financial modeling presentation

Financial Modeling

II BThe Investment Banking Institute

2II BThe Investment Banking Institute


Table of Contents

Integration of Financial Statement Projections / Revolver Modeling

V.

Deriving Historic Ratios, Trends and VariablesIII.

Financial Statement ProjectionsIV.

Spreading Historical Financial StatementsII.

I. Introduction



IntroductionUses for Financial Models in Investment Banking and Private Equity

Investment bankers and Private Equity Professionals often must create financial models that illustrate historic financial statements along with integrated income statement, balance sheet and cash flow projections for evaluating various types of transactions such as:

Sale of the CompanyMerger of the CompanyPublic or Private Placement of new capital (bank loans, high yield issue, IPO or secondary equity offering, private equity or debt placement, etc.)Leveraged buyouts / Management buyoutsRestructuring / Bankruptcy

In these cases, the associate or analyst is expected to construct the financial model with guidance from the management team on assumptions and projections.Typically, the associate and analyst are responsible for “running the model”, including the ability to run base-case, upside, downside and alternate capital structure scenarios. For pitches and other cases where there is no access to the management team, projections from research reports (equity research reports, high yield research reports, credit rating agency reports, etc) can be used.



IntroductionTips for Setting Up the Financial Model

Keep historic and projected income statement, balance sheet and cash flow on same worksheetHave Historic Ratios / Assumptions for Projections on the same worksheet but separate from the worksheet that has income statement, balance sheet and cash flowFormatting is very important in investment banking:

same font and letter size throughout modelclearly labeled pagesblue text usually denotes an input that is a driverblack text is usually outputconvention is one decimal point for $ amounts; 0 or 1 decimal pointsfor percentagesSet print ranges and preferences Footnote all sources and assumptions clearly

Keep it as simple as you can



Table of Contents


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I. Introduction



Spreading Historical Financial Statements

Three to five year history for income statement, balance sheet and cash flow usually sufficient Source of historic financial statements:

Publicly traded companies’ financial statements must be filed with the SEC on a quarterly (10Q) and annual basis (10K) and arepublicly availablePrivate companies: audited financial statements provided by company

Adjust historical income statement for one-time, extraordinary, non-recurring items such as restructuring charges or sale of business divisionWhen spreading the historic financial statements: keep it simple!



Deriving Historic Ratios, Trends and Variables

Goal is to establish historic trends, margins, growth rates, etc. to use for projections Important variables to derive from historic income statement:

Revenue Growth RateCost of Goods Sold (“COGS”) Margin (COGS / Sales)Gross Margin (Gross Profit / Sales)SG&A Margin (SG&A / Sales)Operating Margin (Operating Income / Sales) and Operating IncomeGrowth Rate (aka Earnings before Interest and Taxes (“EBIT”))Depreciation / Gross PP&E*EBITDA Margin (EBITDA / Sales) and EBITDA growth rateEffective Tax Rate (income tax / pre-tax income)Interest expense and interest income will be discussed laterOther income / expense items: need to read notes to financial

statements to determine what they are; if there is some discernable trend, can use it to project; often there is not a trend.

* Depreciation schedules can also be used; for purposes of this model, we are using Depreciation as % of Gross PP&E; Depreciation

Schedule available for illustrative purposes.




Important variables to derive from Historic Balance Sheet and Cash Flow:

Accounts Receivable, Inventory, and Accounts Payable are calculated in number of days:

– Accounts receivable: average number of days for collection calculated as Accounts Receivable balance / Sales * 360 days

– Inventory: average number of days to turn raw purchases into finished goods calculated as Inventory Balance / COGS * 360 days

– Accounts Payable: average number of days for company to pay its suppliers calculated as Accounts Payable balance / COGs * 360 days

Other assets and other liabilities (both current and long-term): need to read notes to financial statements to determine what they are; can use absolute values, percentage of sales / COGS, etc.Capital Expenditure (“Capex”) as % of sales (capital expenditure in cash flow statement / sales for that period)Asset Disposition: read notes to financial statements to see if there is a discernable trend; could be recurring asset sales, or one-time items like the sale of a business division or subsidiary



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I. Introduction



Income Statement Projections

Revenue projections are often based upon historic and expected growthOften, the revenue projections are built up based upon the products, pricing, customers, etc.For example, revenues of a producer of steel coils would be calculated as the number of tons sold * average price per ton; revenue growth would come from an increase in tons sold and / or an increase in average price per tonFor example, revenues for a restaurant chain could be calculated as average revenue per store * number of restaurants; revenue growth would come from an increase revenue per store and / or an increase in restaurants

COGS projections are often based upon the margin (COGS / Sales); however COGS can also be determined by number of units and average cost per unit

COGS is comprised of both variable and fixed costs; variable cost margins stay very similar with increase / decrease in volume, while the absolute fixed costs remain the same, but the margin would change

Depreciation can be calculated as a % of gross PP&E, or detailed depreciation schedules can be used

As detailed depreciation schedules require significant time, space and review by management, depreciation as a % of gross PP&E is a good proxy



Income Statement Projections

SG&A expenses are typically projected as a % of sales; however, some of the SG&A expenses are “fixed”, and therefore do not necessarily increase along with salesInterest expense and income are calculated based upon debt and interest schedules, which will be discussed in detail laterOther income / expense items can be projected based upon expected events (i.e. tax refund, sale of a subsidiary, etc), or some discernable historic trend

Often, the best projection for other income / expense items is $0

Effective taxes are typically projected as a % of pre-tax income; however, any benefit from the use of a Net Operating Loss (“NOL”) or other tax benefit should be taken into account



Balance Sheet Projections - Assets

Cash: related to revolver modeling and will be discussed in detail laterAccounts Receivable: discern historical trend of days; use number of days as assumption / driver

Accounts Receivable balance = number of days / 360 * Revenue Inventory: discern historical trend of days; use number of days as assumption / driver

Inventory balance = number of days / 360 * COGSOther Assets: discern historical trend either absolute value or % of revenueGoodwill:

Goodwill resulting from an acquisition can no longer be amortizedOne-time expenses incurred in the acquisition (legal fees, investment banker fees, financing fees, etc.) can be amortized, typically over 5 – 7 years.



Balance Sheet Projections – Assets (continued)

PP&EGross PP&E = beginning balance Gross PP&E + Capex – Asset salesCapex projection: in cash flow statement; discern historical capex as % of salesAsset Sales projection: discern trend and read notes to financial statements for expected upcoming events (i.e. sale of subsidiary, acquisition closing, etc.); often best projection is $0.Depreciation Expense (income statement) = % of gross PP&EDepreciation Cumulative balance (balance sheet) = beginning depreciation balance + depreciation expense for current period



Balance Sheet Projections – Liabilities and Shareholders Equity

Liabilities Accounts Payable balance: discern historical trend of days; usenumber of days as assumption / driver.

Accounts Payable balance = number of days / 360 * COGS Accrued Liabilities and Other Liabilities balance: discern historical trend; either absolute value or % of COGSDebt: to be discussed in context of debt and interest expense schedule

Shareholders EquityRetained Earnings: Beginning balance + net income after any dividend distributionsOther / (Plug / Balance): In the case of one-time transactions (acquisition, divestiture, writedown of assets, etc), often you will need this account as a plug to balance the balance sheet



Cash Flow Projections

All Changes in all Balance Sheet Accounts must be run through the cash flow; otherwise the balance sheet totals will not balanceAll Non-cash items in the income statement must be added back / deducted from the operating cash flowOperating Cash Flow = sum of:

Net Income: take from income statementDepreciation and Amortization: take from income statementAdd back / deduct any other non-cash expenses / income from the income statement (examples are non-cash interest expense, any non-cash restructuring charges, amortization of capitalized accounts, etc.)Changes in working capital

– Current Assets: Previous period balance – Current period balance– Current Liabilities: Current period balance – Previous period balance

Changes in other assets / other liabilities– Other Assets: Previous period balance – Current period balance– Other Liabilities: Current period balance – Previous period balance



Cash Flow Projections

Cash Flow from Investing Activities = sum of:Capital ExpenditureSale of Assets

Cash Flow from Financing ActivitiesDriven by debt and interest schedule, which integrates the cash and debt balance sheet accounts, interest expense and interest income on income statement, and the cash flow statement

Ending Cash Balance = Beginning Cash Balance + Cash Flow from Period



Debt and Interest Schedule Projections

Establish separate sections for each piece of debt RevolverTerm Loan / Senior Credit FacilitiesNotes / BondsCapital LeasesOther Debt

The notes to the financial statements contain the required amortization payments for each tranche of debt, as well as interest rates

This information is also available in the credit agreements and note indenturesEnding debt balance = beginning debt balance + drawdowns – amortization payments or paydownsInterest Expense = average (beginning debt balance + ending debt balance) * interest rateSince the Revolver will be the account used to integrate the income statement, balance sheet and cash flow, we will save this part of the modeling for lastOnce you have modeled out the beginning debt balance, ending debt balance and interest expense for all debt tranches (except for the revolver), link the results back into the balance sheet and income statement:

Ending debt balance: current period balance sheet itemInterest expense: current period income statement item



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I. Introduction



Revolver Modeling

The Revolver will be the account used to integrate the income statement, balance sheet and cash flowMechanically, the way the model works is as follows:

If cash flow produced during the period (before any revolver paydown or drawdown) + the beginning cash balance is greater than 0, than any excess cash is used to paydown the revolver balance

– The amount of the paydown is the minimum of the beginning revolver balance or the cash flow + the beginning cash balance

If cash flow produced during the period (before any revolver paydown or drawdown) + the beginning cash balance is less than 0, the cash deficit will be funded by a drawdown on the revolver

– The amount of the drawdown is the amount of the cash flow deficit in this model– In reality, there is a revolver availability based on a complicated borrowing base formula

calculated as a % of eligible accounts receivable + eligible inventory – reserves For the purposes of modeling the revolver, the cash flow produced during the period = cash flow from operations + cash flow from investing activities + cash flow from all financing activities except the revolver

As the calculation of the revolver drawdown / paydown, revolver ending balance, and interest expense is a circular reference, you need to set your computer to the proper setting

On the “Tools” bar, go to “Options”, and “Calculation”, click “Manual”, “Iterations”, and type 100 in the box next to “Maximum Iterations”



Revolver Modeling

PROJECTED FINANCIAL STATEMENTS($ in millions) Fiscal Year Ending December 31,

2006P 2007P 2008P 2009P 2010P

Cash FlowNet Income $23.6 $26.4 $29.3 $32.4 $35.7Plus / (minus): Depreciation and Amortization $7 $8 $8 $8 $8 Changes in Working Capital Accounts Receivable ($0.5) ($0.5) ($0.5) ($0.6) ($0.6) Inventory ($0.2) ($0.2) ($0.2) ($0.2) ($0.2) Other Current Assets $0.0 $0.0 $0.0 $0.0 $0.0 Accounts Payable $0.2 $0.2 $0.2 $0.2 $0.2 Accrued Liabilities $0.1 $0.1 $0.1 $0.1 $0.1 Other Current Liabilities $1.0 $0.0 $0.0 $0.0 $0.0 Change in Other Liabilities $0 $0 $0 $0 $0Cash Flows from Operations $31.8 $33.7 $36.7 $40.0 $43.5

Cash Flows from InvestingCapital Expenditures ($8.8) ($9.3) ($9.7) ($10.2) ($10.7)Asset Dispostions $0.0 $0.0 $0.0 $0.0 $0.0Cash Flows from Investing ($8.8) ($9.3) ($9.7) ($10.2) ($10.7)

Cash Flows from FinancingChange in Revolver ($10.6) $0.0 $0.0 $0.0 $0.0Change in Term Loan ($25.0) ($25.0) ($25.0) ($25.0) ($25.0)Change in Unsecured Debt $0.0 $0.0 $0.0 $0.0 $0.0 Total Cash Flows from Financing ($35.6) ($25.0) ($25.0) ($25.0) ($25.0)

Total Cash Flow ($12.7) ($0.6) $2.0 $4.8 $7.8

Beginning Cash Position $58.1 $45.4 $44.8 $46.7 $51.5Change in Cash Position ($12.7) ($0.6) $2.0 $4.8 $7.8Ending Cash Position $45.4 $44.8 $46.7 $51.5 $59.3

Debt and Interest ScheduleRevolver Beginning Revolver Balance $10.6 $0.0 $0.0 $0.0 $0.0(Paydown) / Drawdown ($10.6) $0.0 $0.0 $0.0 $0.0Ending Revolver Balance $0.0 $0.0 $0.0 $0.0 $0.0Interest Rate 6.0% 6.3% 6.5% 6.8% 7.0%Interest Expense $0.32 $0.00 $0.00 $0.00 $0.00

Revolver (paydown) / drawdown =If (Cash Flow from Operations + Cash Flows from Investing +Cash Flows from Change in Term Loan +Changes in Unsecured Debt + Beginning Cash Position) < 0, -(Cash Flow from Operations + Cash Flows from Investing + Cash Flows from Change in Term Loan +Changes in Unsecured Debt+ Beginning Cash Position), -min (beginning revolver balance, (Cash Flow from Operations + Cash Flows from Investing + Cash Flows from Change in Term Loan +Changes in Unsecured Debt+ Beginning Cash Position))



Revolver Modeling

Calculate the interest expense on the revolver as the interest rate * average of beginning revolver balance and ending revolverbalanceLink the revolver balance back into the balance sheet, the interest expense on the revolver back into the income statement,and adjust the changes in revolver in the cash flowOnce the revolver has been properly modeled, the ending cash balance should properly calculate in the cash flow, and this canbe linked into the cash balance in the balance sheet



Table of Contents


V.




I. Introduction

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