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Private and Confidential
g n i l e d o M l a i c n a n i F
Financiall Modeling Training Program Financia Prepared by: Dheeraj Vaidya CEO, Corporate Bridge Academy
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Discussion topics n o i s s e S g n g i n n i l e e v d E
o – M e l c a i n c a n n a i n F i e F t a r o p r o C
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 n o i s s e S g n g i n n i l e e v d E
o – M e l c a i n c a n n a i n F i e F t a r o p r o C
Simplified representation of performance
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
Both past and future
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 n o i s s e S g n g i n n i l e e v d E
o – M e l c a i n c a n n a i n F i e F t a r o p r o C
Need to have clear and well defined assumptions
Assumptions should reflect business realities and expectations
Past as an indicator of future performance, except i n case of • Start up situations • Significant acquisitions or divesture activities • Volatile industry structure
Key tests a financial model should withstand
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 i n future performance Understand Management expectations Check out what other analysts think about the company
How to make Assumptions
Referred to as „drivers‟ or „inputs‟ these are based on a thorough understanding of the business
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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Excel Best Practices n o i s s e S g n g i n n i l e e v d E
o – M e l c a i n c a n n a i n F i e F t a r o p r o C
Maintain Consistency
Makes understanding and constructing easier
Consistent Color scheme makes life easy for self and others using the model BLUE for inputs (histor (historical ical data, assumptions, 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
X
Separate line items are always useful
√
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Excel Best Practices n o i s s e S g n g i n n i l e e v d E
o – M e l c a i n c a n n a i n F i e F t a r o p r o C
Be efficient
Do not input same numbers numbers twice. Also, Excel takes care 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 i n the model • Take care as named cells wil l be duplicated in the new sheet
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Modeling Warm Up! n o i s s e S g n g i n n i l e e v d E
o – M e l c a i n c a n n a i n F i e F t a r o p r o C
Use a Modular Approach
Core Statements – Income Statement, Balance Sheet, Cash Flow Statements • Focus on Others Prepare supporting schedules • Do al alll the the “d “dir irty ty”” wo work rk • 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
Income Statement
Debt & Interest
Plant & Machinery, Depreciation
Cash Flow Statement
Shareholder’s Equity
Intangibles, Amortization
Balance Sheet
Other LT Items
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Things to Remember n o i s s e S g n g i n n i l e e v d E
o – M e l c a i n c a n n a i n F i e F t a r o p r o C
Historical data as a guide for projections
Aim at projecting future performance Remember you are an Analyst and not an Audi tor! Do not get worked up i f 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 Financ Financial ial Statem Statements ents - Overv Overview iew n o i s s e S g n g i n n i l e e v d E
o – M e l c a i n c a n n a i n F i e F t a r o p r o C
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 Inco me Stat Statement ement - Sampl Sample e n o i s s e S g n g i n n i l e e v d E
o – M e l c a i n c a n n a i n F i e F t a r o p r o C
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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Balan Bal ance ce Sheet Sheet - Sam Sample ple n o i s s e S g n g i n n i l e e v d E
o – M e l c a i n c a n n a i n F i e F t a r o p r o C
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 Stat Statement ement - Sampl Sample e n o i s s e S g n g i n n i l e e v d E
o – M e l c a i n c a n n a i n F i e F t a r o p r o C
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 Inco me Stat Statement ement - Sampl Sample e n o i s s e S g n g i n n i l e e v d E
Calculations in Black
Inputs are in Blue
o – M e l c a i n c a n n a i n F i e F t a r o p r o C
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!
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Income Inco me Stat Statement ement - Sampl Sample e n o i s s e S g n g i n n i l e e v d E
o – M e l c a i n c a n n a i n F i e F t a r o p r o C
Forecasted figures
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
Drivers based on input assumptions
Only one blue input cell if constant growth is assumed
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Income Inco me Stat Statement ement - Sampl Sample e n o i s s e S g n g i n n i l e e v d E
o – M e l c a i n c a n n a i n F i e F t a r o p r o C
Inputs from research/ past trends
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. EBITDA. Depreciation & Amortization Amortization will be referenced from schedules to be built in model Drivers
Calculations
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Balan Bal ance ce Sheet Sheet - Sam Sample ple n o i s s e S g n g i n n i l e e v d E
Calculations in Black Inputs are in Blue
o – M e l c a i n c a n n a i n F i e F t a r o p r o C
Its practical to show 2 condensed debt items
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 i tems
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Illustrative Flow of Funds n o i s s e S g n g i n n i l e e v d E
o – M e l c a i n c a n n a i n F i e F t a r o p r o C
Income Statement
Cash Flow Statement
Balance Sheet
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Working Capital Schedule n o i s s e S g n g i n n i l e e v d E
Working Capital Overview
Create the working capital line items Reference the historical balances Calculate past ratios related to working capital i tems Project future working capital by each line i tem Calculate projected cash flows generated out of working capital items Link with balance sheet & cash flow statement work sheets
o – M e l c a i n c a n n a i n F i e F t a r o p r o C
Referenced from Income Statement
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
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Working Work ing Capit Capital al Schedul Schedule e - Samp Sample le n o i s s e S g n g i n n i l e e v d E
Referenced from BS
o – M e l c a i n c a n n a i n F i e F t a r o p r o C
Calculations
Reference the past data from the balance sheet
Calculate net working capital Arrive at increase/ decrease in working capital
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Working Work ing Capit Capital al Schedul Schedule e - Samp Sample le n o i s s e S g n g i n n i l e e v d E
o – M e l c a i n c a n n a i n F i e F t
Calculations
a r o p r o C
Calculate historical ratios and percentages
Use the ending or average balance Both are acceptable as long consistency is maintained
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Working Work ing Capit Capital al Schedul Schedule e - Samp Sample le n o i s s e S g n g i n n i l e e v d E
o – M e l c a i n c a n n a i n F i e F t a r o p r o C
Assumptions
References, if constant
Assumptions for future working capital items
Certain items without an obvious driver are usually assumed at constant amounts Ensure assumptions are reasonable and in li ne with the business
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Working Work ing Capit Capital al Schedul Schedule e - Samp Sample le n o i s s e S g n g i n n i l e e v d E
Drivers
Projections
o – M e l c a i n c a n n a i n F i e F t a r o p r o C
Drivers
Use the future ratios and assumptions to project the forecasted working capital balances
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Working Work ing Capit Capital al Schedul Schedule e - Samp Sample le n o i s s e S g n g i n n i l e e v d E
o – M e l c a i n c a n n a i n F i e F t a r o p r o C
Check and make sure the signs match!
Calculations
Arrive at Cash Flows based on individual line items
Ensure signs are accurate!
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Balan Bal ance ce Sheet Sheet - Sam Sample ple n o i s s e S g n g i n n i l e e v d E
Referenced from Working Capital Schedule
o – M e l c a i n c a n n a i n F i e F t a r o p r o C
Link up the forecasted Working Capital to the Balance Sheet
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Cash Flow Stat Statement ement - Sampl Sample e n o i s s e S g n g i n n i l e e v d E
o – M e l c a i n c a n n a i n F i e F t
Referenced from Working Capital Schedule
a r o p r o C
Link up the forecasted Working Capital cash flows with the Cash Flow Statement
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Illustrative Flow of Funds n o i s s e S g n g i n n i l e e v d E
o – M e l c a i n c a n n a i n F i e F t a r o p r o C
Working Capital Schedule
Sales COGS
Working Capital
Income Statement
Change in WC
Working Capital
Cash Flow Statement
Balance Sheet
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Debt and Interest n o i s s e S g n g i n n i l e e v d E
o – M e l c a i n c a n n a i n F i e F t a r o p r o C
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 activiti es
Calculate cash flow from available financing activities
Calculate ending cash balance
Link up with Balance Sheet
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The Cash Flow Statement n o i s s e S g n g i n n i l e e v d E
Cash Flow from Operating Activities
Net Income
Add: Non Cash Charges/ Incomes
Add: Change in Working Capital
Add: Change in LT assets/ liabilities
o – M e l c a i n c a n n a i n F i e F t a r o p r o C
Cash Flow from Investing Activities
+
Capital Expenditures
Add: Proceeds from Asset Sales
Add: Additions to Intangibles
Add: Business Acquisitions
Free Cash Flow Available for Financing Activities
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
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Change in Cash – Schematic Diagram n o i s s e S g n g i n n i l e e v d E
o – M e l c a i n c a n n a i n F i e F t a r o p r o C
Cash Flow from Operating Activities
+
Net Cash Flow
Cash Flow from Operating Activities
+ Cash Flow from Operating Activities
Add: Effects of Ex. Rates on Cash
Add: Previous year‟s Cash Balance
= Ending Cash Balance
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Cash Flow Stat Statement ement - Sampl Sample e n o i s s e S g n g i n n i l e e v d E
Referenced from Income Statement
Calculations
o – M e l c a i n c a n n a i n F i e F t a r o p r o C
Link up Net Income to the Cash Flow Statement
Calculate Cash Flow from Operating and Investing activities
Calculate Cash Flow Available for Financing Activities
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Cash Flow Stat Statement ement - Sampl Sample e n o i s s e S g n g i n n i l e e v d E
o – M e l c a i n c a n n a i n F i e F t a r o p r o C
Calculations
Calculate Cash Flow Available for Financing Activities and Net Change in Cash
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Cash Flow Stat Statement ement - Sampl Sample e n o i s s e S g n g i n n i l e e v d E
o – M e l c a i n c a n n a i n F i e F t a r o p r o C
Reference from BS
Reference “beginning cash balance” from the Balance Sheet
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Cash Flow Stat Statement ement - Sampl Sample e n o i s s e S g n g i n n i l e e v d E
Excel reads blank cells as Zero
o – M e l c a i n c a n n a i n F i e F t a r o p r o C
Forecasted Cash is yet to be linked – this will be done later in the model
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Cash Flow Stat Statement ement - Sampl Sample e n o i s s e S g n g i n n i l e e v d E
o – M e l c a i n c a n n a i n F i e F t a r o p r o C
Calculations
Calculate Ending Cash Balance
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Cash Flow Stat Statement ement - Sampl Sample e n o i s s e S g n g i n n i l e e v d E
Referenced from Cash Flow
o – M e l c a i n c a n n a i n F i e F t a r o p r o C
Link up “ending cash balance” to the Balance Sheet
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Illustrative Flow of Funds n o i s s e S g n g i n n i l e e v d E
o – M e l c a i n c a n n a i n F i e F t a r o p r o C
Linking up the Core Statements
Depreciation Sales
Income Statement
COGS
Working Capital n o i t a z i t r o m A
Change in WC
Shareholder’s Equity
Working Capital
Cash Flow Statement PP & E, Depreciation
Intangibles, Amortization
n o i t a z i t r o m A
Balance Sheet
Intangibles
Other Long Term Items
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Debt and Inte Interest rest - Sched Schedule ule n o i s s e S g n g i n n i l e e v d E
o – M e l c a i n c a n n a i n F i e F t a r o p r o C
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 Fl ow Statement
Forecast debt balances to the Balance Sheet
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Debt and Intere Interest st Schedule Schedule - Samp Sample le n o i s s e S g n g i n n i l e e v d E
o – M e l c a i n c a n n a i n F i e F t a r o p r o C
Referenced
Set up a Debt Schedule
Reference the Cash Flow Available for Financing
Reference all equity sources and uses of cash
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Debt and Intere Interest st Schedule Schedule - Samp Sample le n o i s s e S g n g i n n i l e e v d E
o – M e l c a i n c a n n a i n F i e F t a r o p r o C
Reference
Assumption
Calculations
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
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Debt and Intere Interest st Schedule Schedule - Samp Sample le n o i s s e S g n g i n n i l e e v d E
o – M e l c a i n c a n n a i n F i e F t a r o p r o C
Reference
Reference the historical long term debt balances from the Balance Sheet
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Debt and Intere Interest st Schedule Schedule - Samp Sample le n o i s s e S g n g i n n i l e e v d E
o – M e l c a i n c a n n a i n F i e F t a r o p r o C
INPUTS from known debt maturities
Input the future debt repayments – fill in the known aggregate maturities of long term debt
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Debt and Intere Interest st Schedule Schedule - Samp Sample le n o i s s e S g n g i n n i l e e v d E
o – M e l c a i n c a n n a i n F i e F t a r o p r o C
References Calculations
Forecast future debt balances
Reference beginning balance
Calculate forecast ending balance
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Debt and Intere Interest st Schedule Schedule - Samp Sample le n o i s s e S g n g i n n i l e e v d E
o – M e l c a i n c a n n a i n F i e F t a r o p r o C
References & Calculations
Reference Long Term Debt Issuance and Long Term Debt (Repayments)
Calculate Cash Available for Revolving Credit Facility
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Debt and Intere Interest st Schedule Schedule - Samp Sample le n o i s s e S g n g i n n i l e e v d E
o – M e l c a i n c a n n a i n F i e F t a r o p r o C
References
Reference the past revolving credit facility balances from the Balance Sheet
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Debt and Intere Interest st Schedule Schedule - Samp Sample le n o i s s e S g n g i n n i l e e v d E
o – M e l c a i n c a n n a i n F i e F t a r o p r o C
References “Cash Sweep” (use MIN logic)
Calculations
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
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Debt and Intere Interest st Schedule Schedule - Samp Sample le n o i s s e S g n g i n n i l e e v d E
Calculate interest expense from Revolver
Calculate the average balance
Make a reasonable assumption for an interest rate
Forecast interest expense
o – M e l c a i n c a n n a i n F i e F t a r o p r o C
Assumption
Calculations
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Debt and Intere Interest st Schedule Schedule - Samp Sample le n o i s s e S g n g i n n i l e e v d E
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
o – M e l c a i n c a n n a i n F i e F t a r o p r o C
Assumption
Calculations
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Debt and Intere Interest st Schedule Schedule - Samp Sample le n o i s s e S g n g i n n i l e e v d E
Calculate interest income from Cash Balances
Calculate the average balance
Make a reasonable assumption for an interest rate
Forecast the interest income
o – M e l c a i n c a n n a i n F i e F t a r o p r o C
Calculations
Assumption
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Debt and Intere Interest st Schedule Schedule - Samp Sample le n o i s s e S g n g i n n i l e e v d E
o – M e l c a i n c a n n a i n F i e F t a r o p r o C
References
Link up interest expense and interest income to Income Statement
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Debt and Intere Interest st Schedule Schedule - Samp Sample le n o i s s e S g n g i n n i l e e v d E
o – M e l c a i n c a n n a i n F i e F t
References
a r o p r o C
Link up debt repayments and borrowings to Cash Flow Statement
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Debt and Intere Interest st Schedule Schedule - Samp Sample le n o i s s e S g n g i n n i l e e v d E
o – M e l c a i n c a n n a i n F i e F t a r o p r o C
Link the debt balances to Balance Sheet
Review final logic for totals and other statistics
Calculations
References
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Illustrative Flow of Funds n o i s s e S g n g i n n i l e e v d E
o – M e l c a i n c a n n a i n F i e F t a r o p r o C
Debt & Interest Schedule Other Long Term Items Depreciation Sales
Income Statement
COGS
Working Capital n o i t a z i t r o m A
Change in WC
Shareholder’s Equity
Working Capital
Cash Flow Statement PP & E, Depreciation
Intangibles, Amortization
n o i t a z i t r o m A
Balance Sheet
Intangibles
Other Long Term Items
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Trouble Shooting Your Model n o i s s e S g n g i n n i l e e v d E
o – M e l c a i n c a n n a i n F i e F t a r o p r o C
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
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Dealing with Circular Models n o i s s e S g n g i n n i l e e v d E
o – M e l c a i n c a n n a i n F i e F t a r o p r o C
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What is Circular Reference n o i s s e S g n g i n n i l e e v d E
o – M e l c a i n c a n n a i n F i e F t a r o p r o C
Interest Expense & Interest Income
Revolver Balance & Cash Balance
Net Income
Free Cash Flow
