basic financial modeling

7/29/2019 Basic Financial Modeling

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Copyright - IMS Proschool Pvt. Ltd.

Limited preview of IMS Proschools Handbook

of Financial Modeling. This handbook

prepares you for NSE India Financial Modeling

Certification.

For more information visit: www.proschoolonline.com


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Financial Modeling

Introduction

Financial Modeling

Session - 1

This section briefly describes financial modeling and its application. The section will help you toget an overall perspective on how building this skill can help different finance professionals.


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What is a Financial Model?

It is a representation for numerical flow of any

financial data.

It is a decision making and planning tool for finance

professionals.

It is performed with the help of a spreadsheet or

some dedicated financial software.

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Who makes financial models and why?

It is widely used in financialdecision making and planningprocesses to answerquestions such as:

Is the stock undervalued or

overvalued?

Whether to make investment in

the project or not?

Should loan be given for a

project or not? What is the

rating of the project or

company?

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Various finance professionalswho use financial modeling

are: Bankers

Investment Bankers

Project Finance

professionals

Equity Researchers

Financial Planning

Advisors

PE & VCs

Hedge Funds


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Copyright - IMS Proschool Pvt. Ltd.5

What does a model look like?

A models can be very basic , perhaps a single excel sheet

OR

It can be 30-40 sheets or even multiple workbooks with

several macros and can be fairly detailed and complex.

It largely depends on the end use that you have in mind.

If used for internal analysis it may remain a simple Excel

worksheet or the final output may be a well done report.


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Example


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Attributes of Good Models

Realistic

Assumptions used in the model should be realistic to get realistic output else a common

saying prevalent among financial modeling professionals is Garbage in, Garbage out.

Error-Free

Many financial decisions are based on models, hence it should be error free for non-

erroneous decision.

Flexible

Changes are inevitable, hence the model should be flexible enough to incorporate any level

of changes.

Easy to use The model should make it easy for a user to understand the movement of figures.

Easy to understand

Should not be a one mans language.


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Prerequisites for Learning Financial Modeling

Knowledge of MS Excel

Basics of Economics

Accounting Fundamentals

Financial Management

Knowledge of Financial

Market




Financial Modeling

Handling Spreadsheets

Financial Modeling

Session - 2

As you may have noticed, financial models are created in spreadsheets generally in Microsoft Excel

though it could be in open office or other spreadsheets. So learning to handle spreadsheets is a

preliminary requirement for financial modeling.

This sections covers key functions and utilities within Excel that are critical for building financial models. It

is highly recommended that you attempt and practice the exercises in this section and not just read

through them, for obvious reasons.



KEY EXCEL FUNCTIONSTHIS SECTIONS WALKS YOU THROUGH IMPORTANT EXCEL FUNCTIONS THAT AREFREQUENTLY USED IN FINANCIAL MODELING. ITS IMPORTANT TO TRY THESE OUT IN

EXCEL.

Financial Modeling



Excel Functions

What are Excel Functions ?

Excel Functions are built-in formulas based on predefined logic thatmakes it easy to calculate the output for a given data.

How to insert a Function?

Click Formulas tab in

Excel. Within the Formulas tab

click Insert Function.

The dialog box shown onthe right would appear on

the screen. Desired function type can

be selected from the dropdown list.

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Find the total sales of the following particulars using excel:

Insert the cell references

whose numbers is to be

added.

Excel Functions-Example

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Excel Functions

Excel Functions Functions types used in Financial Modeling

Excel

Functions

Financial

Date &Timing

Logical

Lookup &Reference

Math &Trig

Statistical

Text

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Excel Functions

o Lookup & References

Choose

Offset

Lookup

VLookup

HLookup

Match

o Sum

Sum

Sumif

Sumifs

Sumproduct

Average

Averageifs

o Count

Count Countif

Countifs

Counta

CountBlank

o If statement & its

alternative

If

And

Or

Max

Min

Commonly used Functions in Financial Modeling

o Dates

Year Month

Day

Date

Date360

Edate

o Financial

PV

FV

PMT

Rate

NPER

IPMT

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Excel Functions

Lookup and References

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Excel Functions

Sum functions

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Excel Functions

Count functions

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Excel Functions

If statement and its Alternatives

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CHOOSE Function:

Find the sales of the particular - Iron Rods:

OFFSET Function:

Find the sales of the fourth particular:

Formula:=CHOOSE(2,C2,C2:C5)

Understanding of formula:

2nd figure from C2 from the range

C3:C5.

Excel Functions

Formula:=OFFSET(B1,4,1,1,1)


In column B, get the value of particular in 4th row and 1

column from B.

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Lookup Function:

Find the sales of the Steel Sheets:

Match Function:

Find the sales less than 150000:

Formula:=LOOKUP("Steel Sheets",B2:B5,C2:C5)


Looks up Steel Sheets in column B, and returns the value

from column C that's in the same row (265887).

Excel Functions

Formula:=MATCH(150000,C2:C5,1)


In column C, get the row whose value is less than 150000.

Output:

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Formula:


Looks for the sales value of fifth row i.e. for Iron Plates.

Excel Functions

HLookup Function:

Find the sales value of the fifth row:

VLookup Function:

Find the sales values of Iron Plates:

Formula:=VLOOKUP(B5,B1:C5,2,FALSE)


Looks up Sales value of Iron Plates in column C, from the

range of particulars and sales.

=HLOOKUP(C1,B1:C5,5,FALSE)

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E l F ti


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FV Function: FV(rate,nper,pmt,pv,type)

Find the FV of insurance premium paid where premium is 1000,

risk free rate is 10% and time is 5 years:

PMT Function: PMT(rate,nper,pv,fv,type)

Find the amount to be invested every year to get an amount of

6105.10 at the end of 5 years and risk free rate is 10%:

Excel Functions

Formula:

=FV(B3,B4,-B2,0,0)

Output:

6,105.10

Formula:

=PMT(B3,B4,0,-B2,0)

Output:

1000

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E l F ti


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NPER Function: NPER(rate, pmt, pv, fv, type)

Find the number of years of investment to get 6105.10 by making

a payment of 1000 annually and risk free rate is 10%:

RATE Function: RATE(nper,pmt,pv,fv,type,guess)

Find the investment rate at which 1000 invested annually for 5

years would yield 6105.10:

Excel Functions

Formula:

=NPER(B3,-B4,0,B2,0)

Output:

5

Formula:

=RATE(B3,-B4,0,B2,0,0)

Output:

10%

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ERRORS IN EXCEL FORMULA BUILDINGHOWEVER EXPERT YOU MAY BE WITH EXCEL, YOU ARE LIKELY TO ENCOUNTER SOME OFTHESE ERRORS WITH REASONABLE REGULARITY. UNDERSTANDING HOW TO CORRECT

THESE MAY BE THE DIFFERENCE BETWEEN GOING HOME BEFORE OR AFTER MIDNIGHT.

Financial Modeling

E i E l f l b ildi


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Errors in Excel formula building

Errors inExcel

Formatting

######

Division byZero

#Div/0!

ReferenceError

#Ref!

Syntactical

#Name? #Null!

Numeric

#Num!

CircularReference

Logical

mistake

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Error Type: Formatting Error ( ####)

Cause:

o This type of error occurs in a situation where the width of a columnis not wide enough to show the data of a cell completely.

o The formula in the cell produces a result that is too wide for the

cell.o There is a negative number in the cell that has been formatted for

dates or times. Dates and times in Excel must be positive values.

Rectification:(Either of them)

o Increase the width of column

o Change the number format that suits the column width.

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Error Type: Division by zero (#DIV/0!)

Cause: This type of error occurs when a non-zero number is

divided by zero.

Rectification:o Divisor can be changed to a non-zero number.

o Cell reference can be changed.

o Use a combination of IF statement and the

ISERROR formula or IFERROR formula in

2007 excel.

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DATA VALIDATION AND ITERATIONAS ANALYSTS ARE BOMBARDED WITH A LOT OFF DATA, ONE SHOULD BE ABLE TO CHECKDATA VERACITY. THIS IS WHERE THE DATA VALIDATION FUNCTIONS COME IN HANDY. FEW

EXCEL FUNCTIONS INCORPORATE POWER OF ITERATIONS. APPLICATION OF THESE CAN

SIGNIFICANTLY IMPROVE THE TASKS ONE CAN DO IN EXCEL.

Financial Modeling

Data Validation


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Data Validation

It prevents invalid data entry in a worksheet.

o Select a cell.

o Go to Data tab, Data Tools group

and click Data Validation.

o Validation tool can be selected

from drop down list.

o On selecting the Data Validation

from the drop down list, the

dialog box named Data

Validation appears on the

screen.

o Validation rule can selected from

the list.

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Data Validation Example


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Data Validation-Example

In the data furnished below, there is a limitation while projecting the

Commission/Bonuses. It should be whole number and should not be

greater than 5000. handle the situation with Data Validation.

o Select a cell.

o Go to Data tab, Data

Tools group and click

Data Validation.

o Select Data

Validation from the

list. Fill the

requirements in the

dialog box.

o Go to Input Message

tab and enter some

message.

Actual Projected

Employee Costs

110 Payroll 45328 60000

120 IRS/FICA/Wk comp/State/SDI 15997 25000

140 Retirement Plan 6249 8000

125 Commissions/Bonuses 2720 4500

Subtotal 70294 97500

Subcontractors & Services

201 Telecommunication Services 637 700

254 Advertising 40

Subtotal 677 700

Total 70971 98200

Account

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o Select a cell.

o Go to Data tab, Data Tools group

and click Data Validation.

o Select Data Validation from the

list. Fill the requirements in the

dialog box.

o Go to Input Message tab and enter

some message.

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Iteration Functions Goal Seek


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Goal Seek works on the terms of cause and effect scenarios. It helps a

user to see the effect on one item in the formula on the other. This

can be used when you know the outcome of a formula but dont knowone input in the formula.

Location of Goal Seeko Go to Data tab, Data Tools

group and click What-if

Analysis.

o Select Goal Seek from the list.

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o On selecting Goal Seek, a dialog

box similar to one shown inright appears on the screen.

o In Set cell box we have to fill cell

whose value we know and value

of the cell has to filled in next

box i.e. To Value.

o By changing cell should be the

cell reference that changes to

bring the desired output.

o Follow the example for better

understanding.

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Goal Seek-Exercise


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Goal Seek-Exercise

Calculate the EMI to be paid on a loan of Rs.1200 @ 2%/month for 6

months.

Formula:

=PMT(B3,B5,-B2,0,0)

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Iteration Functions Scenario Manager


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Iteration Functions Scenario Manager

A scenario is a named combination of values that is assigned to one or

more variable cells in a what-if model. Scenarios to forecast the

outcome of a worksheet model.

Location of Scenario Managero Go to Data tab, Data Tools

group and click What-if

Analysis.

o Select Scenario Manager from

the list.

o On selecting Scenario Manager,

a dialog box similar to one

shown in right appears on the

screen.o Follow the Example for better

understanding

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Scenario - Exercise


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The exercise is to see the effect of changes in Retail Price, COGS

and/or Unit Seles Growth Factor on the profit of the company.

Scenario Exercise

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Scenario Manager-Exercise


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Steps:

o Click Add button on the dialog.

o In the Add Scenario dialog box

(Shown in image), fill any Scenario

name.

o In Changing cells box, write,

B3:B3,B10.

o Press Ok.

Scenario Manager Exercise

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Data Table Exercise


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Steps:

1. Row input cell (=N8)

2. Column input cell (=10)

3. Press OK button.

Final Output of Data Table:

Data Table Exercise

Check:

For Revenue %

Growth of 15%

and Cost

Margin of 70%,

the Gross profit

is 345.

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Data Summarization Pivot Table


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It is a data summarization tool. It makes easier to arrange and

summarize complex data for better analysis.

Location of Pivot Tableo Go to Insert tab, Tables group

and click Pivot Table.

o Select PivotTable from the list.

o On selecting Pivot Table, a

dialog box similar to one shown

in right appears on the screen.

o Follow the Example for better

understanding

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Pivot Table - Exercise


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Prepare Pivot Table for the analysis of the following data:

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Steps:

6. Drag and drop the field from list to areas as

shown in the image in the right.

7. Gives the following output in the Pivot Area

as shown below.

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Steps:

8. Color can be changed as per requirement. The final output of the pivot

table which shows the year wise sale of products geographically.

basic financial modeling

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