A peer review of a financial model is a process that is often overlooked in the model development process. Even if a review is conducted, the reviewer does not spend enough time reviewing nor sees the added value in the review. The model review is more than simply a second set of eyes; it is a technical model review and a corporate governance tool.
Second set of eyes
The model review rightfully identifies mistakes or oversights. Often a financial model is developed at such break-neck speed and short notice, that the model developer can often make the most elementary of mistakes. All model developers can become stale during the model development process, which often results in basic oversight or causing the model to be less user-friendly to stakeholders.
To achieve complete added-value to a company’s financial model, the developer must understand the need to craft and build the model to suit the client company’s specific requirements. Oil & Gas Company 1 Inc may have very different requirements to Oil & Gas Company 2 Inc, for instance the later company may have a very different capital structure and this needs to be considered in building the model’s debt sculpting functionality.
Technical model review
As mentioned in the above, the model needs to be crafted to meet the company’s needs; this means the technical detail from modelling for example an aviation business compared to an education provider is very different. There are more factors to account for in computing total cost of labour for an aviation client, whilst an education or training company will possess more tangible direct costs required in facilitating training delivery.
The peer review will be vital in sense checking tax rates, additional costs of labour, relevant foreign exchange rates, and depreciation treatments from both a tax and accounting perspective. In the case of a corporate valuation, the application of a computed weighted average cost of capital (WACC) or capital asset pricing model (CAPM) to discount forecasted future net cash flows will result in varying corporate valuations, and therefore a peer review would be imperative to ensure an appropriate discount rate is applied.
Corporate governance reasons
Given corporate executives make business decisions based on financial models, it is imperative the model is totally accurate and error free. Hence a peer review is an important corporate governance tool. If a company does not undertake a peer review, they are at risk of making important business decisions based on incorrect financial numbers computed in the financial model.
Sometimes a financial model is developed, managed and owned by the one person – the model developer. The peer review will at least guarantee a knowledge transfer to another person in the company, which will avoid the risk of the model developer leaving the company and no one being able to manage the model. The knowledge transfer issue is strongly correlated with corporate governance; the peer review is not an option but a necessity, given the important decision making that will result from the use of the financial model in question.
The value of a Peer Review
The importance of a peer review to specific financial models in your company cannot be understated. Certain corporate stakeholders may view the time and expense as unnecessary, however the benefits more than compensate that for this. The review of a model will advance corporate governance, transfer of knowledge, validate technical inputs and outputs, and provide an overall second set of eyes with the model.