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Private and Confidential


Financial Modeling

Financial Modeling Training Program

Prepared by: Dheeraj Vaidya


CEO, Corporate Bridge Academy
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Discussion topics
– Evening Session

 Overview of Financial Modeling


 Excel Best Practices
 Modeling Warm Up
 Key Financial Statements
FinanceModeling

 Working Capital Schedule


 Depreciation Schedule
 Amortization Schedule
 Long Term Items (Others) Schedule
Financial

 Building Income Statement


 Shareholder’s Equity Schedule
 Shares Outstanding Schedule
Corporate

 Preparing for Debt & Interest


 Trouble Shooting
 Completing the Financial Model

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Introduction to Financial Modeling

Simplified representation of performance


– Evening Session


 Both past and future

 Blend of skills is required


 Understanding of the company‟s (project‟s) operations
 Accounting Knowledge
FinanceModeling

 Corporate Finance principles


 Excel (spreadsheet) techniques

 Different Types of Models


 Earnings model with projected earnings/ profits
Financial

 Debt/ Recapitalization/ Financing Model


 Merger Consequences model (Mergers/ Acquisitions/ Divestitures)
 Discounted Cash Flow models

 Utility of Financial modeling


Corporate

 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


– Evening Session


 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
FinanceModeling

 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


Financial

 Past as an indicator of future performance, except in case of


• Start up situations
• Significant acquisitions or divesture activities
• Volatile industry structure
Corporate

 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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Excel Best Practices

Maintain Consistency
– Evening Session


 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


FinanceModeling

• 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!
Financial

 More Important – Others should be able to understand!


 Be efficient
 Utilize excel to improve productivity
 Do Not hard code in formulae cells
Corporate

X
 Separate line items are always useful

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Excel Best Practices

Be efficient
– Evening Session


 Do not input same numbers twice. Also, Excel takes care of formatting!
FinanceModeling

 Never Hide rows or columns – its useful to group them instead (Data -> Group)
Financial
Corporate

 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


– Evening Session


 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
FinanceModeling

• Export the supporting schedules to the core statements on completion


 Balance Sheet and Cash Flow Statements
• All projections need to be referenced from Schedules
Financial

Income Debt &


Working Capital
Statement Interest
Corporate

Plant & Machinery, Cash Flow Shareholder’s


Depreciation Statement Equity

Intangibles, Balance Other LT


Amortization Sheet Items

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Things to Remember

Historical data as a guide for projections


– Evening Session


 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


FinanceModeling

 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


Financial

 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?
Corporate

 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


– Evening Session


 Income Statement
 Balance Sheet
 Cash Flow Statement

 Income Statement
FinanceModeling

 Historical information

 Project Revenue and Operating expenses (Sales to EBITDA)

 Balance Sheet
Financial

 Historical data only


Corporate

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Income Statement - Sample
Financial
Corporate – Evening Session
FinanceModeling

 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
Financial
Corporate – Evening Session
FinanceModeling

 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
– Evening Session
FinanceModeling
Financial

 Setting up the Cash Flow Statement


 Past allowances are usually not made – historical cash flow
Corporate

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
– Evening Session

Calculations in Black
FinanceModeling

Inputs are in Blue


Financial
Corporate

 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 Statement - Sample
– Evening Session

Forecasted figures
FinanceModeling

 Forecast net sales for future years


Financial

 Drivers: forecasted annual sales growth


 Sources: management guidance, research,
past trends
 Challenge assumptions for being reasonable
 Footnote all sources for assumptions
Corporate

Drivers based on
input assumptions

Only one blue input


cell if constant
growth is assumed

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Income Statement - Sample
– Evening Session

Inputs from research/ past trends


FinanceModeling

 Forecast future operating expenses

 Drivers: margin assumptions for future operations


 Sources: management guidance, research, past trends
Financial

 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
Corporate

Drivers

Calculations

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Balance Sheet - Sample
– Evening Session

Calculations in Black
FinanceModeling

Inputs are in Blue


Financial

Its practical to show


2 condensed debt
items
Corporate

 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

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Illustrative Flow of Funds
– Evening Session

Income
FinanceModeling

Statement

Cash Flow
Financial

Statement
Corporate

Balance
Sheet

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Working Capital Schedule

Working Capital Overview


– Evening Session


 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
FinanceModeling

 Link with balance sheet & cash flow statement work sheets
Financial

Referenced from Income Statement


Corporate

 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 Capital Schedule - Sample
– Evening Session
FinanceModeling

Referenced from BS

Calculations
Financial
Corporate

 Reference the past data from the balance sheet


 Calculate net working capital
 Arrive at increase/ decrease in working capital

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Working Capital Schedule - Sample
– Evening Session
FinanceModeling
Financial

Calculations
Corporate

 Calculate historical ratios and percentages


 Use the ending or average balance
 Both are acceptable as long consistency is maintained

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Working Capital Schedule - Sample
– Evening Session
FinanceModeling

References,
Assumptions if constant
Financial
Corporate

 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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Working Capital Schedule - Sample
– Evening Session

Drivers
FinanceModeling

Projections
Financial
Corporate

Drivers

 Use the future ratios and assumptions to project the


forecasted working capital balances

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Working Capital Schedule - Sample
– Evening Session
FinanceModeling
Financial

Check and make sure


the signs match!
Corporate

Calculations

 Arrive at Cash Flows based on individual line items


 Ensure signs are accurate!
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Balance Sheet - Sample
– Evening Session
FinanceModeling

Referenced from
Working Capital Schedule
Financial
Corporate

 Link up the forecasted Working Capital to the Balance Sheet

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Cash Flow Statement - Sample
– Evening Session
FinanceModeling

Referenced from
Working Capital Schedule
Financial
Corporate

 Link up the forecasted Working Capital cash flows with the Cash Flow Statement

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Illustrative Flow of Funds

Working Capital Schedule


– Evening Session

Sales

Income
FinanceModeling

COGS
Statement
Working Change in WC
Capital
Working Capital
Financial

Cash Flow
Statement
Corporate

Balance
Sheet

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Debt and Interest

Income Statement – interest expense/ income are incomplete at this stage


– Evening Session


 Balance Sheet – cash and debt items are incomplete at this stage
 Cash Flow Statement –
 Calculate cash flow from operating and investing activities
FinanceModeling

 Calculate cash flow from available financing activities

 Calculate ending cash balance

 Link up with Balance Sheet


Financial
Corporate

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The Cash Flow Statement
– Evening Session

Cash Flow from Operating Activities Cash Flow from Investing Activities
 Net Income  Capital Expenditures

 Add: Non Cash Charges/ Incomes


+  Add: Proceeds from Asset Sales

 Add: Change in Working Capital  Add: Additions to Intangibles


FinanceModeling

 Add: Change in LT assets/ liabilities  Add: Business Acquisitions

Free Cash Flow Available for


Financial

Financing Activities
Corporate

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
– Evening Session

Cash Flow from Operating Activities

+
FinanceModeling

Cash Flow from Operating Activities Net Cash Flow


Financial

+
 Add: Effects of Ex. Rates on Cash
Corporate

 Add: Previous year‟s Cash Balance


Cash Flow from Operating Activities  = Ending Cash Balance

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Cash Flow Statement - Sample
– Evening Session

Referenced from
Income Statement
FinanceModeling

Calculations
Financial
Corporate

 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 Statement - Sample
Financial
Corporate – Evening Session
FinanceModeling

Calculations

 Calculate Cash Flow Available for Financing


Activities and Net Change in Cash

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Cash Flow Statement - Sample
Financial
Corporate – Evening Session
FinanceModeling

Reference from BS

 Reference “beginning cash balance” from the Balance Sheet

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Cash Flow Statement - Sample
– Evening Session

Excel reads
blank cells as Zero
FinanceModeling
Financial
Corporate

 Forecasted Cash is yet to be linked – this will be done later in the model

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Cash Flow Statement - Sample
Financial
Corporate – Evening Session
FinanceModeling

Calculations

 Calculate Ending Cash Balance

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Cash Flow Statement - Sample
– Evening Session

Referenced
from Cash Flow
FinanceModeling
Financial
Corporate

 Link up “ending cash balance” to the Balance Sheet

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Illustrative Flow of Funds

Linking up the Core Statements


– Evening Session

Depreciation
FinanceModeling

Sales

COGS
Income
Statement
Working Change in WC
Shareholder’s
Capital Equity
Financial

Working Capital
Amortization

Cash Flow
Statement
Corporate

PP & E,
Depreciation
Amortization

Balance Other Long


Sheet Term Items

Intangibles,
Amortization Intangibles

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Debt and Interest - Schedule

Calculate Cash Flow Available for Debt Repayment


– Evening Session


 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


FinanceModeling

 Calculate Cash Flow Available for Revolver


 Revolver = Cash Sweep

 Calculate Interest Expense/ Income


 Refer to average debt balances
Financial

 Revolver interest expenses

 Long Term interest expenses

 Cash Balance for Interest/ Income


Corporate

 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
– Evening Session

Referenced
FinanceModeling
Financial

 Set up a Debt Schedule


 Reference the Cash Flow Available for Financing

 Reference all equity sources and uses of cash


Corporate

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Debt and Interest Schedule - Sample
– Evening Session

Reference
FinanceModeling

Assumption

Calculations
Financial

 Calculate Cash Flow from Debt Repayment


 Reference the Beginning Cash Balance from the Balance
Sheet

 Deduct a minimum cash balance


Corporate

 Skip Long Term Debt Issuance/ Repayments, Cash


available for Revolving Credit Facility

and Revolver section for now

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Debt and Interest Schedule - Sample
– Evening Session
FinanceModeling
Financial

Reference
Corporate

 Reference the historical long term debt balances from the Balance Sheet

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Debt and Interest Schedule - Sample
– Evening Session
FinanceModeling
Financial

INPUTS from known debt maturities


Corporate

 Input the future debt repayments – fill in the known aggregate maturities
of long term debt

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Debt and Interest Schedule - Sample
– Evening Session
FinanceModeling

References
Financial

Calculations
Corporate

 Forecast future debt balances


 Reference beginning balance

 Calculate forecast ending balance

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Debt and Interest Schedule - Sample
– Evening Session
FinanceModeling
Financial

References & Calculations


Corporate

 Reference Long Term Debt Issuance and Long Term Debt (Repayments)
 Calculate Cash Available for Revolving Credit Facility

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Debt and Interest Schedule - Sample
– Evening Session
FinanceModeling
Financial

References
Corporate

 Reference the past revolving credit facility balances from the Balance
Sheet

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Debt and Interest Schedule - Sample
– Evening Session
FinanceModeling

References
“Cash Sweep”
(use MIN logic)
Financial

Calculations
Corporate

 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 Interest Schedule - Sample
– Evening Session

 Calculate interest expense from Revolver


 Calculate the average balance

 Make a reasonable assumption for an interest rate


FinanceModeling

 Forecast interest expense


Financial
Corporate

Assumption

Calculations

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Debt and Interest Schedule - Sample
– Evening Session

 Calculate interest expense from the Long Term Debt


 Calculate the average balance

 Make a reasonable assumption for an interest rate


FinanceModeling

 Forecast the interest expense

 Calculate Total Interest Expense


Financial
Corporate

Assumption

Calculations

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Debt and Interest Schedule - Sample
– Evening Session

 Calculate interest income from Cash Balances


 Calculate the average balance

 Make a reasonable assumption for an interest rate


FinanceModeling

 Forecast the interest income


Financial
Corporate

Calculations
Assumption

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Debt and Interest Schedule - Sample
– Evening Session
FinanceModeling

References
Financial
Corporate

 Link up interest expense and interest income to Income Statement

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Debt and Interest Schedule - Sample
– Evening Session
FinanceModeling
Financial

References
Corporate

 Link up debt repayments and borrowings to Cash Flow Statement

Sampel
PrivatePPTs
and Confidential – Not
- Prepared for CLSA
for India
Circulation
(Pune) 50
dheerajvaidya@corporatebridge.net

www.cbacademy.in
Debt and Interest Schedule - Sample
– Evening Session

 Link the debt balances to Balance Sheet


 Review final logic for totals and other statistics
FinanceModeling
Financial

Calculations
References
Corporate

Sampel
PrivatePPTs
and Confidential – Not
- Prepared for CLSA
for India
Circulation
(Pune) 51
dheerajvaidya@corporatebridge.net

www.cbacademy.in
Illustrative Flow of Funds

Debt & Interest Schedule


– Evening Session

Other Long
Term Items
Depreciation
FinanceModeling

Sales

COGS
Income
Statement
Working Change in WC
Shareholder’s
Capital Equity
Financial

Working Capital
Amortization

Cash Flow
Statement
Corporate

PP & E,
Depreciation
Amortization

Balance Other Long


Sheet Term Items

Intangibles,
Amortization Intangibles

Sampel
PrivatePPTs
and Confidential – Not
- Prepared for CLSA
for India
Circulation
(Pune) 52
dheerajvaidya@corporatebridge.net

www.cbacademy.in
Trouble Shooting Your Model

Circular References
– Evening Session


 Understanding what it means?

 Designing a solution for fixing circular references

 Balancing the financial model


FinanceModeling

 Error handling and tracing the logic of the model

 Final Touches
 Validate assumptions

 Ensure formulae are in place


Financial

 Make sure formatting is as desired


Corporate

Sampel
PrivatePPTs
and Confidential – Not
- Prepared for CLSA
for India
Circulation
(Pune) 53
dheerajvaidya@corporatebridge.net

www.cbacademy.in
Dealing with Circular Models
Financial
Corporate – Evening Session
FinanceModeling

Sampel
PrivatePPTs
and Confidential – Not
- Prepared for CLSA
for India
Circulation
(Pune) 54
dheerajvaidya@corporatebridge.net

www.cbacademy.in
What is Circular Reference
– Evening Session

Interest Expense
&
Interest Income
FinanceModeling
Financial

Revolver Balance
Net Income
& Cash Balance
Corporate

Free Cash Flow

Sampel
PrivatePPTs
and Confidential – Not
- Prepared for CLSA
for India
Circulation
(Pune) 55