financial modeling
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All Rights Reserved. Corporate Bridge TM
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www.corporatebridge.net 1Private and Confidential – Not for Circulation
Private and Confidential
Financial Modeling E-Book
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All Rights Reserved. Corporate Bridge TM www.corporatebridge.netPrivate and Confidential – Not for Circulation 2
Discussion topics
Overview of Financial Modeling
Excel Best Practices
Modeling Warm Up
Key Financial Statements
Working Capital Schedule
Depreciation Schedule
Amortization Schedule
Long Term Items (Others) Schedule
Building Income Statement
Shareholder’s Equity Schedule
Shares Outstanding Schedule
Preparing for Debt & Interest
Trouble Shooting
Completing the Financial Model
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Introduction to Financial Modeling
Simplified representation of performance
Both past and future
Blend of skills is required
Understanding of the company’s (project’s) operations Accounting Knowledge Corporate Finance principles Excel (spreadsheet) techniques
Different Types of Models
Earnings model with projected earnings/ profits Debt/ Recapitalization/ Financing Model Merger Consequences model (Mergers/ Acquisitions/ Divestitures) Discounted Cash Flow models
Utility of Financial modeling
Virtual recreation of the actual business (need to understand the business logic) Ability to test assumptions to analyze impact on future performance
• Growth Rates• Operating Margins• Product lines/ business segments• Refinancing/ recapitalization
Understanding the purpose of the modeling in order to create the right design and functionality
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Assumptions – Importance in Financial modeling
Need to have clear and well defined assumptions
Referred to as ‘drivers’ or ‘inputs’ these are based on a thorough understanding of the business
Assumptions should reflect business realities and expectations
No bias should get into the assumptions on the business Always remember “GIGO” – Garbage In Garbage Out Use the past performance and a guide for future expectations Clearly understand the expected changes in future performance Understand Management expectations Check out what other analysts think about the company
How to make Assumptions
Past as an indicator of future performance, except in case of • Start up situations• Significant acquisitions or divesture activities• Volatile industry structure
Key tests a financial model should withstand
Is it a reasonable model Can the assumptions/ model be defended
Features of an effective model
Should be realistic based on reasonable and defensible assumptions and projections Should be flexible and adaptable with dynamic working schedules (or modules) Should be easy to follow, should not intimidate the reader
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All Rights Reserved. Corporate Bridge TM www.corporatebridge.netwww.corporatebridge.net
Excel Best Practices
Maintain Consistency
Makes understanding and constructing easier
Consistent Color scheme makes life easy for self and others using the model
• BLUE for inputs (historical data, assumptions, drivers)
• BLACK for calculations and references on same schedule/ asset
• GREEN reference from another schedule/ sheet
• RED warnings to another user/ links to another model
Clarity of presentation
You should be able to understand the model when you revisit after some time lapse! More Important – Others should be able to understand!
Be efficient
Utilize excel to improve productivity Do Not hard code in formulae cells
Separate line items are always useful
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All Rights Reserved. Corporate Bridge TM www.corporatebridge.netwww.corporatebridge.net
Excel Best Practices
Be efficient
Do not input same numbers twice. Also, Excel takes care of formatting!
Never Hide rows or columns – its useful to group them instead (Data -> Group)
Set up the first sheet as a template for a complete worksheet using Page Set Up• Use Edit -> Move/ Copy Sheet to create as many sheets as required in the model• Take care as named cells will be duplicated in the new sheet
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All Rights Reserved. Corporate Bridge TM www.corporatebridge.netwww.corporatebridge.net
Modeling Warm Up!
Use a Modular Approach
Core Statements – Income Statement, Balance Sheet, Cash Flow Statements• Focus on Others
Prepare supporting schedules• Do all the “dirty” work• Use them as a conduit between core schedules• Export the supporting schedules to the core statements on completion
Balance Sheet and Cash Flow Statements• All projections need to be referenced from Schedules
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Working Capital
Plant & Machinery,Depreciation
Intangibles,Amortization
Income Statement
Cash Flow Statement
Balance Sheet
Debt &Interest
Shareholder’sEquity
Other LTItems
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Things to Remember
Historical data as a guide for projections
Aim at projecting future performance Remember you are an Analyst and not an Auditor! Do not get worked up if historicals do not reconcile (its quite common!)
Reasonable and Defensible set of Assumptions and Projections
Models need to be efficient and clear
A bad model is difficult to follow and audit
A good model should be easy to follow and focus on key drivers
Use Beta testing
Test the logic after inputting right or down – check for flow
Challenge each assumption with the following
How does the model behave if you increase the assumption? What is a impact if the assumption is decreased? Try making the assumption equal to Zero What if the sign of the assumption changes?
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Key Financial Statements - Overview
Create the line items
Income Statement Balance Sheet Cash Flow Statement
Income Statement
Historical information
Project Revenue and Operating expenses (Sales to EBITDA)
Balance Sheet
Historical data only
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Income Statement - Sample
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Setting up the Income Statement
Sources for appropriate line items – financial statements, management guidance and research
Incorporate detailed line items to suit the business under analysis Ensure the income statement represents the company/ industry
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Balance Sheet - Sample
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Setting up the Balance Sheet
Sources for appropriate line items – financial statements, management guidance and research
Simplify or expand line items to sit the analytical objective Modify as required to represent the company/ industry
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Cash Flow Statement - Sample
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Setting up the Cash Flow Statement
Past allowances are usually not made – historical cash flow statements are often difficult to reconcile
Ensure the columns are consistent with the Income Statement and the Balance Sheet
Standard layouts are useful for references from other schedules
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Income Statement - Sample
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Input past information in the Income Statement
Normalize for any non-recurring items Ensure to make notes as necessary Calculate historical ratios & growth rates Do not forget formatting!
Inputs are in Blue
Calculations in Black
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Income Statement - Sample
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Forecast net sales for future years
Drivers: forecasted annual sales growth Sources: management guidance, research,
past trends Challenge assumptions for being reasonable Footnote all sources for assumptions
Only one blue input cell if constant growth is assumed
Forecasted figures
Drivers based on input assumptions
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Income Statement - Sample
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Forecast future operating expenses
Drivers: margin assumptions for future operations Sources: management guidance, research, past trends Challenge assumptions for being reasonable Other Expense/ (Income) is usually a number based on research/ past trends (but not
in % terms like other specific line items) Calculate till EBITDA. Depreciation & Amortization will be referenced from schedules
to be built in model
Drivers
Calculations
Inputs from research/ past trends
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Balance Sheet - Sample
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Input past information for the Balance Sheet
Check if past Balance Sheets are balancing If combining line items into one item, make
sure not to miss out any items
Its practical to show 2 condensed debt items
Inputs are in Blue
Calculations in Black
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Illustrative Flow of Funds
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Income Statement
Cash Flow Statement
Balance Sheet
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Working Capital Schedule
Working Capital Overview
Create the working capital line items Reference the historical balances Calculate past ratios related to working capital items Project future working capital by each line item Calculate projected cash flows generated out of working capital items Link with balance sheet & cash flow statement work sheets
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Setting up the Working Capital Schedule
Ensure clarity by using the same working capital line items in the same order in the balance sheet
Reference Net Sales & Cost of Goods Sold from the Income Statement – these are the drivers for working capital line items
Referenced from Income Statement
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All Rights Reserved. Corporate Bridge TM www.corporatebridge.netwww.corporatebridge.net
Working Capital Schedule - Sample
Reference the past data from the balance sheet
Calculate net working capital Arrive at increase/ decrease in working capital
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Calculations
Referenced from BS
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All Rights Reserved. Corporate Bridge TM www.corporatebridge.netwww.corporatebridge.net
Working Capital Schedule - Sample
Calculate historical ratios and percentages
Use the ending or average balance Both are acceptable as long consistency is maintained
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Calculations
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All Rights Reserved. Corporate Bridge TM www.corporatebridge.netwww.corporatebridge.net
Working Capital Schedule - Sample
Assumptions for future working capital items
Certain items without an obvious driver are usually assumed at constant amounts
Ensure assumptions are reasonable and in line with the business
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AssumptionsReferences, if constant
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Working Capital Schedule - Sample
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Use the future ratios and assumptions to project the forecasted working capital balances
Drivers
Drivers
Projections
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Working Capital Schedule - Sample
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Calculations
Check and make sure the signs match!
Arrive at Cash Flows based on individual line items
Ensure signs are accurate!
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Balance Sheet - Sample
Link up the forecasted Working Capital to the Balance Sheet
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Referenced from Working Capital Schedule
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Cash Flow Statement - Sample
Link up the forecasted Working Capital cash flows with the Cash Flow Statement
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Referenced from Working Capital Schedule
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All Rights Reserved. Corporate Bridge TM www.corporatebridge.netwww.corporatebridge.net
Illustrative Flow of Funds
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Income Statement
Cash Flow Statement
Balance Sheet
Working Capital
Sales
COGS
Change in WC
Working Capital
Working Capital Schedule
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