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Financial modeling using excel

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This e-book is the first e-book of 4 part e-book series on Financial Modeling.Financial Modeling is a tool that can be used to forecast a picture of a security or a financial instrument or a company’s future financial performance based on the historical performance of the entity. Financial Modeling includes preparing of detailed company specific models which are then used for the purpose of decision making and performing financial analysis.
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Financial modeling using excel

1. 1. Financial Modeling – Ebook 1 of 4 Financial Modeling E-book Part 1 of 4 All Rights Reserved. Corporate Bridge TM www.educorporatebridge.com
2. 2. Discussion topics Financial Modeling – Ebook 1 of 4  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 All Rights Reserved. Corporate Bridge TM www.educorporatebridge.com 2
3. 3. Introduction to Financial Modeling Financial Modeling – Ebook 1 of 4  Simplified representation of performance   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      Both past and future 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 All Rights Reserved. Corporate Bridge TM www.educorporatebridge.com 3
4. 4. Assumptions – Importance in Financial modeling Financial Modeling – Ebook 1 of 4  Need to have clear and well defined assumptions   Assumptions should reflect business realities and expectations        Referred to as „drivers‟ or „inputs‟ these are based on a thorough understanding of the business 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 • • •  Key tests a financial model should withstand    Start up situations Significant acquisitions or divesture activities Volatile industry structure 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 All Rights Reserved. Corporate Bridge TM www.educorporatebridge.com 4
5. 5. Excel Best Practices Financial Modeling – Ebook 1 of 4  Maintain Consistency  Makes understanding and constructing easier  Consistent Color scheme makes life easy for self and others using the model • • GREEN reference from another schedule/ sheet • RED warnings to another user/ links to another model Clarity of presentation    BLACK for calculations and references on same schedule/ asset •  BLUE for inputs (historical data, assumptions, drivers) 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 X  Separate line items are always useful √ All Rights Reserved. Corporate Bridge TM Private and Confidential – Not for Circulation www.educorporatebridge.com 5
6. 6. Excel Best Practices Financial Modeling – Ebook 1 of 4  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 All Rights Reserved. Corporate Bridge TM Private and Confidential – Not for Circulation www.educorporatebridge.com 6
7. 7. Modeling Warm Up! Financial Modeling – Ebook 1 of 4  Use a Modular Approach  Core Statements – Income Statement, Balance Sheet, Cash Flow Statements  Prepare supporting schedules • • • •  Focus on Others 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 Income Statement Debt & Interest Plant & Machinery, Depreciation Cash Flow Statement Shareholder’s Equity Intangibles, Amortization Balance Sheet Other LT Items All Rights Reserved. Corporate Bridge TM Private and Confidential – Not for Circulation www.educorporatebridge.com 7
8. 8. Things to Remember Financial Modeling – Ebook 1 of 4  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? All Rights Reserved. Corporate Bridge TM Private and Confidential – Not for Circulation www.educorporatebridge.com 8
9. 9. Key Financial Statements - Overview Financial Modeling – Ebook 1 of 4  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 All Rights Reserved. Corporate Bridge TM Private and Confidential – Not for Circulation www.educorporatebridge.com 9
10. 10. Financial Modeling – Ebook 1 of 4 Income Statement - Sample  Setting up the Income Statement    All Rights Reserved. Corporate Bridge TM 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 Private and Confidential – Not for Circulation www.educorporatebridge.com 10
11. 11. Financial Modeling – Ebook 1 of 4 Balance Sheet - Sample Setting up the Balance Sheet     All Rights Reserved. Corporate Bridge TM 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 Private and Confidential – Not for Circulation www.educorporatebridge.com 11
12. 12. Financial Modeling – Ebook 1 of 4 Cash Flow Statement - Sample  Setting up the Cash Flow Statement    All Rights Reserved. Corporate Bridge TM 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 Private and Confidential – Not for Circulation www.educorporatebridge.com 12
13. 13. Financial Modeling – Ebook 1 of 4 Income Statement - Sample Calculations in Black Inputs are in Blue  Input past information in the Income Statement     All Rights Reserved. Corporate Bridge TM Normalize for any non-recurring items Ensure to make notes as necessary Calculate historical ratios & growth rates Do not forget formatting! Private and Confidential – Not for Circulation www.educorporatebridge.com 13
14. 14. Financial Modeling – Ebook 1 of 4 Income Statement - Sample Forecasted figures  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 Drivers based on input assumptions Only one blue input cell if constant growth is assumed All Rights Reserved. Corporate Bridge TM Private and Confidential – Not for Circulation www.educorporatebridge.com 14
15. 15. Financial Modeling – Ebook 1 of 4 Income Statement - Sample Inputs from research/ past trends  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 All Rights Reserved. Corporate Bridge TM Private and Confidential – Not for Circulation www.educorporatebridge.com 15
16. 16. Financial Modeling – Ebook 1 of 4 Balance Sheet - Sample Calculations in Black Inputs are in Blue Its practical to show 2 condensed debt items  Input past information for the Balance Sheet   All Rights Reserved. Corporate Bridge TM Check if past Balance Sheets are balancing If combining line items into one item, make sure not to miss out any items Private and Confidential – Not for Circulation www.educorporatebridge.com 16
17. 17. Financial Modeling – Ebook 1 of 4 Illustrative Flow of Funds Income Statement Cash Flow Statement Balance Sheet All Rights Reserved. Corporate Bridge TM Private and Confidential – Not for Circulation www.educorporatebridge.com 17
18. 18. Working Capital Schedule Financial Modeling – Ebook 1 of 4  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 Referenced from Income Statement  Setting up the Working Capital Schedule   All Rights Reserved. Corporate Bridge TM 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 Private and Confidential – Not for Circulation www.educorporatebridge.com 18
19. 19. Financial Modeling – Ebook 1 of 4 Working Capital Schedule - Sample Referenced from BS Calculations  Reference the past data from the balance sheet   All Rights Reserved. Corporate Bridge TM Calculate net working capital Arrive at increase/ decrease in working capital Private and Confidential – Not for Circulation www.educorporatebridge.com 19
20. 20. Financial Modeling – Ebook 1 of 4 Working Capital Schedule - Sample Calculations  Calculate historical ratios and percentages   All Rights Reserved. Corporate Bridge TM Use the ending or average balance Both are acceptable as long consistency is maintained Private and Confidential – Not for Circulation www.educorporatebridge.com 20
21. 21. Financial Modeling – Ebook 1 of 4 Working Capital Schedule - Sample Assumptions  Assumptions for future working capital items   All Rights Reserved. Corporate Bridge TM References, if constant Certain items without an obvious driver are usually assumed at constant amounts Ensure assumptions are reasonable and in line with the business Private and Confidential – Not for Circulation www.educorporatebridge.com 21
22. 22. Financial Modeling – Ebook 1 of 4 Working Capital Schedule - Sample Drivers Projections Drivers  All Rights Reserved. Corporate Bridge TM Use the future ratios and assumptions to project the forecasted working capital balances Private and Confidential – Not for Circulation www.educorporatebridge.com 22
23. 23. Financial Modeling – Ebook 1 of 4 Working Capital Schedule - Sample Check and make sure the signs match! Calculations  Arrive at Cash Flows based on individual line items  Ensure signs are accurate! All Rights Reserved. Corporate Bridge TM Private and Confidential – Not for Circulation www.educorporatebridge.com 23
24. 24. Financial Modeling – Ebook 1 of 4 Balance Sheet - Sample Referenced from Working Capital Schedule  Link up the forecasted Working Capital to the Balance Sheet All Rights Reserved. Corporate Bridge TM Private and Confidential – Not for Circulation www.educorporatebridge.com 24
25. 25. Financial Modeling – Ebook 1 of 4 Cash Flow Statement - Sample Referenced from Working Capital Schedule  Link up the forecasted Working Capital cash flows with the Cash Flow Statement All Rights Reserved. Corporate Bridge TM Private and Confidential – Not for Circulation www.educorporatebridge.com 25
26. 26. Illustrative Flow of Funds Financial Modeling – Ebook 1 of 4 Working Capital Schedule Sales COGS Income Statement Change in WC Working Capital Working Capital Cash Flow Statement Balance Sheet All Rights Reserved. Corporate Bridge TM Private and Confidential – Not for Circulation www.educorporatebridge.com 26