Financial modelling e book part 1

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Financial Modeling E-book
Part 1 of 4

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This is the 1st E-Book of the series of 4 free
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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

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
4

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
5

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
Private and Confidential – Not for Circulation 6
X
√

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

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’s
Equity
Other LT
Items

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?

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

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

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

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

 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

 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

 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

 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

Illustrative Flow of Funds
Income
Statement
Cash Flow
Statement
Balance
Sheet

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
 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

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

 Calculate historical ratios and percentages
 Use the ending or average balance
 Both are acceptable as long consistency is maintained
Calculations

 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
Assumptions
References,
if constant

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

Calculations
Check and make sure
the signs match!
 Arrive at Cash Flows based on individual line items
 Ensure signs are accurate!

 Link up the forecasted Working Capital to the Balance Sheet
Referenced from

Cash Flow Statement - Sample
 Link up the forecasted Working Capital cash flows with the Cash Flow Statement
Referenced from

Illustrative Flow of Funds
Income
Statement
Cash Flow
Statement
Balance
Sheet
Working
Capital
Sales
COGS
Change in WC
Working Capital

For FREE Resources
Corporate Bridge Blog
Finance News, Articles, Interview Tips etc
https://www.educorporatebridge.com/blog
For Online Finance Courses
For any other enquiry / information
Email – support@cbacademy.in
https://www.educoporatebridge.com
https://www.educorporatebridge.com/freebies3.php

Financial modelling e book part 1

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