6. Financial modelling

A spreadsheet is one example of a model.

But when the relationship between the input and outputs get too complicated, then more powerful full scale simulation tools need to be used.

Large organisations such as

• Mortgage houses,
• Insurance companies
• Banks
• Governments
• International traders

will have invested millions of pounds for software development.

Their software would include the latest statisticial analysis tools, high level mathematics, vast data pools with millions of entries.

These models would run on anything from mainframes to super-computers.

But at the end of the day they all do the same thing namely provide an answer to the question "What will the future bring?"

Example

When the Chancellor of the Exchequer is planning the new budget, he would use a financial model developed over time by the Treasury to find the answers to these sorts of questions:

–“If I put up child benefit by £5.00 a week, how many billions will that cost?”

–“If I give an extra £50 million to education, will that reduce the money available for the NHS?”

–“If I put up tax on a packet of cigarettes, how much would that really cost people each week?

The model that the Chancellor uses is a lot more complex than a spreadsheet.

There are thousands of different variables to consider in the economy and each one will have an impact on many different things. 

He can’t just decide on the spur of the moment to change the rate of tax, he needs to know how his decision is likely to affect the economy such as

–whether it will increase inflation

–how will it affect individual people and businesses

Notice the term 'is likely to' as there is no perfect model for complex things such as the economy, so software financial modelling can only be seen as an useful tool for businesses and organisationss when making important decisions that affect their future prosperity.