it difficult to utilize them effectively. Conversely, a candidate who has acquired hands-on experience building models will be able to provide immediate contributions to ongoing projects; therefore, such candidates are more desirable employees.
Real-World Finance Problems Are Not Theoretical
Classroom problems tend to be very clean and structured, with all of the necessary data available. In contrast, real-world data can be very complicated, incomplete, and sometimes unreliable. The primary objective of practical financial modeling is to help individuals navigate through these real-life situations. Analysts frequently are required to create assumptions, clean their data, and modify their models as new information comes in; however, theory prepares students for little of this uncertainty. The experience gained by developing skills in practical modeling trains the mind to think critically and adapt quickly to the fast-paced demands of real finance roles.
Excel Skills Matter More than Exam Scores
Excel is the premier tool used in finance-related jobs. The use of shortcut, formula, and structure improves efficiency, as such, practical financial modeling has an extensive focus on Excel skills like linking financial statements, utilizing logical formula, building scenario, and conducting sensitivity analysis, etc. Theoretical knowledge alone does not equip students with these skills. Many students perform well on examinations, yet they can't develop even basic financial models. Conversely, someone with average theoretical knowledge but strong Excel modeling capabilities would perform at a much higher level when engaged in the same position.
Ability to Make Better Decisions From Financial Modeling
Financial modeling is used to show how decisions influenced financial results. For instance, increasing your price might increase your profit, but it might also reduce your sales volume (demand). On the other hand, offering more lenient credit terms may increase revenue but negatively affect cash flow. The relationships between variables become apparent only after constructing and testing a financial model. Although theoretical information provides an explanation, a financial model will help illustrate the numbers behind the variables. Improvement of decision-making function is highly regarded among managers and investors.
Greater Knowledge of the Business Environment
In practice, a financial model is used to make sense of numbers. Financial models provide insight into a company's operations, how it generates revenue, and how it incurs expenses. To develop a revenue projection, it is necessary to obtain information regarding pricing, quantity, and market conditions. To estimate operational expenses, it is necessary to understand how efficiently a business operates. Theory typically remains abstract, whereas by utilizing a practical financial model, it is possible to directly relate banking and finance with the actual operations of businesses. The enhanced understanding enables individuals to be not only more effective professionals but also more confident.
Financial Modeling Builds Problem-Solving Skills
By developing your modelling skills, you develop an ability to solve problems that is applicable to many other job roles. The modelling skills developed through doing practical work assist you in breaking down complex issues into manageable components. Practically developing these skills trains your brain to think logically and systematically. You cannot train your brain to think in this way only by reading textbooks. So, having practical modelling skills helps you to be more confident with new surprises in life.
Faster Career Growth with Practical Skills
Developing strong modelling skills also enables an individual to progress rapidly within their career. Financial models and financial modelling capabilities are viewed positively by management. The additional insights that can be gained through financial modelling capabilities are trusted by management, and ultimately improve the performance of individual employees. Thus, while theoretical information may help to prepare for interviews, the practical skills developed by performing practical modelling activities are the skills that ultimately allow individuals to perform better on a continuous basis. Therefore, in general, strong modelling skills result in higher levels of career growth.
Financial Modeling Is a Core Skill in High-Paying Finance Roles
Building financial models competently is a fundamental ability found in very well-compensated careers found in the finance sector. As outlined in the examples above, financial modeling is part of the profession of being an investment banking analyst, private equity associate, equity research analyst, or a corporate finance manager. In each of these professions, valuation modeling, forecasting the results of the business activities, and analyzing the different possibilities that may arise from those activities are part of one's job. While theoretical knowledge creates a solid foundation for financial modeling, the function of financial modeling is carried out using real-life experience. If an employee has not had experience creating financial models through real-life experience, it will be difficult for the employee to be successful in any of the previously mentioned professions. Therefore, having a strong, practical skill set will provide more value than merely theoretical knowledge will.
Practical Skills Increase Confidence at Work
The ability to complete tasks on one's own provides confidence. Practical financial modeling provides an employee with this confidence. An employee who has completed multiple financial modeling assignments will not be so intimidated by complex tasks. The employee understands how to attack the issue that he or she is facing and find the appropriate solution. Theoretical knowledge creates a knowledge base; therefore, it creates an understanding. However, practical application creates confidence. Employees who have confidence in themselves will perform better, communicate more effectively, and be more respected in their workplace.
Interviews Test Practical Knowledge More Than Theory
Today, many finance recruiters are putting more emphasis on real-world skills as opposed to academic credentials. Candidates will typically be required to create models, conduct analysis using case studies, and demonstrate the effects of changes in dimension on value during interviews. Candidates will also need to show interviewers how they think through problems and apply what they know. Interviewers do not believe that simply memorizing answers to questions will impress them. As such, candidates with previous experience creating financial models are at a significant advantage during interview processes and case studies.
Practical Modeling Helps in Understanding Valuation Clearly
While theoretical valuation concepts such as discounted cash flow may appear straightforward, in practice, they can be quite complex. By creating a DCF model, it is easy to see the effect of assumptions on value. This can illustrate how significant cash flows, discount rates, and growth assumptions are to the overall valuation. While theory can provide valuation formulas, the actual impact of these assumptions is only realized through the modelling of cash flows.
Learning by Doing Creates Long-Term Knowledge
The majority of people forget about theoretical information unless it has been practiced. Since practical financial modelling involves hands-on participation and utilizes trial and error to learn, the material learned in this manner will remain with you long into the future. When creating a financial model, individuals learn the underlying principles of financial modelling through hands-on experience. Therefore, the actual creation of financial models is essential for aspiring finance professionals.
Gaps in Skill Due to Theory vs. Practice in Finance
Although finance graduates learn theoretical concepts in school, many find it difficult to apply what they learned in their first job and therefore, experience a great deal of frustration as they make their way through their careers. Practical Financial Modeling fills the gap between theory and practice by providing finance professionals with the tools to effectively utilize their degree through hands-on experience. As such, the use of practical financial models assists in preparing students for the work environment.
Practical Skills Adapt Better to Industry Changes
The financial industry is continually changing and evolving as a result of technological advancements and new models of doing business. The skills obtained in practical financial modeling can be applied to all parts of the financial services industry and can be adapted for use in other industries as they change and grow. In essence, although the theories learnt in school may become outdated, the knowledge obtained through practical applications of financial modeling will continue to remain relevant for years to come.
Why Students Should Focus More on Practical Learning
Students of finance should have a greater emphasis placed on learning the practical aspects of finance vs. just achieving letter grades and passing tests. Although achieving academic success is paramount, all students must also invest time in learning the practical aspects of financial modeling such as building and creating models through Excel and/or analyzing real-world data of publicly-traded companies. Students who learn and practice these skills will not only have greater confidence through job readiness but will also be well-rounded and gain additional knowledge and/or skills that complement their formal finance education.
Conclusion
A knowledge of finance concepts is essential, however, it is more important to apply what you know to finance practices and real-world scenarios. Practical financial modeling skills are better than theoretical knowledge in that they prepare finance professionals for the day-to-day challenges they face on the job. Financial modeling will improve your decision-making ability, your ability to think analytically about problems and give you confidence as you grow in your career. Candidates who can build financial models, analyze data and provide actionable insights get hired by employers on their first day of work. While theory provides a foundation for financial practices, applying your theoretical knowledge in practice leads to developing true financial expertise. If you are a student or working professional, the focus of your efforts should be on developing practical financial modeling skills in order to achieve success in the field of finance. Those that have practical experience will continue to have an advantage over those that have only been exposed to theoretical financial practices.
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