Not all financial models need to be formally audited or reviewed by an independent party. In some situations the modeler or the company about to rely on the model simply wants to increase their confidence in the financial model. In these situations, there are several alternatives that may be more appropriate than a full formal model audit.
Model review vs model audit
The fees associated with a formal financial model audit are partly due to the extremely structured process involved in a financial model audit. By relaxing certain aspects of this process can achieve the same amount of work for a significantly lower fee.
An efficient approach to model review will differ to a model audit in the following ways
- Before first iteration the client reviews and amends for inconsistencies in maps
- Only one or two iterations
- Cell-by-cell review only performed on selected parts of the model
- Documentation limited to only errors and significant risks
- High level analytical check performed
- No opinion letter issued
This approach can typically be performed at a total cost of 20-40% of a formal financial model audit.
1. Generate consistency maps
If you do not have access to a model review add-in package then ask your model audit company to generate consistency maps for you. This is a very quick process and is the first step in reviewing a model for inconsistencies. You can then work through the outputs yourself to save money on external consultants.
2. Ask a colleague to review your model
This is the oldest trick in the book, but still works a charm. In the same way it is very hard to find your own spelling mistakes, it is very hard to find your own errors in a financial model. One very simple way of quickly improving your model is to ask a colleague (ideally someone who doesn’t really like you and who wants to find errors…) to review your model.
3. High level analytical review
One very efficient approach of finding errors in financial analysis, and one constantly applied by credit committees all over the world, is to print a summary sheet and review it with a calculator. Ideally you should be able to calculate the NPV of your project based on key assumptions using a calculator in half an hour. If something doesn’t look right, assume that it isn’t and get to the bottom of it before someone else does - or worse - you don’t find the error and make a bad investment based on you analysis.
4. Prepare a ‘super-summary’
To facilitate a high-level analytical review it can be useful to prepare a ‘super-summary’. This is typically comprised of no more than five to seven lines of annual data - no more! This can then be used to calculate annual metrics useful for sense checking. A ‘super-summary’ can be used for the following purposes:
- Annual average prices overview
- Debt repayment analysis
- Annual trend analysis - revenue, costs, capex, tax, etc
- Annual profit margins analysis
Andy, it is a good sign that
Excellent blog. Common sense
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