Of course we make mistakes. We are, after all, only human.
Some financial modelling errors are caused by lapses in mathematical skills. However, I witness on my modelling courses just how much normal human behaviour contributes towards many of the problems which plague financial models.
Here are some of them:
We over-complicate
Be clear, break down the steps and don’t use long-winded formulae. The solution is often easier than you think.
We fail to follow the instructions
I have lost count of the number of times people pick up ending balances instead of starting balances, despite a clear definition.
We are inconsistent
Inconsistency causes errors. To guard against this, stick to sensible modelling rules and consistent formats.
We take the quick option
Failing to model a change correctly and taking shortcuts is never a good idea.
We get lost in translation
Sometimes it is difficult to put our thoughts into words and the same goes when translating into Excel. It often helps to do worked examples with easy numbers, either with a pencil and paper or as a little mini-model.
We don’t check enough
Think about the implications of everything you model and check it. Don’t just press enter and move on to the next task.
We fail to apply a logical thought process.
For example, think about the implications of your modelling changes; think about the timing aspects and think about what you know and when you know it.
We can believe what we are told without question
Beware blind beliefs. If someone has told you that circularity in financial models can be solved by switching to iteration or by writing copy paste iterative macros, then apply logic and think again.
We jump to conclusions without sufficient thought
We often make assumptions based on insufficient information. We need to ask more questions. What is going on here? Always say to yourself: never make assumptions.
Some believe that they know the future
For those crystal ball gazers amongst you, I’m afraid that we simply do not know. We can make projections and that is, after all, what these financial models are based on. But as for exact knowledge of the future, that is impossible. The sooner you realise this subtle difference then the better your models will be.
We make excuses and think that rules don’t apply to us
How often have I heard the excuse that “of course models shouldn’t have circularities, but I write complex models and therefore that rule doesn’t apply to me”? Think again.
And lastly, the one which is probably the most important as it affects all of the others:
We don’t give our brains the chance to think
Give your brain a rest. Have a decent lunch break, remember that not much sensible modelling is done after 6pm and switch off those destroyers of focus: email pop-ups and phone beeps. And to free up the brain to think logically, you need to make sure that most of your modelling is automatic. Therefore, work at your keyboard shortcuts.
And, above all, be conscious of all these human traits so that we can learn to keep them under control and thereby build better models.