P. 1
Financial Modeling and Forecasting

Financial Modeling and Forecasting

|Views: 26|Likes:
Published by Vikram Rautela

More info:

Published by: Vikram Rautela on Oct 11, 2012
Copyright:Attribution Non-commercial

Availability:

Read on Scribd mobile: iPhone, iPad and Android.
download as PDF, TXT or read online from Scribd
See more
See less

10/02/2013

pdf

text

original

Financial Modeling & Forecasting

Jason MacMorran www.pncpa.com

Presentation Outline
I. Introduction and Learning Objectives II. Definitions and Standards Overview III. Uses for Financial Models IV. Basics of Financial Modeling V. Basics of Financial Analysis VI. Sensitivity and Scenario Analysis VII. Conclusion

Learning Objectives
Understand accounting standards related to prospective information. Discuss uses and applications for financial models, including uses as decision making tools. Understand basic design and creation of a financial model. Understand uses for financial analysis and sensitivity analysis.

Definitions and Standards Overview

Definitions and Standards Overview
The words projection, forecast, pro forma, model, etc., are often used interchangeably relative to prospective information. In an accounting context, they have different meanings. Generally speaking, the projection, forecast, pro forma or budget will be the ‘output’, and the financial model will include the ‘inputs’ and ‘output’. This section is not intended to be authoritative or a detailed look at standards, but a general overview of what to look for and where to find it!

e. . Projection – presents an entity’s financial position. but is consistent with the purpose of the projection (i. and cash flows. Hypothetical Assumption . results of operations. and cash flows. results of operations. expansion scenario).Key Accounting Terms Forecast – presents an entity’s expected financial position. based on one or more hypothetical (what ifs) assumptions provided by a responsible party. based on responsible party’s assumptions reflecting conditions it expects to exist and actions it expects to take.an assumption used to present a condition or course of action that is not necessarily expected to occur.

Key Accounting Terms Financial Analysis – practitioner develops assumptions. analyzes results. Responsible Party – person or persons responsible for assumptions underlying the prospective financial statements. . and recommends a course of action. Partial Presentation – a presentation of prospective financial information that excludes one or more of the items required for prospective financial statements.

based on historical amounts Expired budgets .Types of Presentations Prospective Information Prospective Financial Statements Forecast Projection Prospective. but not Financial Statements Partial presentations Financial analyses Not Prospective Information Pro forma.

Limited Use – use only by the entity with whom the responsibly party is negotiating. Internal Use – solely for use by the responsible party. Negotiating bank financing. for example: Offering of debt or equity securities under SEC regulations. Offering of tax-exempt bonds. Merger negotiations.Uses of Prospective Information General Use – use by persons with whom the responsible party is not directly negotiating. . for example: Private placement.

Uses of Prospective Information Type of Prospective Presentation Appropriate Uses General Use Forecast Projection Partial Presentation Financial Analysis Yes No No No Limited Use Yes Yes Yes Yes Internal Use Yes Yes Yes Yes .

Examination – evaluating assumptions and presentation of financial information and issuing report. Compilation – assembling prospective statements in conformity with presentation guidelines and issuing report. does not require report. and can be very limited or quite extensive. Agreed-upon procedures – varies by engagement. . Internal Use: Assembly – no type of assurance.Types of Engagements Third-party Use: Special disclaimer on current year budgets – practitioners may not be required to apply any procedures if they make certain disclaimers.

.Independence Independence is required in examination and agreed-upon procedures engagements. but not in compilation or internal use engagements because no assurance is expressed.

Exceptions Litigation and valuation projects often have exceptions to procedure and presentation rules. so long as they are properly disclaimed. .

Key Finance Terms Net Present Value – present value of expected future cash flows minus initial investment. . Internal Rate of Return – discount rate at which investment has zero net present value.

Resources Accounting AICPA Attestation Standards AICPA Guide for Prospective Financial Information AICPA Practice Aid 06-2 Preparing Financial Models PPC’s Guide to Forecasts and Projections Finance Brealey & Myers Principles of Corporate Finance .

Uses for Financial Models .

Financial models should be comprehensive. financial position.Background Financial models should tell a story. internally consistent. investing and financing activities that determine future profitability. and risk. What is the business going to do? How is it going to do it? How is it reflected in the financials? Financial models capture the future operating. and externally reasonable. .

economics. finance.). Finance / economics based models – decision making (net present value. internal rate of return. and business philosophy. corporate psychology. how will competitors react to your planned actions? Does the plan involve risks you know you’re unwilling to take? . Accounting based models – compilations for investors / creditors. Psychology / Philosophy – In a ‘decision making’ model.Background Financial models can integrate elements of accounting. etc.

Uses for Financial Models Financing (debt or equity) Buy vs. Lease Valuation Budgeting Business Plans Strategic Plans Expansion Merger / Acquisition Lost Profits Business Interruption Litigation Support Start-ups Contraction / Closure .

Financial Models in Everyday Life A ‘financial model’ does not have to be complex! Simple situations call for simple financial models: Buy vs. lease of vehicle Impact of change in interest rate on borrowing Payback period on an investment Complex situations call for complex financial models: Merger and acquisition pro-forma and future cost savings Entering new markets / launching new products Litigation .

Basics of Financial Modeling .

Basics of Financial Modeling Define the need Basic organization Sample construction Other layout considerations .

Define the Need What is the desired goal of the financial model? Launching a new product? Integrating a potential acquisition? Refinancing debt? Who is the expected user? Management? Investors? Bankers? What is the expected use? Internal? External? The above issues will govern the sophistication and reporting requirements of a financial model. .

May require ‘one-time’ sources and uses of funds. .Define the Need Presentation / engagement will depend on purpose and audience. May require complete financial statements over a defined time period. May require limited information over a defined time period.

. complete financial statements can help measure return on investment and potential risks. but also most instructive to user: Balance Sheet – measures future liquidity and leverage Income Statement – measures future operating results Statement of Cash Flows – outlines future cash needs for growth (investment and borrowing) and returns to investors Collectively.Complete Financial Statements Most difficult and time consuming to prepare.

including: Prepare a twelve month budget Six months of start-up expenses Amortize a loan over five years Do not necessarily have to be financial statements! .Limited Information Most common.

0% 10.000 11.6% 85.2% 40.5% 85. operating costs.0% 20. equity.7% 25.Sources and Uses of Funds SOURCES AND USES Contribution Cap % $ 500 0.0% . What is it going to be spent on (equipment.000 23. Sources Cash on Hand Bank Revolver Senior Bank Note Subordinated Bank Note Owner Contribution New Equity Total Sources $ Uses Purchase new equipment Operating costs Office manager Refinance Existing Debt Working Capital Cash Total Uses $ $ 10. refinance.7% 50.0% Where is money coming from (bank debt.500 100.000 5.000 29.000 11.000 11.4% 5. etc).000 58.7% 500 0.000 46.8% 0 0.6% 0 0.500 100. etc). Often seen in refinancing and bond offerings.8% 10.

time period should match the business life cycle. . How to handle changes in the economy? For litigation or damage oriented models. time period should correspond to period of damage. 5 year projection for a 20 year real estate deal may not be helpful.Time Period Generally. 20 year projection in a rapidly changing industry may not be relevant.

) .Basic Organization Most financial models include the following basic elements: Identification of the problem to be solved (buy vs. new location. lease.) Output / results (financial statements. net present value. expansion. etc. capital expenditures. etc. impact of competitors. go / no go decision.) Key assumptions (sales growth. margins. etc.

Which question is better: Will the project be profitable? Will the project provide an adequate return on investment? Accounting based financial statements will show profitability.Client / Employer wants to expand an existing product into a new geographic market (new location).Sample Construction Problem . . Net present value / internal rate of return analysis will show return on investment.

. In the case of expansion / new location. the following factors should be considered: Will be a long-term project Will likely require significant investment (equity and /or debt) Will likely require consideration of competitor reactions Based on this ‘problem’ and expected use/users. with consideration of ‘return’ on the investment.Scope ‘Problem’ and expected use/users will define scope of financial model.Sample Construction . output should be complete presentation over a long-term.

or other data (will discuss later) Bad assumptions = bad decisions! . often referred to as ‘projection drivers’ Assumptions should be reasonable and logical Assumptions should be supported by historical trends. industry trends.Sample Construction . economic data.e. a separate ‘tab’ in Excel workbook).Assumptions What are key assumptions? Will vary by client and industry May be impacted by current economic environment in short-term Critical points: Assumptions should be defined separately (i.

714 30.21 1.529 $ $ Year 5 14 26.373 211.21 1.Sample Construction .156 28.137 $ $ Year 4 14 26.103.831 201.606 $ $ Year 5 70 5.529 $ $ Year 4 70 5.07 860.100 32.07 785.07 822.295 Assumed days outstanding Accounts receivable turnover Projected Net Sales Projected accounts receivable Accounts Payable Year 1 Assumed days outstanding Accounts payable turnover Projected Operating Expenses.933 $ $ Year 3 70 5.990 $ $ Terminal 14 26.105 34.158.21 $ 1.792 191. less Int & Depr Projected accounts payable $ $ 14 26.244 27.186 Terminal 70 5.050.07 900.21 $ $ 953.216.135 182.Assumptions Sample Company Projection Assumptions Growth Rates Line Item Revenues Salaries Benefits Supplies Licenses Utilities Repairs and maintenance Insurance Telephone Management fees Miscellaneous Year 1 Year 2 5% 5% 5% 5% 5% 5% 5% 5% 5% 5% 5% Year 3 5% 5% 5% 5% 5% 5% 5% 5% 5% 5% 5% Year 4 5% 5% 5% 5% 5% 5% 5% 5% 5% 5% 5% Year 5 5% 5% 5% 5% 5% 5% 5% 5% 5% 5% 5% Terminal 5% 5% 5% 5% 5% 5% 5% 5% 5% 5% 5% Accounts Receivable Year 1 70 5.07 718.542 222.21 1.000 31.21 1.793 $ $ Year 2 70 5.000.811 $ $ Year 3 14 26.525 .469 $ 233.07 751.549 $ $ Year 2 14 26.

operating expenses. etc. Separating the model into smaller parts helps to catch errors! . etc. If model is very detailed.) Operations not ‘dependent’ on balance sheet or cash flows When appropriate. revenues. separate fixed and variable costs.Sample Construction – Income Statement Easiest place to start: Core assumptions relate to operations (growth rates. cost of revenues. margins. consider separate worksheets for departments.

533 894.122 32.400 60.447 106.400 (32.152 90.440 34.473 1.000 60.400 3.051 196.687 52.831 $ Year 4 1.131 49.618) 91.469 .043 42.230 65.135 $ Year 2 1.760 239.364 (79.000 13.158 150.050 $ 347.380 $ 365.050 140.153 9.000 3.373 $ Year 5 1.000 3.273 $ 953.000 14.075 1.Sample Construction – Income Statement Sample Company Projected Income Statements Year 1 Revenues Operating Expenses Salaries Benefits Supplies Licenses Lease Utilities Repairs and maintenance Insurance Telephone Interest Management fees Miscellaneous Depreciation Total Operating Expenses Operating Income Less: Provision for Income Taxes Net Income $ 286.315 76.736 3.158.360 122.000 1.034 3.820 60.237 $ 300.792 $ Year 3 1.710 28.972 129.829 38.113 33.542 $ Terminal 1.011.288 1.696 29.368 147.414 3.533 928.071 54.533 1.533 862.870 3.411 10.578 34.758 31.000.983 (22.892 69.216.793) 110.000 15.724 60.585 8.261 60.000 59.210 60.586 72.153 228.830 30.050.647 736 36.758 $ 315.906 187.471 (30.533 973.500 1.000 13.103.308 2.375 30.000 12.011 9.362 47.000 12.103 140.000 140.276 900.964 8.304 206.729 1.173 (36.465 1.812 8.853 $ 331.344 (26.216 150.105 316.207 35.669 217.091) 237.150 2.746) 68.600 62.586) 79.350) 97.345 45.

mostly because cash balances are ‘iterative’ (turn on Excel feature). inventory. such as days outstanding / turnover ratios. working capital requirements. Capital expenditures need to support expected level of operations.Sample Construction – Balance Sheet Often more difficult to model. payables) projected from assumptions. etc. Financing (debt / equity) will depend on capital needs. . Retained earnings will roll from net income. Working capital (receivables.

665) 75.077 748.000 147.269 798.776 30.979 798.384 1.777 798.917 1.599 201.851 1.237 1.000 684.529 16.160 $ 564.130 31.295 1.785 1.996 1.157.279 1.128 $ 946.484 $ 1.811 46.237 1.455 191.643.459 $ 1.447.137 31.899 1.409.777 $ 1.298 222.291 88.719.186 1.077 $ 1.840 28.000.000 68.533) 607.404.450 (281.996 233.223.599) 326.771 748.665) 75.480.Sample Construction – Balance Sheet Sample Company Projected Balance Sheets Year 1 ASSETS Current Assets Cash Accounts receivable Total Current Assets Fixed Assets Fixed assets.336.000 239.552 1.899 1.549 61.785 1.301.000.077 .990 (0) 32.000.480.849 1.529 975.068.066) 467.384.279 1.269 $ 1.771 $ 1.000 336.450 (722.684.450 (722.182.158.223.000.719.132) 226.990 34.450 (572.793 549.387 $ 773.292 748.147.157.993 62.239.552 1.367 182.849 1.077 LIABILITIES & EQUITY Liabilities Accounts payable Notes payable Total Liabilities Equity Capital contributions Retained earnings Total Equity Total Liabilities and Equity $ 27.450 (140.979 $ 1.349 47.606 1. net Total Assets Year 2 Year 3 Year 4 Year 5 Terminal $ 366.525 (0) 34.301.000 447.853 211.877 32. at cost Accumulated depreciation Total Fixed Assets.450 (421.996 1.384.964 75.000.933 756.525 1.000.318 1.

Is there a minimum ‘days cash on hand’ to start with? This will influence financing requirements.Sample Construction – Cash Flow Connect the parts from the Balance Sheet and Income Statement. etc). Cash balances are ‘iterative’ (turn on Excel feature). debt financing. . equity financing. Consider a ‘T=0’ time period for initial investments (capital expenditure.

000 1.645) (15.533 140.254 773.409.899 (10.455 $ (14.202 201.808 366.599 946.461 251. End of Year $ 75.Sample Construction – Cash Flow Sample Company Projected Cash Flows T=0 Cash Flows from Operating Activities Net Income Adjust for non-cash items Depreciation Adjust for changes in: (Increase) decrease in accounts receivable Increase (decrease) in accounts payable Net Cash Provided (Used) by Operations Cash Flows from Investing Activities Capital expenditures Net Cash Used in Investing Cash Flows from Financing Activities Loan proceeds Member contributions Principal payments Net Cash Provided (Used) by Financing Net Increase in Cash Cash.367 564.298 $ 227.326) (14.144 564.450) (748.853 1.298 1.445 946.808 178.262 212.709) (13.698 140.000) (174.268 (9.533 150.645) 173.076) 1.089) 26.853 $ 97.971) 209.533 Year 1 Year 2 Year 3 Year 4 Year 5 Terminal $ - $ 68.349) 235.971) (14.996 (748.075.273 .349) (16.580) 1.367 $ (14.109) 1.140) 1.237 $ 79.455 773.000.533 150.392 238.050 $ 110.450) (50.088 366.709) 187.599 $ (15.742) (8.182.347 (147.704) 1.534 227.380 $ 237.758 $ 91.533 140.808 $ (13.559 178.182.853 $ (16.414 (9.115 (10.000 178.326 224.000 1. Beginning of Year Cash.597) 1.698 1.326) 198.794 (11.000) (50.

Sample Construction – Iterative Calculations .

Sample Construction – Cash Flows Most overlooked in financial modeling. . Statement of Cash Flows shows: Timing of capital expenditures for growth Additional borrowing needs Ability to provide return on investment Cash flows available to investors (free cash flows) is a core element in financial decision making. but most important. and is essential to a net present value analysis or an internal rate of return analysis.

533 (50.840 (32.942 Required Rate of Return 20% .276) 81.130 150.091 $ 1.362 $ 252.977) 110.075.000) $ 203.710) 98.438 140.042 $ 214.877) $ 124.533 (8.162 $ 225.273 (9.346 $ 227.146) 93.358 (23.584 (31.799 186.119) $ 316.700 $ 189.575) $ 203.590) 70.203 Net Present Value $ 129.502) $ 109.483 $ 225.909 (36.364 (79.075.080 $ 189.346 111.Sample Construction – Decision Making Sample Company Decision Making T=0 Year 1 Year 2 Year 3 Year 4 Year 5 Terminal EBIT Less: tax on EBIT After-tax EBIT Add: depreciation Less: capital expenditures Less: working capital requirements Free Cash Flows to Debt and Equity N/A $ 94.103 (27.685) $ 147.533 (7.138.700 143.932 150.799 $ 214.978 $ 252.483 163.490 501.091) 237.000) (8.827 140.533 (9.271) $ 130.698 Free Cash Flows to Debt and Equity Present Value $ (1.533 (7.978 100.769 140.000) (1.

Have designated ‘input only’ tabs and clearly delineate variables.Other Layout Consideration Have a summary tab that provides the ‘answer’ concisely. Link and cross-link worksheets Use Excel formulas: If/then Average and median Lookup Forecast Trend .

Basics of Financial Analysis .

Why Perform Financial Analysis? Projection assumptions can be supported by historical financial analysis. Help identify strengths and weaknesses. Basic financial analysis tools include: Common size financial statements Ratio analysis Trend analysis Industry comparatives Financial analysis tools and techniques can: Isolate trends (positive and negative). .

Balance Sheet line items as a percentage of total assets: Identify changes in (and composition of) current assets and liabilities.Common Size Financial Statements Income Statement line items as a percentage of revenues: Identify changes in cost of sales. and other balances sheet items over time. Are margins and compositions expected to stay the same in the future? Why have margins changed? Were the changes expected? . fixed assets. gross profits. and operating expense margins over time. debt.

Ratio Analysis Ratio analysis can assist with understanding and projecting: Growth Cost control Asset turnover Profitability Risk How these ratios have changed (or not) over time. How do ratios compare to benchmarks? Integra Information (www.com) RMA Statement Studies (www.statementstudies.org) Trade associations .integrainfo.

Ratio Analysis Growth Ratios Growth in revenues Growth in expenses Growth in earnings Cost Control Ratios Often common size income statement / margins Turnover Ratios Receivable turnover Inventory turnover Payable turnover Total asset turnover .

07 751.156 28.529 $ $ Year 4 70 5.07 900. less Int & Depr Projected accounts payable $ $ 14 26.549 $ $ Year 2 14 26.21 $ $ 953.831 201.Example Sample Company Projection Assumptions Growth Rates Line Item Revenues Salaries Benefits Supplies Licenses Utilities Repairs and maintenance Insurance Telephone Management fees Miscellaneous Year 1 Year 2 5% 5% 5% 5% 5% 5% 5% 5% 5% 5% 5% Year 3 5% 5% 5% 5% 5% 5% 5% 5% 5% 5% 5% Year 4 5% 5% 5% 5% 5% 5% 5% 5% 5% 5% 5% Year 5 5% 5% 5% 5% 5% 5% 5% 5% 5% 5% 5% Terminal 5% 5% 5% 5% 5% 5% 5% 5% 5% 5% 5% Accounts Receivable Year 1 70 5.21 1.135 182.990 $ $ Terminal 14 26.07 860.21 1.137 $ $ Year 4 14 26.606 $ $ Year 5 70 5.216.186 Terminal 70 5.542 222.469 $ 233.933 $ $ Year 3 70 5.000 31.105 34.103.21 1.525 .244 27.21 1.100 32.792 191.529 $ $ Year 5 14 26.07 718.Ratio Analysis .373 211.295 Assumed days outstanding Accounts receivable turnover Projected Net Sales Projected accounts receivable Accounts Payable Year 1 Assumed days outstanding Accounts payable turnover Projected Operating Expenses.21 $ 1.07 822.811 $ $ Year 3 14 26.793 $ $ Year 2 70 5.07 785.714 30.000.050.158.

Ratio Analysis Profitability Ratios Return on Assets (ROA) Return on Equity (ROE) Return on Investment (ROI) Risk Ratios Leverage Interest coverage Current ratio .

they do a better job of raising questions than providing answers! . and different accounting treatments can skew ratio output.Financial Analysis Beware the pitfalls: Ratios can be complicated by accounting methods: How do comparable companies report inventory. GAAP allows for different treatments. depreciation. Ratios are ‘industry dependent’: CPA firms use different ratios than manufacturing firms Be cautious of ‘rules of thumb’ Financial analysis tools are diagnostic. etc.

Sensitivity and Scenario Analysis .

Sensitivity Analysis Sensitivity Analysis How does the projection respond to different ‘shocks’? Important to know which variables and assumptions are most influential in your model. .

Often used to see best case and worst case. . Used to establish a range of cash flows for the company. but does not necessarily increase confidence in ‘decision’.Scenario Analysis Run multiple scenarios: Measure outcomes of events with different influences.

Monte Carlo Analysis Monte Carlo analysis: Measures outcomes of events with random influences and assigns probabilities based on frequency. Does not give you ‘THE’ answer. . Can run tens of thousands of potential scenarios in seconds. but gives confidence in the range of answers for a set of variables.

Conclusion .

Provide the right output for the expected user.Parting Thoughts Be sure to define the problem and expected use. Support the assumptions. . Consider alternative scenarios.

Questions .

4766 jmacmorran@pncpa.408. APAC 8550 United Plaza Blvd. Suite 1001 Baton Rouge. CPA/ABV. LA 70809 225. MS Postlethwaite & Netterville.com .Contact Information Jason MacMorran. CVA. CFF..

You're Reading a Free Preview

Download
scribd
/*********** DO NOT ALTER ANYTHING BELOW THIS LINE ! ************/ var s_code=s.t();if(s_code)document.write(s_code)//-->