Financial Modeling Best Practices

What Exactly is Financial Modeling?

If you ask five different finance professionals this question, you'll likely get five different answers. In actuality, financial modeling involves creating a quantitative representation of a company’s financial performance to forecast or analyze financial scenarios and potential outcomes, in order to assist with business decision-making. 

In other words, it involves building a digital, numerical “replica” of a business or situation. This is usually done in Excel, using historical data, assumptions/inputs, calculations, and outputs. 

Many financial models are poorly built, painful to update, and difficult to hand over to new modelers.  This is often because finance professionals are self-taught and lack formal training on best practices.  Therefore, establishing and implementing best practices is a prudent step towards improving our financial models. 

This guide focuses on essential best practices for financial modeling, providing a foundational framework rather than attempting to cover every single aspect of financial modeling. As a result, some topics are inevitably excluded. However, we've distilled the key financial modeling topics into four overall areas:

1) Designing the Model

2) Model Layout

3) Formatting

4) Formulas

1) Designing the Model

Before building the model, take time to plan its structure and layout.  Spend time thinking about the overall model layout, considering the outputs and end-product.  Identify the necessary building blocks and map out the model's structure.  Even if you don't have a complete vision for the final model, taking the time to document your initial thoughts on its design can save you from creating a disjointed mess.  Without a plan, it's easy to end up with a model that feels like multiple Excel files have been "Frankensteined" together – an awkward, hard-to-maintain beast that's more frightening than functional.

Design "backward”, starting with the outputs rather than the inputs, always having the end-product top of mind.  Below is an illustration of how we can map out the building blocks that we’ll need for a basic three-statement model:

2) Model Layout 

Once you've designed the model, structure it with a logical data flow:

Inputs  →  Model Calculations  →  Outputs

 1)      Inputs and Drivers         

The Inputs sheet is where you'll enter data that will flow throughout the model.  Centralize inputs on one page to prevent having to search for input locations and to provide a complete picture of necessary inputs. 

2)      Model

This includes the financial statements, the operational schedules, and the capital structure schedules.  This is where the main calculations and the “heavy-lifting” occur.

3)      Outputs (Summary)

The Outputs include the summarized financial statements, and can also include a snapshot of a previous version of the forecasted financial statements (such as the annual budget), along with variances. Include metrics/KPIs, and charts to help users understand and visualize the data.

4)      Cover Page

A well-designed cover page is essential.  It should include a Table of Contents, user guidelines, a Circularity Switch (if applicable), and built-in error checks.     

With this model layout, data flows logically from the tabs on the right to the tabs on the left.  Below is an example of how you can organize the tabs in your model.  You can also color-code the tabs as a means of “grouping” related tabs together.

3) Formatting

To ensure clarity and ease of use, always maintain consistent formatting throughout the model.  Aside from organizing the model into three main sections (inputs, calculations, and outputs), use consistent formatting throughout all the tabs and sheets in the model whenever possible. 

For example, if you need to separate business units into multiple P&L tabs, ensure that all tabs have identical rows and columns. This alignment is crucial, as misaligned total revenue or net income lines between tabs can make creating outputs a nightmare.  Additionally, leave clear and concise notes throughout the model and supporting documents.  These notes provide context for users, making it easier for them to understand the model's logic and functionality.

Font Color Formatting Guidelines

Another way to maintain consistency is to use specific font colors.  Here’s our recommendation:

It’s very useful for users to be able to quickly distinguish between hardcoded values and formulas.  When gathering new data, it’s imperative that you clean it up and apply these formatting conventions.  Also, make sure that your model never embeds a hardcoded value within a formula. 

Hot tip: to identify cells containing hardcoded values, select your data, press F5 to open the "Go To" dialog box, click "Special" and then "Constants”, uncheck "Text" (located underneath "Formulas"), and click OK.  This will take you to cells containing hardcoded values or display the message "No cells were found."

Maintain a Clean, Visually-Appealing Model

Maintaining a visually-appealing model can greatly enhance its effectiveness.  Using "white space" (keeping the first column and row empty) can make a model easier to view.  Color can also be a powerful tool in making a model more appealing and user-friendly.  Use color to highlight headers or draw attention to specific values.  However, be careful when using color, as overuse can have the opposite effect, making the model less pleasing to the eye.

We also recommend removing gridlines by going to "View" in the Excel ribbon and unchecking the "Gridlines" box.

Financial models typically display time periods from left to right along the horizontal axis.  Stick to this convention, unless you’re working on a unique format that may require dates along the vertical axis. 

Finally, do not hide rows or columns; instead, group them to maintain transparency and avoid potential errors.  When a new user inherits a model, hidden data can easily be overwritten.

Hot tip: Use Shift + Alt + ➝ to quickly group a row or column

Periodicity & Layout for Core Model Calculation Tabs

Avoid mixing periodicity across adjacent columns.  Group annual, quarterly, and monthly columns together to maintain a logical flow.  Some models place the annual column at the end (to the right) of each fiscal year, which breaks the flow.  Other models incorrectly group all annual columns to the far right of monthly columns. Don't do this. It can cause issues when adding new fiscal months, because the annual columns, to which outputs are linked, will need to be moved. 

To avoid this problem, keep annual columns on the left side of the sheet, followed by the quarterly columns, and finally the monthly detail columns on the right.  This “cascade” layout will ensure a consistent and stable structure.

Use a Vertical Structure

When building a model with multiple schedules, use a vertical structure to simplify linking between sections.  Avoid placing some schedules on the far right and others below, as this can create an illogical layout.  Whenever possible, keep schedules on a single tab, unless it becomes impractical. 

For complex operating models, we recommend separating the three financial statements onto individual tabs to avoid unnecessary clutter.  As you add more detail, analysis, or metrics, you'll likely need additional space beneath each statement.

While some financial modeling resources recommend consolidating financial statements onto one tab to simplify linking and reduce errors, we believe it should depend on the ultimate purpose of the model.  For high-level, annual models, this is fine.  However, for detailed, monthly operating models, this approach is not recommended. By standardizing formatting between tabs, aligning time periods, and incorporating error checks, you can achieve the same benefits without compromising clarity.  Plus, there’s an added psychological benefit from keeping each statement clean and visually distinct from one another.

Printing

Always maintain schedules print-ready or ready to be saved as a PDF document.  Receiving an Excel file that requires additional formatting to print or save can be frustrating.  To ensure print-readiness, first go to “Page Layout” in the Excel ribbon and click on “Orientation” to change it to Landscape or leave as Portrait if you prefer.  Next, set the print area by highlighting the desired portion of the sheet, then click on “Print Area” and “Set Print Area”. 

Hot tip: to create multiple print areas on the same sheet, use the Ctrl button while selecting additional areas with your mouse.  This allows you to create separate pages from a single Excel sheet.

4) Formulas

When building a financial model in Excel, aim to use one formula per row, whenever possible.  Grouping annual, quarterly, and monthly columns together helps maintain consistent formulas across each row. While formulas in annual or quarterly summary sections and actualized month columns will differ, forecast month columns should have consistent formulas across. 

Hot tip: to quickly identify inconsistent formulas across rows, select your data, press F5, and in the "Go To" box, select "Special", then "Row differences", and click OK.  This will take you to cells with differing formulas, or you will receive a message that "No cells were found".

Breaking formulas down into small components will enable others to more easily understand your model.  Avoid building out a very long formula in a single cell.  Instead, break it down into separate cells whenever possible.  Although this may require adding additional rows into your model, it will make it far easier to audit and comprehend.

Hot tip: use the Trace Precedents feature to help you audit formulas by pressing Ctrl + [.  This will take you to the first cell or array that is directly referenced by a formula. Use F5 + Enter to go back to where you started.

Resist the urge to create overly complicated formulas.  Most things can be accomplished with SUM, SUMIFS, INDEX-MATCH, and XLOOKUP.  Simplify whenever possible and don’t use nested IF statements; consider using the MIN or MAX functions instead, which can often accomplish the same thing without the added complexity. 

Use Flags Above Your Data

Use “flags” above your monthly detail to help you quickly summarize the data.  These flags are particularly useful when populating annual and quarterly summary sections in financial statements, as well as when generating outputs and analyses.  The example below shows how "flags" (boxed in red) can be used on an income statement.  The left section displays annual figures, while the right section shows the first three months of the 2026 fiscal year.  These flags are utilized in the criteria_range1 portion of a SUMIFS formula to aggregate values by fiscal year.

Leave a Blank (Buffer) Row Above Totals

Always leave a blank row above a subtotal or total, as this allows you to easily insert new rows later without disrupting your formulas.  By including the blank row in your SUBTOTAL or SUM formula, you'll ensure that the total updates automatically.  Additionally, when it comes to formatting, apply a top border directly to the total cell instead of a bottom border to the cell above.  This ensures that the border remains associated with the total, even if you insert new rows.  It also simplifies the process of copying formulas down to the cell above the total, as you won't copy over existing border formatting.

Corkscrew Schedules

Use "corkscrew" schedules to track beginning and ending balances, such as when you need to create supporting schedules for your balance sheet.  A corkscrew schedule is an approach used to track changes in balances over time.  It works by linking the beginning balance of a period to the ending balance of the prior period, then adjusting for any increases or decreases to arrive at a new ending balance.  The corkscrew method is sometimes also known as the BASE method (beginning balance, additions, subtractions, and ending balance).  Below is an example of a corkscrew schedule that also utilizes the MAX function in place of an IF function to ensure that the decrease never exceeds the starting balance:

Error Checking

We all make mistakes – build error checking into your model.  Omitting this step can lead to errors going unnoticed until your model or its outputs are shared with stakeholders.  To avoid this, build formulas (i.e., simple variance checks) to ensure that supporting schedules align with the financial statements everywhere in the model, and summarize your checks on the cover page.  Test your model thoroughly to identify and fix errors before someone else discovers them for you. 

Example of Error Checks

 Error Checks Summarized on Cover Page

Circularity

Circularity in a financial model occurs when a cell references itself, either directly or indirectly.  While circular references often indicate errors, they can also be intentional.  For example, calculating interest expense based on the average starting and ending loan balances in a three-statement model creates circularity.  This is due to the circular loop created by net interest flowing to the income statement, then the cash flow statement, and back to the cash balance.  Another example is company bonuses calculated as a percentage of net income, which in turn affects net income.

Circularity can be controversial due to the following three main risks that can exist when circularity is introduced in a financial model:

1. Iterative calculations must be enabled to avoid error messages

2. Users may not understand when to use circularity, and may not understand the difference between circularity that’s used intentionally as opposed to circularity that exists due to a model error

3. Circular models can sometimes crash

However, circularity can sometimes enhance model accuracy and the risks can be mitigated with proper training.  Users need to understand how to use a circular model and that a broken model can be recovered with the help of a circularity breaker (covered in the course on Mastering the 3-Statement Financial Operating Model). 

Hot tip: to check for errors created by unintentional circularity, turn off the circularity breaker and turn off the Excel setting that enables iterative calculations.  If the file still includes circular references, then you know that there is a mistake in the model that needs to be corrected.