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Financial modeling seeks to create a financial representation of a business or security by establishing the variables the influence the business and determining current and future value. This allows financial professionals to make investment decisions, manage risks and calculate the cost of capital. Excel is the favored tool of practitioners of financial modeling. The two main applications of financial modeling are business financial modelling and financial instrument modeling but the use of financial models can extend to any quantification process that seeks to establish and determine the relationship between a set of variables.

Business financial modeling is used extensively by hedge funds, managed funds and financial analysts to establish fair value for a business or security and to monitor financial performance. By performing the necessary calculations and comparing it to fundamental performance standards, investment managers make decisions on whether to buy, hold and sell. When the market moves ahead of underlying valuations and business performance does not continue to maintain pace, managers seek alternative avenues for capital deployment as the risk of holding the security increases when prices extend beyond the theoretical values assigned by the financial model. Investment decisions are, in part, made with consideration to financial model analysis and by assigning weight to the importance of macroeconomic, microeconomic and exogenous variables that are likely to impact on the business and share price performance.

Financial instrument modeling is used by the financial industry to structure derivative based products and to make investment decisions on them. A common application of financial instrument modeling is in the field of options. Traders and investment professionals use these models to establish fair value of the instrument. The black scholes option model is one such model that serves as a framework of reference for financial industry professionals to price products, structure solutions and make investment and trading decisions based on the changes in the variables that affect the pricing of the security.

Financial modeling software tools are evolving to meet the demands of financial industry professionals who are faced with the task of modeling complex data sets. Although Excel is a common tool used by a diverse range of industries, more sophisticated tools calibrated for financial number crunching such as Matlab are gaining popularity because it provides the functions and environment to build your own applications in a very short time for immediate deployment. This specialized tool is heavily weighted with complex scientific and mathematical functions and has become a favored tool of analysts working for investment companies.

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