People often ask us when they should use a customized financial model versus an off-the-shelf valuation tool. Each valuation tool has strengths that should be utilized at different phases of the valuation process.
Strengths of an Off-the-Shelf Financial Valuation Tool
A key time to use an off-the-shelf financial valuation tool or generic financial model is during the early screening phase of a project. Using this type of high-level tool will save you time when you’re working with general assumptions or publicly available information. It’s a good gut-check tool, allowing you to quickly evaluate if the project passes your initial investment requirements. We like to compare this type of valuation tool to an online mortgage calculator. It’s a great way to evaluate if a home is in your price range, but you’d never use only the calculator to make the decision to purchase a home.
Another time to use an off-the-shelf tool is if you don’t have the background or the industry knowledge that you need to analyze the financial aspects of your project, like tax laws.
Off-the-shelf tools are great for high level screening or when you don’t have the background to dive more into particular project in the early stages.
Strengths of a Customized Financial Model
When you start more seriously thinking about an opportunity, that’s the time to make the switch from using an off-the-shelf valuation tool like IHS PowerTools or ARIES Petroleum Economics and Reserves Software to developing a customized financial model.
A customized financial model excels at analyzing what-if scenarios that are unique to your particular opportunity. Additionally, if you need to view the investment through your company’s financial lens and evaluate how the opportunity is going to impact your value and how it’s going to fit into your overall portfolio, you must have a customized financial model. An off-the-shelf valuation tool simply is not going to give you the level of detail you require to make an informed investment decision.
Additionally, if you’re considering investing in a project that has moving parts, you’ll need to look at the market forces and the elements that are within your control that also impact the valuation. Your financial model will need to be dynamic enough to roll up all of these considerations in a simple and easy-to-understand format. Once you’re ready to invest time and energy into pulling together your business case, as well as perform the sensitivity analysis, and before you head into negotiations, you’ll need a fine-tuned customized financial model that allows you to look at a project through your unique financial lens.
A customized financial model is essential to understanding all the different value drivers, and to guarantee you understand the value trade-offs prior to negotiations. If you’re looking for more information, please contact us.
About Darby Finance
Darby Finance helps clients make better financial decisions by transforming complex data into a compelling and easy-to-understand financial story. We work alongside our clients to develop customized financial models, valuations, and sophisticated investor presentations while utilizing more than 40 years of experience in energy, finance and investor relations.