Governance is essential to any organization in any industry. Model governance is no exception to this rule and is critical in ensuring the accuracy of models used in the financial sector. 

It helps to ensure that models are updated regularly, appropriately validated and tested, and used in an effective manner. Let’s look at model governance closely.

What Is Model Governance?

Model governance includes all activities, processes, and procedures related to managing the development, execution, and control of financial models used by companies. It is a framework that helps organizations develop, maintain, and use accurate, reliable, and up-to-date models.

Model governance is also a form of risk management in that it helps mitigate the risk associated with model development and utilization. It provides a structure for organizations when dealing with complex financial models. Plus, it ensures that models are used correctly and in accordance with company policy.

Goal of Model Governance

The ultimate goal of model governance is to promote the development of quality models. Companies achieve this through a combination of processes, policies, procedures, and controls designed to ensure that predictive models are created, tested, and deployed in a systematic and rigorous way.

As part of this effort, companies should also strive to ensure that model performance is monitored and tracked over time. Furthermore, any risks associated with using the models are identified and managed.

Components of Model Governance

Model governance has several parameters. Here are some of them.

Recording

The first step in creating seamless financial models is recording data. It includes an organization’s assets, liabilities, income, and expenses.

The data also includes any financial projections that are made by a business. Recording this information helps create a history and track changes in a company’s financial position over time.

Auditing

Human error and coding errors can lead to inaccurate or incomplete data. Auditing helps validate the accuracy and completeness of financial models by ensuring that all relevant data is captured and reported.

Validation

Validation is an important part of model governance that ensures accuracy by testing and verifying the information used in a model. It identifies any potential issues with the data or assumptions used in the model and can often be automated to ensure accuracy.

Approval

Someone in the company needs to approve the model before it is used in any financial reporting. In most cases, this will be a senior executive or the C-suite.

Approval is a crucial part of model governance and should involve an objective evaluation of the model. Here are some guidelines for approval:

• Review the assumptions and data used in the model.
• Check for any errors or discrepancies in the model’s output.
• Ensure that the model is consistent with any existing financial policies or regulations.

Monitoring

A one-time approval is not enough. Model governance also includes regular monitoring of the model to ensure that its assumptions and outputs remain accurate over time.

For instance, any changes to the underlying assumptions or data used in the model should be reviewed and approved. Let’s say you created a financial model for your startup based on your post-Covid projections.

Now that the world is slowly emerging from the pandemic, you should check to see if any of your assumptions have changed and adjust your model accordingly.

How to Incorporate Model Governance for Financial Models?

Before creating a model governance framework for financial modeling in your company, you should be familiar with the four elements of governance. They include:

• Predictability
• Participation
• Accountability
• Transparency

By incorporating all four elements into the financial modeling process, you can ensure that models are designed and managed in a way that will produce accurate results and meet performance goals. Here’s how to use model governance in financial modeling.

Step 1: Set Your Governance Criteria

What do you expect from the financial models in your company? What should be included, what should be excluded, and what are the standards for performance? Establish these criteria before you begin designing models.

Step 2: Identify Your Model Governance Committee

Select a group of people who will be responsible for overseeing the development and management of financial models. The committee should include analysts, managers, and executives who are knowledgeable about the models and their performance.

Step 3: Establish Modeling Standards

Define the standards that must be met to use a model. From data accuracy to updating frequency, these standards should be clearly defined. Establish protocols for testing and validating models as well.

For instance, the committee should consider how much data is needed to accurately measure performance and the type of data that should be included.

Step 4: Set Up Model Governance Policies

Create policies that outline how models should be used and monitored. For example, the committee should establish guidelines on how to handle changes or updates to the models, plus rules for who can make modifications.

Step 5: Monitor Model Performance

Once the model governance framework is in place, the committee should regularly review and monitor the performance of the models. Any changes or updates to the models should be made with the approval of the committee.

Step 6: Establish Model Documentation Requirements

Finally, require that all models are properly documented. It should include the criteria used to create the model, its purpose, and any changes made over time.

The relevant stakeholders should have easy access to the documentation. Meanwhile, any changes to the model should be logged for future reference.

Create Pitch Deck-Ready Financial Models With Proper Governance

Since most investors spend under three minutes reviewing a pitch deck, it’s important to make sure your financial model tells the whole story quickly. But how do you accomplish this?

Numberly is at your service. We create bespoke, high-quality financial models that are tailored to illustrate the key points of your business plan. Besides model creation, we are also at your side in case you need an update.

Let’s say your startup has built a new product, and you are ready to take it to investors. You want to make sure that your financial model conveys the right message: your company is trusted and credible. We will help you create a financial model with proper governance to support your business narrative. Call us today.