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Private and Confidential
Financial Modeling Training Program
Prepared by: Dheeraj Vaidya
CEO, Corporate Bridge Academy
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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
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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
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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
Private and Confidential – Not for Circulation 4
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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
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√
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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
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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
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Working Capital
Plant & Machinery,
Depreciation
Intangibles,
Amortization
Income
Statement
Cash Flow
Statement
Balance
Sheet
Debt &
Interest
Shareholder’s
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
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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
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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
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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
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Income Statement - Sample
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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
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Income Statement - Sample
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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 input cell if constant growth is assumed
Forecasted figures
Drivers based on input assumptions
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Income Statement - Sample
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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 (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
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Balance Sheet - Sample
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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, make sure not to miss out any items
Its practical to show 2 condensed debt items
Inputs are in Blue
Calculations in Black
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Illustrative Flow of Funds
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Cash Flow
Statement
Balance
Sheet
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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
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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
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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
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Calculations
Referenced from BS
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Working Capital Schedule - Sample
Calculate historical ratios and percentages
Use the ending or average balance
Both are acceptable as long consistency is maintained
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Calculations
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Working Capital Schedule - Sample
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
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Assumptions
References,
if constant
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Working Capital Schedule - Sample
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Use the future ratios and assumptions to project the forecasted working capital balances
Drivers
Drivers
Projections
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Working Capital Schedule - Sample
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Calculations
Check and make sure the signs match!
Arrive at Cash Flows based on individual line items
Ensure signs are accurate!23Sampel PPTs - Prepared for CLSA India (Pune)
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Balance Sheet - Sample
Link up the forecasted Working Capital to the Balance Sheet
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Referenced from
Working Capital Schedule
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Cash Flow Statement - Sample
Link up the forecasted Working Capital cash flows with the Cash Flow Statement
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Referenced from
Working Capital Schedule
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Illustrative Flow of Funds
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Statement
Cash Flow
Statement
Balance
Sheet
Working
Capital
Sales
COGS
Change in WC
Working Capital
Working Capital Schedule
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Debt and Interest
Income Statement – interest expense/ income are incomplete at this stage
Balance Sheet – cash and debt items are incomplete at this stage
Cash Flow Statement –
Calculate cash flow from operating and investing activities
Calculate cash flow from available financing activities
Calculate ending cash balance
Link up with Balance Sheet
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The Cash Flow Statement
Cash Flow from Operating Activities
Net Income
Add: Non Cash Charges/ Incomes
Add: Change in Working Capital
Add: Change in LT assets/ liabilities
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Cash Flow from Investing Activities
Capital Expenditures
Add: Proceeds from Asset Sales
Add: Additions to Intangibles
Add: Business Acquisitions
Cash Flow from Financing Activities
Available Cash Flow is used for:
Repayment of Debt, payment of dividend, repurchase of equity, maintain higher cash balances
Cash flow deficit is funded by”
Revolving debt, issuance of LT debt, issuance of equity, cash balances
+
Free Cash Flow Available for
Financing Activities
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Change in Cash – Schematic Diagram
Cash Flow from Operating Activities
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Add: Effects of Ex. Rates on Cash
Add: Previous year‟s Cash Balance
= Ending Cash Balance
+
Net Cash FlowCash Flow from Operating Activities
Cash Flow from Operating Activities
+
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Cash Flow Statement - Sample
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Link up Net Income to the Cash Flow Statement
Calculate Cash Flow from Operating and Investing activities
Calculate Cash Flow Available for Financing Activities
Referenced from
Income Statement
Calculations
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Cash Flow Statement - Sample
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Calculate Cash Flow Available for Financing Activities and Net Change in Cash
Calculations
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Cash Flow Statement - Sample
Reference “beginning cash balance” from the Balance Sheet
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Reference from BS
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Cash Flow Statement - Sample
Forecasted Cash is yet to be linked – this will be done later in the model
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Excel reads
blank cells as Zero
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Cash Flow Statement - Sample
Calculate Ending Cash Balance
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Calculations
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Cash Flow Statement - Sample
Link up “ending cash balance” to the Balance Sheet
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Referenced
from Cash Flow
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Illustrative Flow of Funds
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Linking up the Core Statements
Income
Statement
Cash Flow
Statement
Balance
Sheet
Working
Capital
Sales
COGS
Change in WC
Working Capital
PP & E,
Depreciation
Depreciation
Intangibles,
Amortization
Am
ort
ization
Intangibles
Am
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ization
Other Long
Term Items
Shareholder’s
Equity
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Debt and Interest - Schedule
Calculate Cash Flow Available for Debt Repayment
Reference in past information on Long Term Debt
Make sure to enter the mandatory Long Term Repayments (refer to repayment schedule provided in the Annual Report in the discussion on Debt Section)
Calculate forecasted Long Term Debt Repayments
Calculate Cash Flow Available for Revolver
Revolver = Cash Sweep
Calculate Interest Expense/ Income
Refer to average debt balances
Revolver interest expenses
Long Term interest expenses
Cash Balance for Interest/ Income
Link Up
Forecasted interest expense/ income to Income Statement
Forecasted debt repayments/ borrowings to Cash Flow Statement
Forecast debt balances to the Balance Sheet
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Debt and Interest Schedule - Sample
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Set up a Debt Schedule
Reference the Cash Flow Available for Financing
Reference all equity sources and uses of cash
Referenced
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Debt and Interest Schedule - Sample
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Calculate Cash Flow from Debt Repayment
Reference the Beginning Cash Balance from the Balance Sheet
Deduct a minimum cash balance
Skip Long Term Debt Issuance/ Repayments, Cash available for Revolving Credit Facility
and Revolver section for now
Assumption
Calculations
Reference
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Debt and Interest Schedule - Sample
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Reference the historical long term debt balances from the Balance Sheet
Reference
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Debt and Interest Schedule - Sample
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Input the future debt repayments – fill in the known aggregate maturities of long term debt
INPUTS from known debt maturities
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Debt and Interest Schedule - Sample
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Forecast future debt balances
Reference beginning balance
Calculate forecast ending balance
References
Calculations
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Debt and Interest Schedule - Sample
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Reference Long Term Debt Issuance and Long Term Debt (Repayments)
Calculate Cash Available for Revolving Credit Facility
References & Calculations
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Debt and Interest Schedule - Sample
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Reference the past revolving credit facility balances from the Balance Sheet
References
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Debt and Interest Schedule - Sample
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Set up the logic for the revolver – the cash sweep must be able to:
Borrow if a cash flow deficit
Pay down itself with free cash flow
Stop at a „zero‟ balance
References
“Cash Sweep”
(use MIN logic)
Calculations
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Debt and Interest Schedule - Sample
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Calculate interest expense from Revolver
Calculate the average balance
Make a reasonable assumption for an interest rate
Forecast interest expense
Calculations
Assumption
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Debt and Interest Schedule - Sample
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Calculate interest expense from the Long Term Debt
Calculate the average balance
Make a reasonable assumption for an interest rate
Forecast the interest expense
Calculate Total Interest Expense
Calculations
Assumption
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Debt and Interest Schedule - Sample
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Calculate interest income from Cash Balances
Calculate the average balance
Make a reasonable assumption for an interest rate
Forecast the interest income
CalculationsAssumption
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Debt and Interest Schedule - Sample
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Link up interest expense and interest income to Income Statement
References
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Debt and Interest Schedule - Sample
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Link up debt repayments and borrowings to Cash Flow Statement
References
50Sampel PPTs - Prepared for CLSA India (Pune)
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Debt and Interest Schedule - Sample
Private and Confidential – Not for Circulation 51
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Link the debt balances to Balance Sheet
Review final logic for totals and other statistics
ReferencesCalculations
51Sampel PPTs - Prepared for CLSA India (Pune)
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Illustrative Flow of Funds
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Debt & Interest Schedule
Income
Statement
Cash Flow
Statement
Balance
Sheet
Working
Capital
Sales
COGS
Change in WC
Working Capital
PP & E,
Depreciation
Depreciation
Intangibles,
Amortization
Am
ort
ization
Intangibles
Am
ort
ization
Other Long
Term Items
Shareholder’s
Equity
Other Long
Term Items
52Sampel PPTs - Prepared for CLSA India (Pune)
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Trouble Shooting Your Model
Private and Confidential – Not for Circulation 53
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Circular References
Understanding what it means?
Designing a solution for fixing circular references
Balancing the financial model
Error handling and tracing the logic of the model
Final Touches
Validate assumptions
Ensure formulae are in place
Make sure formatting is as desired
53Sampel PPTs - Prepared for CLSA India (Pune)
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Dealing with Circular Models
Private and Confidential – Not for Circulation 54
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54Sampel PPTs - Prepared for CLSA India (Pune)
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What is Circular Reference
Private and Confidential – Not for Circulation 55
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Free Cash Flow
Interest Expense
&
Interest Income
Revolver Balance
& Cash BalanceNet Income
55Sampel PPTs - Prepared for CLSA India (Pune)
