Investment Banking Financial Models vs. Consulting Financial Models

Investment banking and management consulting are two of the most sought after – and thus competitive – industries in the business world. Both are extremely data driven and involve varying levels of financial modeling. In this article, we will be discussing the similarities and differences between investment banking financial models and financial models used in consulting.

Overview of Investment Banking Financial Models

Financial models are the bread and butter of the investment banking world and are the primary reason banks get paid the big bucks. Depending on the industry and type of transaction, these financial models can look very different from the ones you’ll build in consulting. And this makes sense: bankers and consultants do fundamentally different jobs. Overall, investment banking analysts build models based on two types of transactions – M&A or capital raises – and models are mainly built to accurately value companies.

Top 3 similarities of Investment Banking Financial Models to Consulting Financial Models:

1. Models are Driven by the Type of Transaction and Require Specific Analysis

Most investment banks offer services for two types of transactions: mergers & acquisitions or capital raises (i.e. Initial Public Offerings or debt raises). Depending on what the client needs, there is usually a specific analysis that the investment bank knows it needs to conduct.

For mergers & acquisitions, common analyses include Discounted Cash Flow, Trading Comparables, Precedent Transactions, Accretion/Dilution, and Leveraged Buyout.

For capital raises, common analyses include Initial Public Offering valuation, debt repayment waterfalls, and debt restructuring models.

After a meeting with a client, investment bankers will typically know exactly what kinds of financial analyses are required, and they’ll get straight to work. Because investment banks have been around for so long, they have long established processes for each type of transaction. These models are still complex and have unique elements depending on the client’s needs, but they are largely similar.

2. Heavy Emphasis on Accounting

Investment bankers need to develop a strong understanding of accounting to build accurate models and best serve the needs of their clients. Investment banks spend extremely large amounts of time and money training their employees in accounting, which is the foundation of financial modeling.

The three main financial statements are the income statement, the cash flow statement, and the balance sheet. These three accounting statements are used heavily throughout almost all investment banking financial models. This differs from consulting, where there is usually a focus on just the income statement.

Investment bankers spend a lot of time pressure-testing a client’s financial projections and will often help clients forecast entire financial statements for future years. To do this, bankers need to understand how the three financial statements connect with each other so they can utilize them for various financial analyses. Even though clients have their own finance departments, they will often lean on investment bankers for these analyses as they pursue complicated and sensitive transactions.

3. Most Financial Modeling Revolves Around Valuation

Clients typically already have their own finance departments and understand what their historical financial numbers look like. They also may have projections of where they see their businesses going in the next few years. Investment banks add value by helping clients utilize these numbers to determine valuation, or in other words, how much they are worth.

Corporations are large, complicated organizations. To value a business that has thousands of employees, hundreds of products, and a global reach, clients need to hire professionals who are experts at valuation. Investment bankers focus on prioritizing the important financial figures out of the sea of thousands of different metrics in order to value a company.

Though there are many different services that an investment bank offers, valuation is by far the most important analysis that banks provide. As a result, most financial models built by bankers focus on valuation, as opposed to other services that require modeling, such as market sizing or pricing strategy. The best IB modeling course on the market was built by BIWS – check it out if you’re on the IB path.

Overview of Consulting Financial Models

While management consulting isn’t particularly known for financial modeling, the industry does require data-driven analysis. Like investment banking, the analysis required differs from project to project and varies amongst industries. Consultants run what is commonly referred to as scenario analysis. Because each client question being answered is different from a previous project, there is no use of templates in consulting, while bankers can sometimes get away with using a foundational financial model template. Still, there are notable similarities amongst consulting financial models.

Top 3 similarities of Consulting Financial Models to Investment Banking Financial Models:

1. Models are Unique to the Business and Project

Unlike investment banking, where there are set types of transactions that occur repeatedly, management consulting projects are unique. Great consulting firms take pride in offering specific and catered advice to their clients, rather than providing cookie-cutter insight.

As a result, financial models in consulting tend to have no templates and most are built from scratch. Though there may be some overlaps in the types of projects that consultants work on (i.e. cost cutting, pricing analysis, new product entry), consulting projects typically cover a wide range of business problems that require different analyses.

For instance, you may have one project that has a primary objective of launching a new product into an existing market. To provide the right recommendation, your team may need to analyze the market opportunity for the product, create a pricing model, and measure the size of the product gap in the market.

For the same objective for a different client, your analyses may be completely different. Instead of the aforementioned analyses, your client may require an analysis on potential product cannibalization and cost cutting to create more budget for the new product.

2. Heavy Emphasis on Research

While financial modeling is the bread and butter of investment banking, data-driven analysis and recommendations backed by intense research are the hallmarks of great consulting firms. Consultants spend hours, weeks, or months focusing on various types of research in order to back the assumptions in their financial models.

Data usually comes from a combination of primary and secondary research. To make matters more complex, consultants are often tasked to come up with data that isn’t available but is required to complete an analysis. As a result, consultants have to come up with different ways to triangulate into the right data using a range of sources. These include publicly available information, conducting massive surveys, hosting expert interviews to validate key assumptions, and ultimately, gut checking to make sure any assumptions aren’t totally crazy.

As you can imagine, all this research results in extremely large datasets that feed into highly unique financial models. The data also usually feeds into some key financial figures. For example, a survey with 10,000 responses built around pricing strategy can help consultants recommend the right price for a new product offering, which eventually feeds into the revenue side of the equation.

3. Large Focus on the Income Statement

Most management consultants are not experts in accounting, and they don’t need to be. Consulting firms don’t require a full understanding of how the three financial statements connect because their projects tend to focus on the income statement. Clients go to consulting firms to help them with ultimately increasing their revenue or decreasing their costs – they just ask for this help in different ways.

For instance, to increase revenue, a client could launch a new product, enter a new market, or adjust its pricing strategy. All of these could be potential objectives of a consulting project and they all lead to the income statement.

Therefore, financial models in consulting don’t usually require a heavy knowledge in accounting. Of course, a solid understanding of accounting never hurts, but most projects are geared towards the client’s income statement. It is extremely rare for a consultant to have to work with all three main financial statements for one project.

Similarities and Differences in Investment Banking and Consulting Financial Models

Now that you understand the main features of investment banking and consulting financial models, let’s compare and contrast them. As you may expect, there are several similarities and differences between the models in these two industries.

Similarity #1 – Various Scenarios

Both investment banking and consulting financial models are built to compare impact based on different levers you are assessing. As a result, the structure of the models in both industries tend to be built to compare different scenarios, which can help identify important risk factors. Oftentimes, this entails creating a conservative, base, and optimistic case for several assumptions.

Similarity #2 – Tons of Assumptions

Modeling in both investment banking and consulting require many assumptions backed by data and research. Both industries require looking towards the future and projecting financial figures, meaning that the inputs are not certain. Banks and consulting firms spend large quantities of time building out these assumptions in their models.

Similarity #3 – Detail is Important

For both industries, the stakes and client expectations are high. It’s not uncommon for Excel models to crash because there is so much information packed into them. In addition, these models need to be double and triple checked so that they accurate insights can be drawn from them.

Difference #1 – More Research in Consulting

Consulting financial models tend to have much more research backing their assumptions. This is because consulting firms are often entering new territory and helping clients solve business problems where there are no clear answers. As a result, consultants need to gather large quantities of data. On the other hand, investment banks utilize historical precedents, public information, and industry research reports that already exist to support their assumptions.

Difference #2 – More Financial Complexity in Investment Banking

While there is less research backing investment banking assumptions, there is a lot more financial complexity in investment banking financial models. Bankers need a more solid understanding of accounting in order to properly utilize the right financial metrics when valuing a company. On the other hand, most consulting projects ultimately lead to the income statement, and require less of an understanding of the purpose of each line on the three main financial statements.

Difference #3 – More Precedent Examples in Investment Banking

While valuation can also have its ambiguities, there are specific analyses that are industry standard that help companies understand their worth. As a result, when presented with a modeling task, investment bankers can look at previous similar models to get a sense of what kind of model needs to be built. On the other hand, consulting models tend to require more originality of thought and are almost always built from scratch to cater to the client’s needs.

Summary

As you have seen, investment banking financial models can vary quite a bit from consulting financial models. However, at the end of the day, whether you are interested in investment banking or consulting, a knowledge of financial modeling is a must.

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