Why is Excel Not the Best Tool for Financial Modelling?
Companies all across the world use financial modeling. As we have discussed in several articles in this module, financial modeling solves many business problems. However, just like every other science, financial modeling too has evolved! The art and science of financial modeling have been mostly developed on a tool called Microsoft Excel. However, over time, Excel has become old and obsolete. In this article, we will discuss the various limitations of MS Excel in order to explain why it is not the best tool for financial modeling now.
Microsoft Excel has some serious limitations when it comes to the accuracy of the financial model. There are famous spreadsheet errors that have costed companies billions of dollars. JP Morgan is the best example of this. The bank used to rely extensively on Excel-based financial models in order to manage their portfolio. In 2012, the bank lost close to $6 billion, and later it was revealed that the banks team could not make the right decisions because they were blindsided by the erroneous data, which was provided by their Excel-based model. The exact cause has not been revealed. However, there is anecdotal evidence that the numbers on the spreadsheet were not accurately copied from one sheet to another. This led to a gross miscalculation and, finally, to a huge loss.
Excel is actually plagued by a wide variety of software limitations. If a company uses an Excel-based financial model, it has to be aware of the possible human errors, capacity limitations, and development errors that may be built into the model. Also, a small mistake in the financial model can have a cascading effect later on. These mistakes are difficult to detect and can have catastrophic consequences.
As the complexity of the financial model increases, the utility of Excel decreases inversely. This is because Excel is basically a two-dimensional model. However, in reality, data needs to be processed in multiple dimensions. This is because there are hundreds of variables that may affect the financial results of a company in real life.
Excel is not capable of handling these situations. For instance, some kind of analysis, such as Monte Carlo simulation, uses large volumes of data. It is a known fact that Excel is not the best tool for Monte Carlo analysis. Investment banking firms have started using other software which is more reliable.
Difficulty in Collaboration
Basic versions of the Excel sheet only allow one user to work on the sheet at a time. This becomes a major limitation given the fact that in real-life, financial models are so huge and complex that they are seldom managed by a single person. Therefore, if Excel is being used, a person needs to complete work on the Excel sheet. Once the task is completed, they need to e-mail that sheet to a different person. The second person may send the sheet back with more changes. Reconciling different versions of the same financial model becomes a major challenge if Excel is used.
Advanced versions of Excel allow multi-user functionality. This allows for better and more seamless collaboration. However, licenses for these versions are very expensive. Hence, when a company does a cost-benefit analysis, they generally find out that they are better off buying other financial modeling software since it works out cheaper and provides better features as compared to Excel.
High Requirement of Human Skill
Companies that use Microsoft Excel have realized that it turns out to be expensive since it also requires very skilled people, and these people have to be paid higher salaries.
An Excel sheet is blank and unstructured. Hence, creating a financial model in that sheet requires a lot of skill on the part of the financial modeler. These modelers need to be good at programming as well as an understanding of the financial function. This is not the case when other, more advanced software is used for financial modeling. A lot of the features which have to be programmed into Excel are available as out of box functionalities within other software. This reduces the dependence on human skills.
Also, if a person is working on multiple projects in Excel, managing the workflow becomes a tedious task. The end result is numerous spreadsheet which looks confusing and has similar names. Advanced software allows users actually to spend time analyzing the data. The administrative tasks such as importing and exporting data are performed automatically by the software.
The only advantage of Excel is that it is unstructured and allows the modeler to create the model in any way that they see fit. Hence, it is still the tool of choice for types of models that are not easily available in out of the box financial modeling software.
The bottom line is that MS Excel is only suitable for financial models that arent too complex or big. Continuing to use Excel despite its limitations, can have significant financial consequences.
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The article is Written By Prachi Juneja and Reviewed By Management Study Guide Content Team. MSG Content Team comprises experienced Faculty Member, Professionals and Subject Matter Experts. We are a ISO 2001:2015 Certified Education Provider. To Know more, click on About Us. The use of this material is free for learning and education purpose. Please reference authorship of content used, including link(s) to ManagementStudyGuide.com and the content page url.
- What is Financial Modelling?
- Objectives of Financial Modelling
- Steps to Create a Financial Model
- Financial Modelling Heuristics
- Financial Modelling: Advantages and Limitations
- Why is Financial Modelling so Complex?
- The Future of Financial Modelling
- Creating a Revenue Model
- What is Cost Modelling?
- Important Decisions Influenced by Cost Modeling
- Financial Modeling: Important Metrics
- Scenario Analysis: A Primer
- Risk Management in Financial Modeling
- Modeling Discounted Cash Flows
- Debt Schedule in Financial Modelling
- Managing Assumptions During Financial Modelling
- Financial Modeling for Banks
- Financial Modelling for Insurance Companies
- The Merger Modeling
- Merger Modelling: The Accretion/Dilution Analysis
- Financial Modelling For Leveraged Buyouts (LBOs)
- Circular References in Financial Modelling
- Financial Modelling in Real Estate
- Why is Excel Not the Best Tool for Financial Modelling?
- Testing the Financial Model
- The Last Step: Handing Over the Financial Model
- How to Incorporate Ethical and Social Elements in Financial Modelling