FM Ebook - Part 1

All Rights Reserved.
Corporate Bridge
TM

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www.educorporatebridge.com
Financial Modeling E-book
Part 1 of 4
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All Rights Reserved. Corporate Bridge
TM

2
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
Shareholders 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 companys (projects) 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

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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

Private and Confidential Not for Circulation
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X

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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
Shareholders
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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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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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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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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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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Income
Statement

Cash Flow
Statement

Balance
Sheet
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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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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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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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Use the future ratios and assumptions to project the
forecasted working capital balances
Drivers
Drivers
Projections
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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!
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Link up the forecasted Working Capital to the Balance Sheet
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Referenced from
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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
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Illustrative Flow of Funds

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Income
Statement

Cash Flow
Statement

Balance
Sheet
Working
Capital
Sales
COGS
Change in WC
Working Capital
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