Corporate Bridge Financial Modeling eBook - Part 1

7/29/2019 Corporate Bridge Financial Modeling eBook - Part 1

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Financial Modeling E-book

Part 1 of 4


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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

Shareholders Equity Schedule

Shares Outstanding Schedule

Preparing for Debt & Interest

Trouble Shooting

Completing the Financial Model


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Introduction to Financial Modeling

Simplified representation of performance

Both past and future

Blend of skills is required

Understanding of the companys (projects) 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

Private and Confidential Not for Circulation 5

X


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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

Shareholders

Equity

Other LT

Items


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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 flowstatements 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 IncomeStatement

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 inputcell if constantgrowth is assumed

Forecasted figures

Drivers based oninput 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 (butnot in % terms like other specific line items)

Calculate till EBITDA. Depreciation & Amortization will be referenced from schedulesto 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, makesure not to miss out any items

Its practical to show2 condensed debtitems

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 IncomeStatement 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 atconstant amounts

Ensure assumptions are reasonable and in line with the business


Assumptions

References,

if constant


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

Drivers

Drivers

Projections


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Calculations

Check and make surethe 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



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Cash Flow Statement - Sample

Link up the forecasted Working Capital cash flows with the Cash Flow Statement


Referenced fromWorking 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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Corporate Bridge Financial Modeling eBook - Part 1

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