Immersion Learning

The Spreadsheet Street

by Branko Slavko Rodic, MBA '15 (4/21/14)
Branko Slavko Rodic, MBA '15“Rocket Scientist” is a somewhat old term used to describe the first generation of financial quants that arrived on Wall Street in the early 1980s. Typically trained in applied math or statistics, “rocket scientists” were well-known for their adventurous spirit and love for innovation. They built very complex financial models used to forecast future performance, manage risk and yes, attract adoration in others. Financial modeling, which is usually not so extreme, is at the core of investment banking.

Over the last couple of months, the Investment Banking Immersion (IBI) team at Johnson has received a relatively broad exposure to financial modeling concepts through a half-semester long class (part of the IBI program), as well as through weekend-intensive courses delivered by Training the Street and Pillars of Wall Street (PWS). Founded by ex-Jefferies & Company investment bankers, PWS is a highly respected provider of financial modeling training for soon-to-be investment bankers, with a client list including top tier investment banks and business schools. Having the opportunity to hear another perspective on the same topic was very beneficial to all of us.

In parallel, PWS offered basic and an advanced course. The IBI team predominantly attended the advanced course, where the highly energized instructor covered everything from the logics of the three-statement model to time (read: life) saving shortcuts and other best practices. The training was very useful in that it addressed some of the relatively more advanced topics such as circularity in the model, model integrity and cash sweep. We all had an opportunity to learn or rethink the mechanics of a model, how financial statements tie together and what drives the output by building models from scratch or by stress testing/debugging existing ones. The swift change in perspective from model preparer to model reviewer taught us how to quickly pinpoint and correct flaws.

That brings us to a very important lesson from the PWS training: the dangers in financial modeling. The biggest danger probably is, “we got this.” No, we don’t. We have merely scratched the surface. Just because our balance sheet balances, it certainly does not mean that our model is correct. Another one is, “the more complex, the better.” Again, no. Take it from my own, limited experience - it is unbelievably easy to get carried away and add unnecessary complexity to a model. As the complexity reaches higher levels, the level of common sense tends to drop and the model becomes inherently more prone to flaws. Finally, “it is correct”. A model is an assumptions-based estimate of a given company’s future financial position and performance. With all of the modeler’s rigor, foresight and imagination, a model is an approximation of the future, nothing more.

It might be wiser to assess financial models by asking what they ignore and how wrong they are likely to be rather than what they can do or how great they are. It seems to be the same question from a different angle, but even if you are a modern “rocket scientist,” the angle (attitude) still matters. It matters because the consequences of a model gone wrong cannot be contained within a spreadsheet.