What is the Financial Model Audit?
Why is the auditing of financial models so important, and who does it? World-renowned model auditors will audit everything in your financial model, from the technical assumptions to the accounting methodologies and formula logic. They will even ensure that scenarios in the model are run correctly! Why is this so important?
In financial modelling, accuracy and reliability are of utmost importance. As businesses and investors rely on these models to make informed decisions, even the smallest errors can lead to significant consequences. In this blog post, we will delve into the concept of the Financial Model Audit, a critical process that ensures the integrity and robustness of financial models. We will also discuss insights and best practices shared by industry experts on the Financial Modelling Podcast, shedding light on the importance of auditing and how it can benefit businesses and stakeholders alike. Join us as we explore the essential role of the Financial Model Audit in maintaining the credibility of financial models and safeguarding the decision-making process in today's dynamic and complex financial landscape.
Financial Model Building is an Art, Not a Science
Every financial model, especially those that provide forecasts, are incorrect. I often say this at work, to the bemusement and shock of my colleagues. The fact is though if my models were correct, I shouldn’t be building financial models, but instead be trading, gambling or playing the lottery! A forecast is merely a view on the future if our current assumptions all hold out to be 100% true. I personally don’t see how this is possible, especially when dealing with modelling companies or wind farms. That said, it is important that our models are logically correct and also accurately apply the assumptions we are using.
Famous Financial Model Errors
There are more than a few famous Excel errors, but two that stand out in recent history include the following.
During the London 2012 Olympics, an Excel error led to one event being oversold. Visitors who purchased tickets to a synchronised swimming event actually ended up getting upgraded tickets, with some even attending the 100m final, one of the hottest events at the Olympics. You can read more about the error here.
Known as the ‘Excel Error Hear Around the World’, Rogoff and Reinhart’s paper overstated economic growth and for high-debt countries due to a very basic Excel error that could have been easily avoided. More about that famous error here.
A Financial Model Audit isn’t just about Model Logic
So, before financial close on a deal, we send our financial models to be audited. The auditors tell us lots of things about our models, namely:
- Are there any formula or logic errors?
- Are the assumptions being used correctly?
- Is the accounting in line with accounting standards?
- Does the legal and technical documentation and the financial model tie up?
- Sometimes specific elements such as tax are audits as well.
This is exceptionally important for a financial model who has spent weeks or months on end developing a financial model. You get so deep into the details that it is often difficult to spot your own errors. Indeed, sometimes errors are exceptionally difficult to identify, requiring model audit software to reveal them.
How do we go about auditing Financial Models?
There are a number of model auditors out there. Still, for the beginner modeller who wants to identify issues on their own, there are a number of model auditing software packages available as well. I would recommend you experiment with these software packages to assess where your likely mistakes are. Model audits make us better modellers and make our financial models more robust.
Conclusion
In conclusion, the Financial Model Audit is an indispensable process in the realm of financial modelling, providing an additional layer of assurance and confidence in the accuracy and reliability of financial models. As we have explored in this blog post and through the insights of industry experts on the Financial Modelling Podcast, conducting a thorough audit can help businesses and investors avoid costly mistakes, make informed decisions, and achieve their financial goals.
As the world of finance continues to evolve and become more complex, the importance of the Financial Model Audit cannot be overstated. By embracing this essential process and adhering to best practices, organizations can enhance their financial modelling capabilities, reduce risks, and ensure that their models stand up to scrutiny.
Ultimately, the Financial Model Audit serves as a testament to the commitment of businesses and financial professionals to maintain the highest standards of accuracy, transparency, and accountability. It is this dedication to excellence that will drive success and create a solid foundation for future growth and prosperity in the world of finance.
As always, good luck and happy modelling!
Matthew