Financial modelling: to model is to understand

FINANCIAL MODELLING EXPERTS

Author:

Kenny Whitelaw-Jones

Published:

27 May 2012

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I’ve just finished writing some teaching material that focuses on foreign exchange, for our online FAST Financial modelling course. It reminded me of how little I understood when I became an accountant.

Take inventory for example. In the first two weeks of accountancy training, we did bookkeeping. We learned about inventory. We learned that inventory was valued at the lower of cost and net realisable value. We were tested on inventory. Could we do the double entry bookkeeping? Could we prove that we should retain our training contracts with our big important firms by showing we knew what to do with inventory? In those early days, I knew what to do with inventory. But I did not understand it. It was only when I came to model inventory that I got it.

What modelling gets you to realise is a simple fact that most accountants just don’t think about: the whole point of inventory is that it excludes any profit margin. The lower of cost or net realisable value means no profit.

Not a thing.

On countless occasions – and once at Wolverhampton Wanderers – I have stood in front of an audience of accountants and told them about cork screws in financial modelling. “What makes inventory go up?”, I ask. “Purchases”, they reply. “Quite right”, I say. “Now: what makes inventory go down?”. “Sales”, they reply. Every time. Without fail.

Of course it is not sales – it is cost of sales (since cost of sales excludes profit margin). And every accountant when they stop to think about it knows that it is cost of sales. Financial modelling forces you to think about it.

 
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Kenny Whitelaw-Jones
Kenny Whitelaw-Jones is no longer with F1F9 but we really like this blog so we've kept it.