Fin Modeling

Financial Statement ModelingFinancial Statement ModelingCopyright 2008 © by Wall Street Prep, IncCopyright 2008 © by Wall Street Prep, Inc. | All rights reserved. | All rights reserved

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SAMPLE PAGES FROM TUTORIAL GUIDE

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SECTION 1: PREPARING FOR MODELING

Welcome letter

Introduction

Gathering historical documents/information

Understanding projections

Modeling techniques in Excel

SECTION 2: BUILDING A FINANCIAL STATEMENT MODEL

Income statement – historicals

Income statement – projections

Debt schedule

Interest expense

SECTION 3: ENHANCEMENTS TO A COMPLETE MODEL

Balancing the model and circularity

Ratio analysis

Form toggles, sensitivity and scenario analysis

Table of contents

Income statement – projections

Balance sheet – historicals

Balance sheet – projections

Working capital schedule

Deferred taxes

Intangible assets

Property, plant, & equipment

Treasury stock and shares outstanding

Minority interests and equity in affiliates

Goodwill and other balance sheet items

Retained earnings

Cash flow statement – projections*****************************


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• Take the last reported year’s sales growth rate, and project that growth rate to future years (called “straight-lining projections”)

Calculation (black cells)Formula in Excel =E3*(1+F4)

Calculation (black cells)Formula in Excel =E3*(1+F4)

Understanding projections

Example of a driver (simple sales driver)

For illustrative Purposes Only3

Copyright © 2007 by Wall Street Prep, Inc.

Historical inputs (blue cells)Historical inputs (blue cells)

Calculations (black cells)Calculations (black cells) Simple driver

(blue cells)Simple driver (blue cells)

We’ll discuss formatting rules

extensively in the next section.

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• Maintain standard formatting of numbers throughout your model

• Maintain standard formatting of worksheets throughout your model

• Maintain standard column and row headings across multiple sheets


$ sign only shown on first row of worksheet

Formatting (cont’d)



Negative numbers shown in parenthesis

EPS and share price data: always carry to 2 decimals ($25.43)

first row of worksheet and highlighted financial results

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Golden RuleUnderstand what you are modeling

☺ Structure your model as clearly and simply as possible so it can be easily checked (audited) by others, and usable in your absence.

☺ Assumptions should be placed together on one page and be explicit and driven off clearly identified drivers when possible.

☺ Save often and keep many versions of your model. Believe us – Excel does crash sometimes!

Modeling best practices



Footnotes

• Written in the bottom of the model

• Shows up when model is printed

• Clients will see these

Comments

• Embedded within a specific cell (Shift F2)

• Do not show up when model is printed

• For internal purposes

☺ When appropriate, explain your work via footnotes or comments

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Never re-enter the same input in different places: Your model should flow dynamically so that if one assumption (input) changes, the whole model changes.


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Do not embed numbers within formulas

When updating model inputs, you are more likely to forget an input buried within a formula.

Modeling habits to avoid



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When inputting historical financial statements, calculate where appropriate

Total assets – although disclosed – should be calculated in the financial model as the summation of all assets.� *****************************


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Avoid “hiding information” by hiding rows, moving information on to the side of the model, or below the model.

It is easy to forget that you hid the rows


�Rows 5-8 are hidden

Modeling habits to avoid



If you must hide information, “group” the rows or columns so the hidden information shows up on the margin.

Shortcut in Excel to group / ungroup rows: Shift + Alt + Right arrow key / Left arrow key

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Inserting rows in Excel

Highlight row: Shift SpacebarAdd row: Shift Ctrl =

Insert a dynamic

header formula in

Excel

Using the & sign, you can combine text and formulas, so that whatever you type in the company name input area should automatically change the header.




Formatting inputs

As in all models, inputs are blue and calculations are black. In addition, inputs are designated by the light yellow background color for easier navigation.

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Adjust historical IS for nonrecurring items

Insert lines below reported COGS, SG&A and Other, Non-operating Income, and Taxes that will reference the nonrecurring items input area to calculate pro forma (normalized) historical results.




Also remember to change EBIT, EBT, and net income calculations to reflect pro forma (vs. reported) results.

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Remember minority expense and equity income!

Recall that we just excluded minority interest expense and equity income from the ‘Other’ expense category. As such, we will explicitly identify them (on an after-tax basis) by multiplying the pre-tax figures by CL’s effective tax rate.

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Confirm model’s historical EPS matches consensus EPS

Since our EPS matches the consensus EPS, we can be fairly certain that we have caught all the nonrecurring items and made all the adjustments that The Street has made.

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See next page for explanation of the formula

Working capital schedule



Accounts receivable – 3 ways to project:

1. By default, the model grows accounts receivable balances at the revenue growth rate. Assumption is that sales that generate accounts receivable will grow at the same rate as cash sales.

1. User can override this projection by projecting days sales outstanding

2. User can override both the default and the DSO projection by inputting an absolute projection for accounts receivable.

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We will calculate PP&E by projecting capital expenditures, depreciation, and asset sales during the year as follows:

PP&E: Beginning-of-year balance

+Capital expenditures:

During the year


- Disposition of assets/asset sales:

Modeling asset dispositions/sales

Only model these if the company continually sells assets and the practice is expected to continue.

Sale leasebacks

Some companies continually sell assets and



- Depreciation: During the year

=PP&E:

End-of-year balance

- Disposition of assets/asset sales: During the year

Some companies continually sell assets and lease them right back as a financing tool or to alter their capital structure. If the company you are analyzing does this consistently, you should also project a reduction in PP&E as a result of the sale-leaseback.

Modeling write-downs

Similarly to intangible assets, unless we have specific information to the contrary, we do not typically have a basis for expecting any asset write-downs, and do not incorporate any projections for this in our model.

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• Reference historical PP&E balance from balance sheet

• Input historical capital expenditures from cash flow statement (p.41)

• Determine whether historical asset sales reported on the cash flow statement (p.41) will be recurring, and if so, input them as well.

• Calculate historical depreciation: D&A minus amortization expense.



Copyright © 2007 by Wall Street Prep, Inc.Wall StreetWall StreetPrepPrep™™

Project PP&EReference 2004 actual PP&E balance from balance sheet

Set up the row headers

minus amortization expense.

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CL management disclosed that capital expenditures in 2007 are expected to increase to a rate of 5% of revenues (10-K p.21). We will hold this ratio constant throughout our projection period. Remember to format the cell blue because there is a constant inside the formula.




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Straight-line recurring asset sales




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Reference net income and depreciation & amortization from the income statement

Cash flow statement – projections



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Working capital assets

Increases / (decreases) in year–over-year balances represent cash outflows / (inflows)




Calculate cash impact of all working capital assets

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Working capital liabilities

Increases / (decreases) in year–over-year balances represent cash inflows / (outflows)




Calculate cash impact of all working capital liabilities

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Deferred tax liabilities

Increases / (decreases) in year–over-year balances represent cash inflows / (outflows)




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Debt schedule



10. Reference from balance sheet

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11. Reference cash from prior year’s balance sheet balance

Debt schedule



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Circularity

Interest expense

Debt levels

Debt levels increase because of lower free

cash flows

Higher interest expense because of higher debt

levels




Net Income

Cash surplus/deficit

Reduced net income because of higher interest expenseReduced free cash flows

because of lower net income*****************************


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• Due to this circularity, your model may sometimes become unstable and lines may show REF!, Div/0! or #Value errors.

• The model “blows up”

These errors happen for no good reason!



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What to do

when the

model “blows

up”

Step 1: Do not panic – ensure the ‘Iteration’ box is checked for 100 iterations as illustrated. If the

Excel 2007 Office Button > Excel Options > Formulas tab



illustrated. If the error persists, turn to the next page for guidance.

Excel 2003 Tools > Option > Calculation tab

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Option 1: Manually break the circularity

1. Copy the interest expense reference from the income statement off to the right – beyondthe last projection column.

2. Replace the income statement interest expense projections with zeros. This effectively“breaks” the circularity – the errors should now disappear.

3. Copy and paste the interest expense formulas (that you pasted to the right of yourmodel) back into the income statement.

Option 2: Insert a circularity breaker toggle (preferred option)

What to do when the model “blows up”



Option 2: Insert a circularity breaker toggle (preferred option)

1. Create an input cell somewhere in the model where the user can either type in “1” or “0”.

2. When the user inputs “0” in that cell, it tells Excel to automatically place zeros instead ofinterest expense projections on the income statement. This will “break” the circularityand the errors are flushed out.

3. Then, the user can input “1” again in that cell, which will replace the zeros with theproper interest expense reference on the income statement.

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Naming Cells:

Ctrl F3



Name the cell “circref”

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Inserting a circularity breaker toggle

Insert an IF statement to modify the interestexpense formula to incorporate thecircularity breaker, such that if it is turnedon, the interest expense becomes zero,breaking the circularity in the model.



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Once user selects 0, Excelautomatically places zeros instead ofinterest expense projections, “breaking”the circularity and flushing out anyerrors.



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Model completed

• We have now completed building an integrated, fully dynamic financial statement model

• Scroll down to the balance sheet and ensure that projected assets = projected liabilities + shareholders’ equity



Balance-check should read 0 for every projected year. If not, you will need to locate the source of the error. Turn to the next page for guidance.

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Sensitivity & scenario analysisSensitivity & scenario analysis

Incorporating data tables, Incorporating data tables, the OFFSET function, form the OFFSET function, form toggles, and scenarios into toggles, and scenarios into the model.the model.

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Decide what assumptions to “sensitize”




Input the following ranges of assumptions in a schedule below the ratio analysis.

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• Close the Properties window• In Excel 2003: Click on the top left icon in the Control Toolbox – “Exit design

mode.” Close the Control Toolbox• In Excel 2007: Click on ‘Design Mode’ in the Developer Tab.

Excel 2003

Exit design mode


Excel 2007

Click design mode



Your toggle is now ready to use!

Toggle between scenarios and see how the projections in the model change*****************************


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Cleanup: move the ‘Select a case’ input

• Since this area is no longer the user input area (now users seelct the desired scenario from a toggle), be sure to remove this from the face of the model.

• Some modelers paint this white to hide it altogether. If you do this, be careful, because once you paint it white, you may forget it is there and inadvertantly delete it by accident.



Cut and paste to the right off the model as illustrated:

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• We will now create a data table that will calculate 2007 EPS based on a range of 2007 revenue growth and gross profit margin assumptions

• Input a range of revenue growth rates in a column• Input a range of gross profit margins in a row• Reference 2007 EPS (the output variable) from model above into the cell

between the input row and input column as illustrated below




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• Highlight the matrix

• Excel 2003: Type Alt d t (Data>Table...)

Excel 2007: Type Alt a w t (Data>What-if analysis>Data Table)

• Reference the row input variable from the model above (2007 gross profit margin is the row input variable)

• Reference the column input variable from the model above (2007 revenue growth is the column input variable)

• Hit Enter

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Terms of UseTerms of Use

All materials included in Wall StreetPrep’s Self Study Program including “Step-by-step Tutorial Guide”, Wall StreetPrep’s proprietary portfolio of financial models, supplementary notes, are not to be duplicated, copied, disseminated or distributed without the expressed, written permission of Wall StreetPrep, Inc. The Self Study Program as well as case studies used during live classes are designed for illustrative purposes only and does not, in any way, constitute and investment thesis or recommendation.

Copyright

2008 Wall StreetPrep, Inc. All rights reserved. "Wall StreetPrep", "Wall Street Prep", "The EDGE Self Study Program", and various marks are trademarks of Wall Street Prep, Inc.

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Fin Modeling

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