Introduction to statement modelling for student

WHAT IS A FINANCIAL MODEL ?A tool built in a spreadsheet that’s used to forecast a business’s financial performance into the future and make business decisions.. TYPES OF FINANCIAL MODEL

TO

3 – STATEMENT MODELLING

WHAT IS A FINANCIAL MODEL ?

A tool built in a spreadsheet that’s used to forecast a business’s

financial performance into the future and make business decisions Some key decisions where the financial model is required

:-• Corporate decisions

• project finance

• corporate transactions

• investment decisions

TYPES OF FINANCIAL MODELS

3 – statement model

DCF model

Merger (M&A) model

Capital raises model

Leverage buyout model

Sum of the parts model Forecasting model Consolidation model Option pricing model Budget model

HIERARCHY OF FINANCIAL MODELING

LBO Analysis Capital raising M&A analysis Sensitivity analysis Scenario analysis DCF Analysis

3 – Statement modeling Income statement, balancesheet, cash flow statement

Discounted cash flow

analysis to value a business,

project or investment

Estimate changes in the value

of a business in different possible scenarios

Evaluate how sensitive an

investment is to change in

drivers

Evaluate the attractiveness of a potential acquisition, merger or venture

Analyze the pro forma of raising

debt or equity

Determine how much leverage can be used to purchase a company

MODELING BEST PRACTICES

What problem is the model meant to

solve ?

Who is the end user?

What are the users supposed to do with

the model?

What is the min no of inputs &

outputs to build a useful model? Plan how the inputs & outputs willbe laid out ?

Keep all the inputs in one place

Consider using excel tools such as data validation and conditional formatting

Use test data to ensure model work as expected.

FORECASTING METHODS

TOP – DOWN ANALYSIS BOTTOMS – UP ANLYSIS REGRESSION ANALYSIS YEAR – OVER – YEARANALYSIS

• Start with the total

addressable market

(TAM)

• Work down from

there based on

market share and

segment until arriving

at revenue.

• Start with the most basic drivers of business

• Build up the analysis all the up to revenue

• Analyze relationship between revenue and other factors using the regression analyses in excel.

• Most basic form of forecasting

• Calculate year-over-year change in

revenue

FINANCIAL FORECASTING FRAMEWORK

• Assumptions and drivers :-historical ratios and figures that drive the forecast

• Income statement :- summarize the company’s P&L

• Balance sheet :- displays company’s assets, liabilities & shareholder’s equity

• Cash flow statement :- reports cash generated and spent by the

company

• Supporting schedule :- breaks down longer calculations such as PP&E, capex, depreciation etc.

FINANCIAL FORECASTING

APPROACH

• We need historical data to evaluate the trends and forecast the future.

• At least five years of prior data is required to figure out future margins

1 HISTORICAL DATA

2 ASSUMPTIONS AND DRIVERS

• Very important part of model

• We use isolate drivers so that we can test how the model reacts to them

• Identifying these drivers requires detailed knowledge of the business

• Model drivers are volatile and have a significant impact on model outputs

3 FORECAST REVENUES DOWN TO EBITDA

• For income statement forecasting we need supporting schedules for

depreciation, interest and taxes

4 FORECAST GROSS MARGINS AND SG&A EXPENSES

• Use historical figures or trends to forecast the future margins

• Consider factors such as economies of scale, inflation, learning effects of labor and materials

5 FORECAST WORKING CAPITAL

• WC includes only operational and not finance/interest bearing cost

• WC= Current assets + inventory - current liabilities

 AR days :- no of days on average the business takes to collect its receivables

• Receivable days = (365*AR)/revenue

• Forecast receivable days = (AR days *revenue)/365

 AP days :- no of days on average business takes to repay its payables

• Payable days = (365*AP)/cogs

• Forecast payable days = (AP days*cogs)/365

 Inventory days :- no of days on average for which inventory is held prior its sales

• Inventory days = (365*inventory)/cogs

• Forecast inventory days = (inventory days*cogs)/365

6 FORECAST CAPITAL ASSETS

• This includes PP&E, capex and depreciation

• Intangible assets can be modeled as well

• Forecast depreciation and amortization based on the company’s policies

• Calculate capital asset turnover ratio = revenue/PP&E, which shows how much capital assets a company has required to generate revenue historically

7 FORECAST CAPITAL STRUCTURE

• This impacts both the income statement as well as the balance sheet

• Consider if debt and equity held constant or it changes over time based on cash flow

• Ask yourself – do we want model the status quo for this company or we need to model a different capital structure in the future

8 COMPLETE THE CASH FLOW STATEMENT

REVIEW AND AUDIT

• Sanity check ( check the assumptions and drivers )

• Check row differences

• Trace precedents and dependents

• Check formulas and constants (constants are required

to be only entered once )

• Check for error messages and alerts in the model