Other Methods Ltd

Practical Application of Financial Modelling Back to top

Competition for investment opportunities is growing. A recent Bain Capital report estimated that by 2020 there will be $900 trillion of financial capital in comparison to global GDP of only $90 trillion. In this environment, it will be a competitive advantage to be able to weigh up possible investments quickly and comprehensively. Financial models will be a key part of this process.

In recent decades with advances in IT and markets, financial models have become more sophisticated. For the purposes of this article, I have split financial modelling (FM) into two broad categories which I have called Continuous and Discrete.

I have used "Continuous" FM to refer to the mathematically and computationally complex financial models built by quants for purposes such as the pricing of financial instruments. In the document I describe at very high level how an option might be priced using data inputs such as volatility (based on historic share price fluctuations) and the Black-Scholes-Merton formula.

I refer to the mathematical regression / linear interpolation app for an example ofhow a set of data can be used to formulate a simple algorithm for estimating a value outside of the observed data set.

I have used "Discrete" FM to refer to the Excel-based cash flow forecasts produced by people who have some level of accounting knowledge to appraise investments such as the construction and operation of a wind farm.

I also refer to the very simple app of stock and bond cash flows as an illustration of this type of model.

In conclusion, I hope that it is apparent that financial models can be hugely valuable. In light of this, access to competent financial modelling resource will be of increasing value to investors and the business community.

To download the full PDF document, please click here.

Advertising and the development of web business: Back to top

Recent articles in the FT have pointed out that although the core service offering of Google and Facebook can be considered quite different, they both earn the bulk of their revenues from advertising.

There is concern that this might pose certain risks to the development of web-based companies: they might be forced to ‘zero-sum’ competition for the same revenue stream as other companies which operate in a fairly different market, and they might prioritise traffic through their site over focused, individualised service delivery to each customer.

The revenue source that media and advertising presents is enormous, and web traffic is still destined to grow at a phenomenal rate for years to come, so the effects of the trend (for traffic volume over service quality) will not be felt for years yet. Nevertheless, the concern remains.

However, there are a number of points that might work to alleviate the concerns raised by this perspective:

1. Although Google and Facebook do rely on advertising revenue so far, they are also exploring other business streams and means of making revenue. They are diversifying and differentiating as they go. At some point their advertising revenues will be only one of several revenue streams, and the other product lines may be charged for separately.
2. In some respects these two companies are quite similar – they connect users with other resources, in a similar way that telephone directories and contact books used to. So, in this respect, they are logical companies for advertisers to target.
3. The business models that they have adopted might serve as a guide to other companies looking to boost their web presence: understand that the advertising revenue stream may work in your favour, particularly in the early days of getting your service established, and try and build a strategy which includes it into your business plan.

At the moment advertising is doing wonders for growth of companies using modern networking technologies and the Internet. Some distortions will arise from rapid organic development of the web. Rather than seeking to reign in the effect of advertising, companies should capitalise on it or, if they perceive that their competitors’ core service offerings are being compromised by their focus on advertising, by beating them in the service delivery of that offering.

FT articles:

1. ‘An insider’s warning for the tech industry,’ in the FT of 24/04/2013, by Ravi Mattu
2. Various articles by Emily Steel in the FT’s Special Report on ‘Digital and Social Media Marketing’ (www.ft.com/reports) on 25/04/2013.

TBD Back to top