financial modeling

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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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All Rights Reserved. Corporate Bridge TM www.corporatebridge.net

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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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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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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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


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


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


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


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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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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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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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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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


Income Statement

Cash Flow Statement

Balance Sheet

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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


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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Working Capital Schedule - Sample

Reference the past data from the balance sheet

Calculate net working capital Arrive at increase/ decrease in working capital


Calculations

Referenced from BS

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Calculate historical ratios and percentages

Use the ending or average balance Both are acceptable as long consistency is maintained


Calculations

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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


AssumptionsReferences, if constant

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Use the future ratios and assumptions to project the forecasted working capital balances

Drivers

Drivers

Projections

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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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Link up the forecasted Working Capital to the Balance Sheet


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


Referenced from Working Capital Schedule

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Illustrative Flow of Funds


Income Statement

Cash Flow Statement

Balance Sheet

Working Capital

Sales

COGS

Change in WC

Working Capital


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