The Best Practices for Financial Model Audit and Reviews |
Posted: January 24, 2023 |
Creating a financial model is just the first step in the process. It must be reviewed for accuracy and correctness to ensure that all assumptions are sound and results valid. Financial model audit and review is an important practice because it keeps models reliable, accurate, and able to meet their objectives. However, since financial modeling is new for startups, companies often overlook the importance of model reviewing and auditing. The article explains the best practices for financial model audit and review. What Is A Financial Model Audit? Generally, an audit refers to analyzing and verifying the accuracy and consistency of a financial model. A financial model audit aims to obtain an independent opinion on whether the model is valid and can be relied upon. It requires assessing a financial model's underlying assumptions, inputs, outputs, and results to make sure the model is based on sound financial principles and assumptions, is properly constructed, and is correctly implemented. Who Conducts It? An independent financial model auditor or a team of auditors with expertise in financial modeling, accounting, and economics conduct the audit. The auditor should have an understanding of the industry in which the model is being developed and a deep knowledge of economic and financial principles that underpin it. Components of a Financial Model Audit Every financial model audit consists of three components:
In addition to these components, there may be other specific requirements depending on the type of financial model being audited. For example, an audit of a mortgage-backed securities model may require the auditor to review valuation models used for each asset. What Is a Financial Model Review? Reviewing a financial model looking at the structure of the model, its assumptions, inputs, and outputs. A financial model review involves analyzing and validating the integrity of a financial model's by reviewing the data, assumptions, and logic used to arrive at a conclusion. It has the following benefits:
Who Reviews the Financial Model? In a startup, one of the most common financial model reviews is conducted by the CFO, controller, or a professional from an accounting firm. A financial analyst or consultant can also do a financial model review. How Often Should Financial Model Reviews Take Place? Financial model reviews should occur regularly, usually once a year. If there are any major changes in the model or if the assumptions or data used in the model change, you should review it more frequently. For example, if the company's financial projections need to be updated on a quarterly basis, you should review the model every quarter. Additionally, if there are major changes in personnel or processes, you should also review the model. Best Practices for Reviewing and Auditing Financial Models You've created a financial model. Good job! Now, it's time to review and audit your model periodically. Here are some best practices in this regard. Establish Clear Objectives Why do you need to review and audit your financial model? What specific outcomes are you hoping to achieve? You need to set clear objectives before beginning the process. These objectives could be:
Create a Checklist Once you have established the objectives of your review and audit, create a checklist to help guide the process. Your checklist should include questions, tests and scenarios that you can use to evaluate the accuracy and reliability of your financial model. Review Historical Data In order to have an accurate model, the data you're working with must be up-to-date and accurate. Before beginning your review or audit, check to ensure that your historical data is up-to-date and accurate.
Review the Assumptions Your financial model is based on certain assumptions. It's important to review these assumptions regularly to ensure they remain valid. When reviewing your assumptions, consider the following questions:
Check the Model Formulas Test formulas to ensure accuracy and that results match expectations. Pay close attention to formulas that involve calculations with multiple cells or sheets. Check for any errors in the formulas and adjust as needed. It's imperative to check the following formulas:
Perform Stress Tests & Scenario Analysis Stress tests and scenario analysis can help identify areas where the model may be too fragile or not robust enough. Suppose a certain assumption changes or a new risk arises. Could the model withstand it? A stress test or scenario analysis helps you identify any potential weaknesses in the model and allows you to take corrective action. Document Your Review & Audit Process Documenting your procedure will helps others understand your methodology if they need to review or audit it in the future. It also sets the tone for future reviews and audits. Document your objectives, assumptions, formulas, tests, and results. Create a template that you can use for future reviews and audits. Start With a Cohesive Financial Model Your model audits and reviews won't be helpful if you don't start with a well-made financial model. Luckily, Numberly takes care of this for you. We create models that tell your unique story, reflect your assumptions, and are flexible enough to adjust to changing markets. Schedule a call with us to get started.
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