MINOR PROJECT REPORT SUBMITTED TOWARDS THE PARTIAL FULFILLMENT

OF

BACHELOR OF COMMERCE (HONS.)

PROJECT REPORT

ON

Financial Modeling

Batch: 2017-2020

SUBMITTED BY: PROJECT GUDIE:

TUSHAR KATARIA Ms. Divya Gupta

01502488817 (Assistant Professor)

 Declaration
I hereby declare that the following documented project report on “Financial modeling” is an
original and authentic work done by me for the partial fulfillmentBachelors of Commerce
[hons.] of degree program.

I hereby certify that all the endeavour put in the fulfillment of the task are genuine and original
to the best of my knowledge and I have not submitted it earlier elsewhere.

SIGNATURE

NAME – Tushar Kataria

COURSE– Bachelors of Commerce [hons.]

YEAR / SHIFT- 2nd year / 2nd shift

ENROLLMENT NO. – 001524088817
 Acknowledgement

It is in particular that I am acknowledging my sincere feeling towards my mentors who

graciously gave me their time and expertise.

They have provided me with the valuable guidance sustained and friendly approach it would
have been difficult to achieve the results in such a short span of time without their help.

I deem it my duty to record my gratitude towards my internal project supervisor Ms. Divya
Gupta who devoted her precious time to interact, guide and gave me the right approach to
accomplish the task and also helped me to enhance my knowledge and understanding of the
project.

Signature:
Name:
UNIT-I
1. EXCEL AS A TOOL IN FINANCIAL MODELING

1.1 Basic Excel in brief

Row

MS Excel: Rows. In Microsoft Excel, a row runs horizontally in the grid layout of a
worksheet. Horizontal rows are numbered with numeric values such as 1, 2, 3. ...
Each row in the worksheet has its own row number which is used as part of a cell reference
such as A1, A2, or M16.

Column

A column is a vertical series of cells in a chart, table, or spreadsheet. Below is an example of

a Microsoft Excel spreadsheet with column headers (column letter) A, B, C, D, E, F, G, and
H. As you can see in the image, the last column H is the highlighted column in red and the
selected cell D8 is in the D column.

Cell

A cell is the intersection between a row and a column on a spreadsheet that starts with cell
A1. In the following example, a highlighted cell is shown in a Microsoft
Excelspreadsheet. D8 (column D, row 8) is the highlighted cell. Any modifications made
while this cell is highlighted will be limited to this item in the spreadsheet.

Active cell

Alternatively referred to as a cell pointer, current cell, or selected cell, an active cell is a
rectangular box, highlighting the cell in a spreadsheet. An active cell helps identify what cell
is being worked with and where data will be entered.

How to insert

Insert a cell

Step 1. Choose the cell or numbers of cells where you want to add new cells. Meaning if you
want to add ten new cells then select ten cells on the worksheet.

Step 2. If you want to terminate any selection then simply click on any cell from the
worksheet to cancel the selection.

Step 3. Next, go to the Home tab and click on "Insert" from the Cells category.

Step 4. Now, click on "Insert Cells" to continue.

Step 5. You will have to choose in which direction you want to push the surrounding cells
and click on insert.
Insert rows

Step 1. Select the row and right-click on it and click on "Insert".

Step 2. Alternatively, you can click on Home tab and then click on "Insert" from the Cells
group category.

Step 3. Next, click on "Insert Sheet Rows".

Insert column

Step 1. Select the column or a range of column and right click on it followed by clicking on
"Insert".

Step 2. Alternatively, click on Home tab and then choose "Insert" from the Cells group.

Step 3. Click on "Insert Sheet Columns" and adjust the settings of the adjacent columns.
Cut, Copy and Paste

Cut, Copy, and Paste are useful operations in Excel XP. You can quickly copy and/or cut
information in cells and paste them into other cells. These operations save you from having to
type and retype the same information.

The Cut, Copy, and Paste buttons are located on the Standard toolbar.

The Cut, Copy, and Paste operations also appear as choices in the Edit menu.

The Cut, Copy, and Paste operations can also be performed using shortcut keys.
 Cut Ctrl+X
Copy Ctrl+C

Paste Ctrl+V

DELETING CELLS, ROWS, OR COLUMNS

Deleting cells gets rid of the whole kit and caboodle — cell structure along with all its
contents and formatting. When you delete a cell (or an entire row or column), Excel has to
shuffle the position of entries in the surrounding cells to plug up any gaps caused by the
deletion.

To delete the actual cell selection rather than just clear the cell contents, follow these steps:

1. Select the cells, rows, or columns you want to delete.

2. Click the drop-down button attached to the Delete button in the Cells group of the Home tab.

3. Click Delete Cells on the drop-down menu.

The Delete dialog box opens, showing these options for filling in the gaps:

o Shift Cells Left moves entries from neighbouring columns on the right to the left to
fill in gaps created when you delete the cell selection. This is the default option.

o Shift Cells Up moves entries up from neighbouring rows below.

o Entire Row removes all the rows in the current cell selection.

o Entire Column deletes all the columns in the current cell selection.
Resize

Double click on the border, and all of the rows or columns will automatically adjust to fit
the data. To adjust an entire worksheet with both rows and columns, type Control A to
select the entire worksheet. Then, double click with a double arrow on
any column or row border.

Add / hide / unhide comment

First I should say that the ways of inserting text and picture notes are different. So let's begin
with the easiest of two and add a text comment to a cell.

1. Select the cell that you want to comment on.

2. Go to the REVIEW tab and click on the New Comment icon in the Comments section.

Note. To perform this task you can also use the Shift + F2 keyboard shortcut or right-
click on the cell and choose the Insert Comment option from the menu list.
 By default, every new comment is labelled with the Microsoft Office user name, but this
may not be you. In this case you can delete the default name from the comment box and
enter your own one. You can replace it with any other text as well.

Note. If you want your name to always appear in all your comments, follow the link to
one of our previous blog posts and find out how to change the default author name in
Excel.

3. Enter your remarks in the comment box.

4. Click on any other cell in the worksheet.

The text will go, but the little red indicator will remain in the upper-right corner of the cell. It
shows that the cell contains the comment. Just hover the pointer over the cell to read the note.

Wrap text in excel

Microsoft Excel can wrap text so it appears on multiple lines in a cell. You can format the
cell so the text wraps automatically, or enter a manual line break.

Wrap text automatically

1. In a worksheet, select the cells that you want to format.

2. On the Home tab, in the Alignment group, click Wrap Text .

Notes:

o Data in the cell wraps to fit the column width, so if you change the column width, data
wrapping adjusts automatically.
o If all wrapped text is not visible, it may be because the row is set to a specific height or that
the text is in a range of cells that has been merged.

Adjust the row height to make all wrapped text visible

1. Select the cell or range for which you want to adjust the row height.
2. On the Home tab, in the Cells group, click Format.
3. Under Cell Size, do one of the following:
o To automatically adjust the row height, click AutoFit Row Height.
o To specify a row height, click Row Height, and then type the row height that you want in
the Row height box.

Tip: You can also drag the bottom border of the row to the height that shows all wrapped
text.

Enter a line break

To start a new line of text at any specific point in a cell:

1. Double-click the cell in which you want to enter a line break.

Tip: You can also select the cell, and then press F2.

2. In the cell, click the location where you want to break the line, and press Alt+ Enter.

Filtering and sorting

Sorting

let’s say you had the spreadsheet above and wanted to sort by price. This process is fairly
simple. You can either highlight the whole column or even click on the first cell in the
column to get started. Then you will:

 Right click to open the menu

 Go down to the Sort option – when hovering over Sort the sub-menu will appear
 Click on Largest to Smallest
 Select Expand the selection
  Click OK

The whole table has now adjusted for the sorted column. Note: when the data in one column
is related to the data in the remaining columns of the table, you want to select Expand the
selection. This will ensure the data in that row carries over with sorted column data.

Filtering Data

The filter feature applies a drop down menu to each column heading, allowing you to select
specific choices to narrow a table. Using the above example, let’s say you wanted to filter
your table by Company and Salesperson. Specifically, you want to find the number of sales
Dylan Rogers made to Eastern Company.

To do this using the filter you would:

 Go to the Data tab on Excel ribbon

 Select the Filter tool
 Select Eastern Company from the dropdown menu
 Select Dylan Rogers from the Salesperson dropdown menu
Merge and Centre

Merge cell is a function in database programming that enables different nearby cells to be
joined into a single larger cell. This is finished by choosing all cells to be merged and picking
the “Merge Cells” order. Centre means that it enables the alignment of text to be in the
centre.

How to Use Merge and Centre in Excel?

1. Select the adjacent cells you want a merge.

2. On the Home button, go to alignment group, click on merge and center cells in excel.

3. Click on merge and center cell in excel to combine the data into one cell.
4. Once you click, merge and Centre, selected cells will be combined into one cell and the
text comes in centered like the above screenshot.

Conditional formatting

Conditional formatting in Excel enables you to highlight cells with a certain color, depending
on the cell's value.
Highlight Cells Rules
To highlight cells that are greater than a value, execute the following steps.

1. Select the range A1:A10.

. On the Home tab, in the Styles group, click Conditional Formatting.

3. Click Highlight Cells Rules, Greater Than.

4. Enter the value 80 and select a formatting style.

5. Click OK.

Result. Excel highlights the cells that are greater than 80.

6. Change the value of cell A1 to 81.

Result. Excel changes the format of cell A1 automatically.

Note: you can also highlight cells that are less than a value, between a low and high value, etc

Conditional formatting presets

Excel has several predefined styles—or presets—you can use to quickly apply conditional
formatting to your data. They are grouped into three categories:

 Data Bars are horizontal bars added to each cell, much like a bar graph.

 Color Scales change the color of each cell based on its value. Each color
scale uses a two- or three-color gradient. For example, in the Green-
Yellow-Red color scale, the highest values are green, the average values
are yellow, and the lowest values are red.

 Icon Sets add a specific icon to each cell based on its value.
Macros

A macro is simply a series of instructions. After you’ve created a macro, Excel will execute
those instructions, step-by-step, on any data that you give it.

For example, we could have a macro that tells Excel to take a number, add two, multiply by
five, and return the modulus.

Now, whenever we tell Excel to run that macro, we don’t have to manually do each step;
Excel will do them all.

To start automating your Excel actions with macros, you’ll need to “record” a macro.

Recording a macro is how you tell Excel which steps to take when you run the macro.

And while you can code a macro using Visual Basic for Applications (VBA), Excel also lets
you record a macro by using standard commands.

Let’s take a look at a basic example. In our spreadsheet, we have a list of names and a
corresponding list of their sales for the month:

We’ll record a macro that sorts the sales from highest to lowest, copies the information of the
most successful salesperson, and changes the formatting to make that information stand out.
Before we get started, we’ll need to make sure that the Developer tab is visible.

Head to File > Options, and select Customize Ribbon in the sidebar. Then, in Main Tabs,
make sure that Developer is checked:

Click OK, and open up that tab in the main window. You’ll see a button labeled Record
Macro.

To start recording a macro, just click that button.

You’ll be asked to name your macro (we’ve named ours “HighSales”), and enter a shortcut
key if you choose.

Keep in mind that there are already a lot of Ctrl-based shortcuts, so try not to overwrite any
of those that you use regularly.
You can also choose to save the macro in one of three places: the current workbook, a new
workbook, or your personal macro workbooks.

1.2 Problem solver

Excel Solver is an optimization tool that can be used to determine how the desired outcome
can be achieved by changing the assumptions in a model. It is a type of what-if analysis and
is particularly useful when trying to determine the “best” outcome, given a set of more than
two assumptions. Learn with video instruction in CFI’s Advanced Excel Course.

How to Use Excel Solver – Example

The best example of how to use Excel solver is by graphing a situation where there is a non-
linear relationship between, for example, the number of salespeople in a company and
the profit that they generate. There is a diminishing return on salespeople, so we want to
figure out what the optimal number of people to hire is. Put another way, we want to figure
out how many salespeople we should hire to get the maximum amount of profit.

Step 1: Ensure the Solver Add-In is Installed

The first step is to make sure you have Solver installed in your Excel file. To do this, go to
File -> Options -> Add-Ins -> Manage Excel Add-Ins. When the dialogue box appears, make
sure the box is ticked, as shown below.

Step 2: Build a Model

Here, we’ve created an example where there is a non-linear relationship between the number
of salespeople in a company and their profit. This is because as more salespeople are added,
the less effective they become. Image a very niche market that only has a certain number of
customers.

As you add more salespeople initially, you generate a lot more revenue, but at some point
additional sales people run out of new people to prospect and they become dead weight for
the company. The point of this model is to show an example that can’t easily be calculated
using Goal Seek or some other solution.
Learn with video instruction in CFI’s Advanced Excel Course.

Step 3: Use the Ribbon to Launch Excel Solver

The Excel Solver function is located on the Data Ribbon and the keyboard shortcut on
Windows is Alt, A, Y21. Once the dialog box appears you will notice several options you can
work with.

1. Set the “Objective” cell. In our case, this is Profit.

2. Set it “To” something (Max, Min, or a specific value). In our case, we want the Max
Profit.
3. Select the Cell(s) you want to change in order to find the solution. In our case, we
want to select the number of salespeople cell.
4. Add constraints. If you want to set a constraint (e.g., a cell must be > or < some
number), you can add this in. In our case, there are no constraints.
5. Click “Solve.”
6. Decide if you want to keep the solution in the cells or restore the original values.
Graph Solution
In this example, we’ve also shown how you could use a graph to get the solution, and this
really helps illustrate the relationship between the number of salespeople and the profit of the
business. Using both Excel Solver and the graph together really instills confidence in our
analysis.

1.3 What if Analysis

What-if-analysis in Excel is a tool in Excel that helps you run reverse calculations, sensitivity
analysis and scenarios comparison.

Decision making is a crucial part of any business or job role. When you can take decisions,
which are informed based on data, the outcome of the business or project or task is always
more in control.

Thus, What if Excel is used by almost every data analyst and especially middle to higher
management professionals, to make better, faster and more accurate decisions based on data.
3 parts of what-if-analysis in Excel

 Goal Seek – Reverse calculations

 Data Table – Sensitivity analysis
 Scenario Manager – Comparison of scenarios

Goal Seek in What if analysis

Let’s consider a simple dataset, where the invoice amount is Rs. 10,000, on which there is 9%
CGST and 9% SGST, which thus amounts to a total of Rs. 11,800.

The customer asks you for a discount of Rs. 800 and thus the final amount should be Rs.
11,000.

Now, the equation in simple terms is, X + 18% = 11000, where X is the invoice amount, 18%
is the total GST.

To find out, how much + 18% = 11000, we will use Goal Seek in What if analysis.

 Place your cursor on the ‘Total’ cell

 Under the ‘Data’ tab, click on ‘What-If-Analysis’, then on ‘Goal Seek’

 In ‘Set Cell’, B4 will automatically be selected as you had kept your cursor on it.
 In ‘To value’, enter the desired value, 11000 in this case.
 In ‘By changing cell’, choose the value that needs to be changed, invoice amount in this
case. Thus cell B1 is selected.
 Press Ok

Excel will reverse calculate and immediately give you the value Rs. 9,322, which + 18%
equals exactly to Rs. 11,000

This was a very simple example of using Goal Seek in what-if analysis. You can use Goal
Seek even for more complex models, let’s take an example of a Car loan model.

The ‘EMI’ calculated Rs. 19,786 is the outgoing amount per month. The value is negative as
money is going out of your pocket.

But, you have a budget of only Rs. 17,000 per month. So, how much can you afford as ‘Price
of Car’?
Put the Goal Seek values as above and you will know the Price of Car that you can afford.

This was calculations at multiple levels that Goal Seek in What-if analysis did, as it had to
consider Available funds, ROI, Number of payments to reverse calculate and give you the
answer.

That’s how powerful it is.

Data Table in What-If analysis

Data Table is used for Sensitivity analysis. What this means is basically, either 1 or 2 of the
inputs in your model are changing, you want to know output based on each change.

Let’s take the same Car loan example as earlier.

Now, after applying the Goal Seek, you know you can afford to buy a car worth Rs. 7,15,526
instead of Rs. 8,00,000.

1-input Data Table

Then you go to the Car showrooms and research on more cars available. You find out 5 cars
that you like, you want to know what would be the EMI amount for each of the car?

Car 1 – Rs. 5,54,000

Car 2 – Rs. 5,96,000

Car 3 – Rs. 6,24,000

Car 4 – Rs. 7,36,000

Car 5 – Rs. 7,94,000

Use what if analysis data table to find this.

Since only 1 input is changing, that is, Price of Car, we will use 1-input data table.

Make this structure in your Excel sheet next to your model.

In D3, you can write anything you want, doesn’t matter.

Next to that, in E4, put =B9. Basically, you are pointing to the formula that is used to
calculate the EMI. Thus, here you have informed Excel that you want to calculate the
resulting EMI for each value, using the formula in B9.

Now select this structure you have created and go to ‘Data table’ under what-if analysis in
Data tab.
Since our options of Prices of Cars are put vertically in a column, we will use Column input
cell. Select cell B1 to inform Excel that the 5 values are Price of Car values.

Press OK

Excel has calculated for you, the EMI for each change in Price of Car.

2-input Data Table

Similarly, you can have 2 inputs varying and still get the respective outputs.

So now you think about what if I change the duration of the loan, and compare for all these 5
cars?

Go to Data Table and select Row input cell as ‘No. of payments in months’ and Column input
cell as ‘Price of car’
You will get the EMI amount for each combination in no time, without much effort or any
complicated formulas.

Scenario Manager in what if analysis

Let’s say you are working in a Car Showroom in the Sales department. You have been given
the task to plan the sales for the next quarter. You must build multiple scenarios and prepare a
comparison of all the scenarios.

You make a model as below and then want to create multiple scenarios based on number of
cars that you will be able to sell for each of the cars.

Under What-if analysis, go to scenario manager.

Click on ‘Add’

Let’s start building our 1st scenario

 Scenario Name – Best Case

 Changing Cells – select cells C2:C6 as these are the No. of cars that you will be able to
sell, basically the variable cells
 Press OK
 Enter values for each Car

I have entered values as above, you can enter whatever you like.

Similarly add 1 more Scenario and name it as ‘Worst Case’. The changing cells will ofcourse
remain the same.

I have put in the below values for Worst case.

You can create many more scenarios like this.

Compare the scenarios

Now that your scenarios are created, let’s compare them.

In the Scenario Manager window, click on Summary.

You will now be asked for ‘Result cells’. Choose the Total Sales Value, cell D8, as that’s
what you want to compare. If you want to compare more outputs, you can choose multiple
cells here too.

A new Sheet will be created automatically on pressing OK which will give you a comparison
of the Current values in your Sheet + the 2 scenarios you created.

Thus, in best case, the Total Sales is over Rs. 6 CR. Worst Case is 3.77 CR.
Now you can take your business decisions based on this output.

Goal Seek
What if you want to know how many books you need to sell for the highest price, to obtain a
total profit of exactly $4700? You can use Excel's Goal Seek feature to find the answer.
1. On the Data tab, in the Forecast group, click What-If Analysis.

2. Click Goal Seek.

The Goal Seek dialog box appears.

3. Select cell D10.

4. Click in the 'To value' box and type 4700.

5. Click in the 'By changing cell' box and select cell C4.

6. Click OK.

Result. You need to sell 90% of the books for the highest price to obtain a total profit of
exactly $4700.
1.4 Pivot table and Pivot chart

A pivot table is a program tool that allows you to reorganize and summarize selected
columnsand rows of data in spreadsheet or database table to obtain a desired report. A pivot
chart is thevisual representation of a pivot table in Excel.

Q. Create a Pivot Table and Pivot Chart

A B C
1000 3000 4000

2000 5000 1000

8000 1000 7000

1.2Basic Formulas

1. SUM:

The SUM function is categorized under Math and Trigonometry functions. The function will
sum up cells that are supplied as multiple arguments. It is the most popular and widely used
function in Excel.
Formula

=SUM (number1, [number2], [number3]……)

The SUM function uses the following arguments:

1. Number1 (required argument) – It is the first item that we wish to sum.

2. Number2 (required argument) – It is the second item that we wish to sum.
3. Number3 (optional argument) – It is the third item that we wish to sum.

2. AVERAGE:

The AVERAGE function is categorized under Statistical functions. It will return the average
value of given series of numbers in Excel. It is used to calculate the arithmetic mean of a
given set of arguments in Excel. This guide will show you step-by-step how to calculate the
average in Excel.

As a financial analyst, the function is useful in finding out the average (mean) of a series of
numbers. For example, we can find out the average sales for the last 12 months for a
business.

Formula
=AVERAGE (number1, [number2], …)

The function uses the following arguments:

1. Number1 (required argument) – It is the first number or a cell reference or a range for
which we want the average.
2. Number2 (optional argument) – They are the additional numbers, cell references or a
range for which we want the average. A maximum of 255 numbers is allowed.

3. COUNT:

The COUNT Function is a Statistical function. The function helps count the number of cells
that contain a number, as well as the number of arguments that contain numbers. It will also
count numbers in any given array. It was introduced in Excel in 2000.

As a financial analyst, the COUNT function is useful in analyzing data if we wish to keep a
count of cells in given range.

Formula

=COUNT (value1, value2….)

Where: Value1 (required argument) – The first item or cell reference or range for which we
wish to count numbers.

Value2… (Optional argument) – We can add up to 255 additional items, cell references, or
ranges within which we wish to count numbers.

Remember this function will count only numbers and ignore everything else.

4. COUNTA:
The COUNTA Function is categorized under Statistical functions and will calculate the
number of cells that are not blank within a given set of values. The COUNTA function is
also commonly referred to as the Excel COUNTIF Not blank formula.

As a financial analyst, the COUNTA function is useful if we wish to keep a count of cells in a
given range. Apart from crunching numbers, we often need to count cells with values. In such
scenario, the function can be useful.

Excel Count if Not Blank Formula

=COUNTA (value1, [value2] …)

The Excel count if not blank formula uses the following arguments:

1. Value1 (required argument) – It is the value at which we evaluate the function.

2. Value2 (optional argument) – Additional arguments that represent the values that we
wish to count.

5. COUNTIF:

The COUNTIF function will count the number of cells that meet a specific criterion. The
function is categorized under Statistical functions.

In financial analysis, the COUNTIF function is quite helpful. Take for example when we
need to count the number of times a salesperson exceeded his target. We can do this by using
COUNTIF.
Formula

=COUNTIF (Range, criteria)

The COUNTIF function uses only one argument:

1. Range (required argument) – It defines one or several cells that we wish to count. The
range of cells are those cells that will be tested against the given criteria and counted
if the criteria are satisfied.
2. Criteria – It is a condition defined by us. It is tested against each of the cells in the
supplied range.

6. IF:

An Excel IF Statement tests a given condition and returns one value for a TRUE result, and
another value for a FALSE result. For example, if sales total more than $5,000 then return a
“Yes” for Bonus, otherwise, return a “No” for Bonus. We can also use the IF function to
evaluate a single function or we can include several IF functions in one formula. Multiple IF
statements in Excel are known as nested IF statements.
As a financial analyst, the IF function is used often to evaluate and analyze data by evaluating
specific conditions.

The function can be used to evaluate text, values, and even errors. It is not limited to only
checking if one thing is equal to another and returning a single result. We can also use
mathematical operators and perform additional calculations depending on our criteria. We
can also nest multiple IF functions together to perform multiple comparisons.

IF Formula

=IF(logical test, value_if_true, value_if_false)

The formula uses the following arguments:

1. Logical_test (required argument) – It is the condition to be tested and evaluated as

either TRUE or FALSE.
2. Value_if_true (optional argument) – It is the value that will be returned if the
logical_test evaluates to TRUE.
3. Value_if_false (optional argument) – It is the value that will be returned if the
logical_test evaluates to FALSE.

When using the IF function to construct a test, we can use following logical operators:

 = (equal to)
 > (greater than)
 >= (greater than or equal to)
 < (less than)
 <= (less than or equal to)
 <> (not equal to)
7. SUMIF:

The SUMIF function is categorized under Math and Trigonometry functions. It will sum up
cells that meet the given criteria. The criteria are based on dates, numbers, and text. It
supports logical operators such as (>, <, <>, =) and also wildcards (*?). This guide to the
Sum If Excel function will show you how to use it, step-by-step.

As a financial analyst, SUMIF is a frequently used function. Suppose we are given a table
listing the consignments of vegetables from different suppliers. The names of the vegetable,
names of suppliers and quantity are in column A, column B, and column C, respectively. In
such scenario, we can use the SUMIF function to find out the sum of the amount related to a
particular vegetable from a specific supplier.

Formula

=SUMIF (range, criteria, [sum_range])

The formula uses the following arguments:

1. Range (required argument) – It is the range of cells that we want to apply the criteria
against.
2. Criteria (required argument) – It is the criteria which are used to determine which
cells need to be added.

When we provide the criteria argument, it can either be:

 A numeric value (which may be an integer, decimal, date, time, or logical value) (e.g.
10, 01/01/2018, TRUE) or
 A text string (e.g. “Text”, “Thursday”) or
 An expression (e.g. “>12”, “<>0”).
 3. Sum_range (optional argument) – It is an array of numeric values (or cells containing
numeric values) that are to be added together if the corresponding range entry satisfies
the supplied criteria. If the [sum_range] argument is omitted, the values from the
range argument are summed instead.

8. VLOOKUP:

The VLOOKUP function in Excel is a tool for looking up a piece of information in a table or
data set and extracting some corresponding data/information. In simple terms, the
VLOOKUP function says the following to Excel: “Look for this piece of information (e.g.,
bananas), in this data set (a table), and tell me some corresponding information about it (e.g.,
the price of bananas)”.

VLOOKUP Formula

=VLOOKUP (lookup_value, table array, col_index_num, [range_lookup])

To translate this to simple English, the formula is saying, “Look for this piece of information,
in the following area, and give me some corresponding data from another column”.

The VLOOKUP function uses the following arguments:

1. Lookup_value (required argument) – Lookup_value specifies the value that we want

to look up for in the first column of a table.
2. Table array (required argument) – The table array is the data array that is to be
searched. The VLOOKUP function searches in the left-most column of this array.
3. Col_index_num (required argument) – This is an integer, specifying the column
number of the supplied table array that you want to return a value from.
4. Range_lookup (optional argument) – This defines what this function should return in
the event that it does not find an exact match to the lookup_value. The argument can
be set to TRUE or FALSE, which means:
o TRUE – Approximate match, that is, if an exact match is not found, use the
closest match below the lookup_value.
 o FALSE – Exact match, that is, if an exact match not found, then it will return
an error.

VLOOKUP is used with the following steps:

1. Select the name that’s entered in cell C20.

2. Select the range of the entire table B14:D18.
3. Select the corresponding output from column “3.”
4. “False” requires an exact name match.

9. HLOOKUP:

HLOOKUP stands for Horizontal Lookup and can be used to retrieve information from a
table by searching a row for the matching data and outputting from the corresponding
column. While VLOOKUP searches for the value in a column, HLOOKUP searches for the
value in a row.

Formula

=HLOOKUP (value to look up, table area, row number)

10. CONCATENATE:

The CONCATENATE Function is categorized under Text Functions. The function helps to
join two or more strings into one string.
As a financial analyst, we often deal with data when doing financial analysis. The data would
not always be structured for analysis and we would often need to combine data from one or
more cells into one cell or split data from one cell into different cells. The CONCATENATE
function helps us to do that.

Formula

=CONCATENATE (text1, [text2] …)

The CONCATENATE function uses the following arguments:

1. Text1 (required argument) – It is the first item to join. The item can be a text value,
cell reference or a number.
2. Text2 (required argument) – The additional text items that we wish to join. We can
join up to 255 items that are up to 8192 characters.

11. Drop Down List:

An Excel drop down list is a data validation function that allows users to select an option
from a list of choices. It can be particularly useful in performing financial modeling and
analysis by incorporating scenarios and making a spreadsheet more dynamic.

How to Make an Excel Drop down List?

Below are step-by-step instructions on how to build a drop down list in Excel:
Step 1: Create a List of Options
Make a vertical list of options you want users to be able to choose from.

Step 2: Pick a Cell and Access Data Validation on the Ribbon

Pick a cell where you want the Excel drop down list to be located and use the ribbon to
access the Data Validation function, which is located on the Data ribbon.

Step 3: Select “List” and Link the Data

When the data validation dialogue box appears, you will need to select “List” where it asks
you what you want to “Allow” in the cell.

Once that is done, you can select the data you want to include as the options that will appear
in the list.

12. Accrint
The Microsoft Excel accrint function returns the accrued interest for a security that pays
interest on a periodic basis. The accrint function is a built-in function in Excel that is
categorized as a FinancialFunction. It can be used as a worksheet function (WS) in Excel. As
a worksheet function, the ACCRINT function can be entered as part of a formula in a cell of
a worksheet.
Syntax: =ACCRINT( issue date, first interest date, settlement date, rate, par, frequency,
[basis], [calculation method] )

13. Accrintm

The Microsoft Excel accrintm function returns the accrued interest for a security that pays
interest at maturity. The accrintm function is a built-in function in Excel that is categorized as
a FinancialFunction. It can be used as a worksheet function (WS) in Excel. As a worksheet
function, the accrintm function can be entered as part of a formula in a cell of a worksheet.

Syntax : =ACCRINTM( issue date, maturity date, rate, par, [basis] )

Issue date : The date that the security was issued.

Maturity date :The maturity date of the security.

Rate : The annual coupon rate for the security.

Par : The par value of the security. If this parameter is omitted, the ACCRINTM function will
assume that the par is set to $1,000.

Basis : Optional. It is the type of day count to use when calculating interest for the security. If
this parameter is omitted, it assumes that the basis is set to 0. It can be any of the following
values.
 14. PV Function

The Excel PV function is a financial function that returns the present value of an investment.
You can use the PV function to get the value in today's dollars of a series of future payments,
assuming periodic, constant payments and a constant interest rate.

Purpose:

Get the present value of an investment

Syntax :

=PV (rate, nper, pmt, [fv], [type])

Arguments:

 rate - The interest rate per period.

 nper - The total number of payment periods.
 pmt - The payment made each period.
 fv - [optional] A cash balance you want to attain after the last payment is made. If omitted,
assumed to be zero.
 type - [optional] When payments are due. 0 = end of period, 1 = beginning of period. Default
is 0.
 15. FV Function

The Excel FV function is a financial function that returns the future value of an investment.
You can use the FV function to get the future value of an investment assuming periodic,
constant payments with a constant interest rate.

Purpose:

Get the future value of an investment

Syntax :

=FV (rate, nper, pmt, [pv], [type])

Arguments:

 rate - The interest rate per period.

 nper - The total number of payment periods.
 pmt - The payment made each period. Must be entered as a negative number.
 pv - [optional] The present value of future payments. If omitted, assumed to be zero. Must be
entered as a negative number.
 type - [optional] When payments are due. 0 = end of period, 1 = beginning of period.

16. RATE Function

The Excel RATE function is a financial function that returns the interest rate per period of an
annuity. You can use RATE to calculate the periodic interest rate, then multiply as required
to derive the annual interest rate. The RATE function calculates by iteration.

Purpose

Get the interest rate per period of an annuity

Syntax
 =RATE (nper, pmt, pv, [fv], [type], [guess])

Arguments

 nper - The total number of payment periods.

 pmt - The payment made each period.
 pv - The present value, or total value of all loan payments now.
 fv - [optional] The future value, or desired cash balance after last payment. Default is 0.
 type - [optional] When payments are due. 0 = end of period. 1 = beginning of period. Default
is 0.
 guess - [optional] Your guess on the rate. Default is 10%.

17. PMT Function

The Excel PMT function is a financial function that returns the periodic payment for a loan.
You can use the NPER function to figure out payments for a loan, given the loan amount,
number of periods, and interest rate.

Purpose

Get the periodic payment for a loan

Syntax

=PMT (rate, nper, pv, [fv], [type])

Arguments

 rate - The interest rate for the loan.

 nper - The total number of payments for the loan.
 pv - The present value, or total value of all loan payments now.
 fv - [optional] The future value, or a cash balance you want after the last payment is made.
Defaults to 0 (zero).
 type - [optional] When payments are due. 0 = end of period. 1 = beginning of period. Default
is 0.

18. NPER Function

The Excel NPER function is a financial function that returns the number of periods for loan
or investment. You can use the NPER function to get the number of payment periods for a
loan, given the amount, the interest rate, and periodic payment amount.

Purpose

Get number of periods for loan or investment

Syntax

=NPER (rate, pmt, pv, [fv], [type])

Arguments
 rate - The interest rate per period.
 pmt - The payment made each period.
 pv - The present value, or total value of all payments now.
 fv - [optional] The future value, or a cash balance you want after the last payment is made.
Defaults to 0.
 type - [optional] When payments are due. 0 = end of period. 1 = beginning of period. Default
is 0.

19. PPMT Function

The Microsoft Excel PPMT function returns the payment on the principal for a particular
payment based on an interest rate and a constant payment schedule.The PPMT function is a
built-in function in Excel that is categorized as a Financial Function. It can be used as a
worksheet function (WS) and a VBA function (VBA) in Excel. As a worksheet function, the
PPMT function can be entered as part of a formula in a cell of a worksheet. As a VBA
function, you can use this function in macro code that is entered through the Microsoft Visual
Basic Editor.

Syntax : =PPMT( interest_rate, period, number_payments, PV, [FV], [Type] )

Interest rate -The interest rate for the loan.

Arguments
Period- The period used to determine how much principal has been repaid. Period must be a
value between 1 and number payments.

Number payments -The number of payments for the loan.

PV -The present value or principal of the loan.

FV Optional. It is the future value or the loan amount outstanding after all payments have
been made. If this parameter is omitted, it assumes a FV value of 0.

Type Optional. It indicates when the payments are due. If the Type parameter is omitted, it
assumes a Type value of 0
20. IPMT
The Microsoft Excel IPMT function returns the interest payment for an investment based on
an interest rate and a constant payment schedule.

The IPMT function is a built-in function in Excel that is categorized as a Financial Function.
It can be used as a worksheet function (WS) and a VBA function (VBA) in Excel. As a
worksheet function, the IPMT function can be entered as part of a formula in a cell of a
worksheet. As a VBA function, you can use this function in macro code that is entered
through the Microsoft Visual Basic Editor.

Syntax

IPMT( interest_rate, period, number_payments, PV, [FV], [Type]

Arguments

Interest rate -The interest rate for the investment.

Period- The period to calculate the interest rate. It must be a value between 1 and number
payments.

Number payments -The number of payments for the annuity.

PV -The present value of the payments.

FV Optional- It is the future value that you'd like the investment to be after all payments have
been made. If this parameter is omitted, it will assume a FV of 0.
Type Optional.- It indicates when the payments are due. If the Type parameter is omitted, it
assumes a Type value of 0.
UNIT-II
2.FINANCIAL MODELING BASIC CONCEPTS

2.1 INTRODUCTION:-

What is a financial model?

A financial model is simply a tool that’s built in Excel to forecast a business’ financial
performance into the future. The forecast is typically based on the company’s historical
performance, assumptions about the future, and requires preparing an income statement,
balance sheet, cash flow statement and supporting schedules (known as a 3 statement model).
From there, more advanced types of models can be built such as discounted cash flow
analysis (DCF model), leveraged-buyout (LBO), mergers and acquisitions (M&A), and
sensitivity analysis. Below is an example of financial modeling in Excel.

What is a financial model used for?

The output of a financial model is used for decision making and performing financial
analysis, whether inside or outside of the company. Inside a company, executives will use
financial models to make decisions about:

 Raising capital (debt and/or equity)

 Making acquisitions (businesses and/or assets)
 Growing the business organically (i.e. opening new stores, entering new markets, etc.)
 Selling or divesting assets and business units
 Budgeting and forecasting (planning for the years ahead)
 Capital allocation (priority of which projects to invest in)
 Valuing a business
What are Financial Modelling Benefits?
The main benefits of Financial Modeling are:-

 The ability to forecast and plan a business

 The ability to value a business or company
 To help raise capital such debt or equity
 To analyze mergers, acquisitions, and other corporate development opportunities
 To analyze investments such as stocks and bonds, and
 To better understand how a business works.

What are sectors of Financial Modeling?

 Investment Banking / Equity Research:

Financial Modeling is the basic tool for fundamental analysis and valuations.
Investment banker uses it to arrive at a valuation in M&A or fund raising
transactions. Equity Analysts use it to value stocks and come up with buy/sell/hold
recommendations.
 Project Finance/Credit Rating:
Financial model help bankers, credit analysts to project future revenues and costs
and to make an informed judgment about projects viability. They are then able to
decide if they should extend loans or what the credit rating of a project or
company should be.
  Corporate Finance:
Financial Modeling is used by companies to assess their own finances and
projects. It is hence an input in creating funding plans for corporate projects.
 Entrepreneurs/Private Equity:
Entrepreneurs use Financial Models to present their plans to potential investors as
much as to plan their strategies. Running different simulations can often be an
important tool in avoiding potential risks.

2.2 TYPES OF FINANCIAL MODEL:-

There are many different types of financial models. In this guide, we will outline the top 10
most common models used in corporate finance by financial modeling professionals.

Here is a list of the 10 most common types of financial models:

1. Three Statement Model

2. Discounted Cash Flow (DCF) Model
3. Merger Model (M&A)
4. Initial Public Offering (IPO) Model
5. Leveraged Buyout (LBO) Model
6. Sum of the Parts Model
7. Consolidation Model
8. Budget Model
9. Forecasting Model
10. Option Pricing Model

#1 Three Statement Model

The three statement model is the most basic setup for financial modeling. As the
name implies, in this model the three statements (income statement, balance sheet, and
cash flow) are all dynamically linked with formulas in excel. The objective is to set it up so
all the accounts are connected, and a set of assumptions can drive changes in the entire
model. It’s important to know how to link the three financial statements, which requires a
solid foundation of accounting, finance and Excel skills.
#2 Discounted Cash Flow (DCF) Model

The DCF model builds on the 3 statement model to value a company based on the Net
Present Value (NPV) of the business’ future cash flow. The DCF model takes the cash flows
from the 3 statement model, makes some adjustments where necessary, and then uses
the XNPV function in Excel to discount them back to today at the company’s Weighted
Average Cost of Capital (WACC).These types of financial models are used in equity
research and other areas of the capital markets.

#3 Merger Model (M&A)

The M&A model is a more advanced model used to evaluate the pro forma accretion/dilution
of a merger or acquisition. It’s common to use a single tab model for each company, where
the consolidation where Company A + Company B = Merged Co. The level of complexity
can vary widely and is most commonly used in investment banking and/or corporate
development.

#4 Initial Public Offering (IPO) Model

Investment bankers and corporate development professionals will also build IPO models in
Excel to value their business in advance of going public. These models involve looking
at comparable company analysis in conjunction with an assumption about how much
investors would be willing to pay for the company in question. The valuation in an IPO
model includes “an IPO discount” to ensure the stock trades well in the secondary market.

#5 Leveraged Buyout (LBO) Model

A leveraged buyout transaction typically requires modeling complicated debt schedules and
is an advanced form of financial modeling. An LBO is often one of the most detailed and
challenging of all types of financial models as they many layers of financing create circular
references and requires cash flow waterfalls. These types of models are not very common
outside of private equity or investment banking.
#6 Sum of the Parts Model

This type of model is built by taking several DCF models and adding them together. Next,
any additional components of the business that might not be suitable for a DCF analysis
(i.e. marketable securities, which would be valued based on the market) are added to that
value of the business. So, for example, you would sum up (hence “Sum of the Parts”) the
value of business unit A, business unit B, and investments C, minus liabilities D to arrive at
the Net Asset Value for the company.

#7 Consolidation Model

This type of model includes multiple business units added into one single model. Typically
each business unit is its own tab, with consolidation tab that simply sums up the
other business units. This is similar to a Sum of the Parts exercise where Division A and
Division B are added together and a new, consolidated worksheet is created. Check out CFI’s
free consolidation model template.

#8 Budget Model

This is used to model finance for professionals in financial planning & analysis (FP&A) to
get the budget together for the coming year(s). Budget models are typically designed to be
based on monthly or quarterly figures and focus heavily on the income statement.

#9 Forecasting Model

This type is also used in financial planning and analysis (FP&A) to build a forecast that
compares to the budget model. Sometimes the budget and forecast models are one combined
workbook and sometimes they are totally separate.

#10 Option Pricing Model

The two main types of models are binomial tree and Black-Sholes. These models are based
purely on mathematical models rather than subjective criteria and therefore are more or less a
straightforward calculator built into Excel.
2.3 STEPS OF CREATING FINANCIAL MODEL:-

STEPS IN CREATING A MODEL

Whether you are creating a financial model using Excel or VBA, you must take a systematic
approach. A systematic approach always involves planning ahead and this takes some time.
Most people do not like to plan and think they can save time by starting to build a model right
away without spending time on planning.

However, for all but the simplest models, not taking the time upfront to do some planning and
not taking a systematic approach ends up being both frustrating and a waste of time Here are
the key steps you should follow in creating both Excel and VBA models. The details vary
somewhat depending on whether you are working with Excel or VBA, and I will discuss
them in later chapters. You should keep two other things in mind. First, in practice, you do
not have to follow the steps strictly in this order, nor do you have to finish one completely
before going onto the next one. Most of the time you will have to go back and forth to some
extent. It will depend on the circumstances. Second, over time, you should try to create your
own variation on this basic approach and learn to adapt it to different situations. Excel and
VBA are flexible tools and you can usually make changes almost a any stage without a great
deal of difficulty. But this still will take more time than if you do it right the first time, and
making changes later increases the chances of missing some of the other changes that have to
go with them.

Step 1: Define and Structure the Problem

In real life, problems rarely come neatly defined and structured. Unless you take the time
upfront to define and structure the problem and agree on them with the user (your boss, for
example), you may end up having to extensively change the model you first create. When
your boss asks you a question whose answer requires developing a model, she often has only
a vague idea of what she is really seeking As a finance person and a model, you are
responsible for putting it all in more concrete terms before proceeding Start by discussing and
defining why the model is needed and what decisions if any, will be made based on its output
that is, what questions the model is puts need discussed, all models have to capture the
relationships among their variables, and discovering and quantifying these can take a lot of
time. How much into doing this should depend on how important the project is and supposed
to answer. Then establish how accurate or realistic the out to be. As we effort you how
accurate or realistic the outputs need to be.

Step 2: Define the Input and Output Variables of the Model

Make a list of all the inputs the model will need and decide who will provide the or where
they will come from. This is crucial. For example, if you are creating a model to do the
business plan for your company, the inputs must come from the business managers. You
cannot just guess what sales grow rates they will be able to achieve, how much they will have
to spend on plants and equipment to support those sales growths, and so forth. You may not
need the actual numbers upfront but the list of inputs should be established based on your
discussions with the business managers so that you can make them independent variables in
your model. Otherwise you may have go back later on and change a lot of things in the
model. Make a list of the tabular, graphical, and other outputs the model needs to create. To
some extent, these should be driven by the decisions that will be made based on them. One
advantage of Excel is that a lot of the output can be just printouts of your spreadsheets,
provided the spreadsheets have been laid out properly. If you plan ahead and lay out your
spreadsheets with the outputs in mind, you will save yourself a lot of time later on.

Step 3: Decide Who Will Use the Model and How Often

Who will use the model and how often it will be used make a lot of difference. In this book, I
am assuming that you are developing the models either for your own use or for use by others
who are familiar with Excel and understand the model, at least to some extent. When you
create models for others' use, it involves much more work. You have to make sure that these
people cannot enter data that do not make sense, they cannot accidentally damage parts of the
model, and they change the necessary outputs automatically and so forth. These are
collectively called the user interface, and the more elegant, more easy to use, and more robust
you want to make a model, the more work it is. You also have to plan for many of these
features ahead of time. How frequently a model will be used is another important issue. If a
model is going to be used only once in a while, then it does not matter if it takes a long time
to run or if it takes some extra work every time to create the outputs. A model will be used
frequently, however, should be designed differently.
Step 4: Understand the Financial and Mathematical Aspects of the Model

It is important to remember that the computer cannot do any thinking; you have to tell it
exactly how all the calculations in the model will have to be done. In most situations, if you
do not know how you would do the calculations by hand you are not going to be able to write
the necessary formulas or instructions for the computer to do it. It does not pay to start
building the model until you are sure you could solve the problem by hand. It usually takes
beginners a lot of time to create a model and they often think that it is their Excel or VBA
skills that are slowing things down. This may true, but at least as often the problem is in their
understanding of the finance mathematics of the model they are trying to create. You will
save lot of time you do not even sit down in front of the computer to create a model until you
are sure that you know how to solve the problem

Step 5: Design the Model

There are two aspects to designing a model. One is to sketch the steps that Excel or VBA will
have to follow to solve the problem. For simple models, you may want to write down only
the broad steps or perhaps even do it in your head. For more complex problems, however,
you should work on paper and use a degree of detail that suits your level of experience and
the complexity of the problem The less experience you have, the more detailed the sketch
should be. Once again, remember that this may seem like a waste of time, but ultimately it
will save you time compared to plunging into your spreadsheet or VBA program without
such a sketch of the model. The other aspect of design is planning how the model will be laid
out in Excel or VBA. Are you going to do the entire model in one spreadsheet (or VBA
module or split it into several spreadsheets (or VBA modules or procedures)? Editing an
Excel or VBA model is easy. So you do not have to decide every detail ahead of time, but
you need to have an overall design in mind or on paper depending on the complexity of the
problem and your level of experience. As I discussed before, you also need to think about the
kind of user interface you want to create and the reports you want the model to produce.

Step 6: Create the Spreadsheets or Write the VBA Codes

For most models, this is the big step. Most of this book covers the details of this step, so there
is no need to get into them here
Step 7: Test the Model

Almost no model works correctly the first time it is used; you have to find the problems
(bugs) and fix them. The bugs that prevent the model from working at all or produce
obviously wrong answers are generally easier to find and fix However, models often include
hidden bugs that create problems only for certain values or certain combinations of values for
the input variables. To find them you have to test a model extensively with a wide range of
input variables. You have to take somewhat different approaches to testing and debugging a
model depending on whether you are working with Excel or VBA. Both Excel and VBA
provide some special tools for this purpose; I will discuss these tools and provide suggestions
on how to debug models in Excel and VBA in later are a few helpful hints that apply to
both. There is no standard approach to testing and debugging a model. You almost always
have to use your ingenuity to figure out what will be the best way to test and debug a
particular model. Your ability to do so will improve with experience." The better you
understand a problem and a model, the easier it will be to it. If you changes in certain
independent variables effect the values of certain dependent variables, then you can change
they a values of the independent variables to see if the dependent variables are changing in
the right direction and by the right orders of magnitude. This is one of the best tools,
especially for debugging large models, and you should do a lot of testing using this approach.
You can also use this approach to hunt down the sources of the problems: Starting from a
value that looks wrong, backtrack through the values of the intermediate dependent variables
to see where the problem may be originating. This approach may sound some what value and
abstract, but with experience, you will find that you can locate and fix most bugs rapidly
using this approach. Checking a model's output against hand-calculated answers is a common
and effective approach to debugging. In some situations, doing hand calculations may not be
practical, but you may be able to use Excel itself to do some side calculations to test
individual parts of the model

Step 8: Protect the Model

Once you have completed a model, and especially if you are going to give it to user to use,
you should consider protecting it against accidental or unauthorized changes. In addition, you
may also want to hide parts of the model so that others not see certain formulas, data, and so
on. Excel provides several flexible tools that you can use to hide and protect parts or all of
your model. A good strategy is to cluster and color code all the input cells of a model and
protect and hide the everything else in the workbook. parts of your VBA models as well

Step 9: Document the Model

There is less need to protect VBA modules because most users do not even know how to
open them. Nonetheless, if you think it is necessary, you can protect Documenting a model
means putting in writing, diagrams, flowcharts, and so on, the information that someone else
(or you yourself in the future) will need to figure out what it does, how it is structured, and
what assumptions are built into it. One can then efficiently and effectively make changes to
(update) the model if necessary. For large systems (for example, the reservation systems for
airlines), the amount of necessary documentation can be enormous; it is often put on CDs for
easy access and use. Professional system development organizations have elaborate standards
for documentation, because different pieces of large systems are developed by different
people-many of whom may not be around for very long. Also, it is almost certain that the
systems will have to be constantly Over time, anyone who creates models develops his own
system of documentation. As long as you keep in mind the objectives I mentioned before,
you have a lot of leeway to come up with your own system as well. Both Excel and VBA
offer a number of features that let you easily do a lot of the documentation as you work on
your model. You should take full advantage of them and do as much of your documentation
as possible while creating the model. This is important for two reasons. First, if you write
your documentation when things are fresh in your mind, it will save you time later and you
will be less likely to forget to document important things. Second, everyone hates (or learns
to hate) documentation. It is no fun at all, especially if you try to do it all at once at the end of
the project. If you do not work on the documentation until the end, chances are you will never
do it. Then, if you have to use the model again a few months later or have to update it, you
will end up spending hours or even days trying to figure out what you did. Do your
documentation as you go along and finish it immediately after your model is done You have
to take somewhat different approaches to when you document Excel and VBA models. I will
discuss how in the appropriate later chapters
Step 10: Update the Model as Necessary

This is not a part of the initial model development, but almost all models require updating at
some point, either because some things have changed or because you want to adapt it to do
something else. This is where the documentation becomes useful. Depending on how much
updating is involved, you may want to go through all of the above steps again. You should
also thoroughly update the documentation and include in it the information on who updated
it, when and why, and what changes were made.
2.4 ADVANCE EXCEL FUNCTIONS:-

#INDEX MATCH

Formula: =INDEX(C3:E9,MATCH(B13,C3:C9,0),MATCH(B14,C3:E3,0))

This is an advanced alternative to the VLOOKUP or HLOOKUP formulas (which have

several drawbacks and limitations). INDEX MATCH is a powerful combination of Excel
formulas that will take your financial analysis and financial modeling to the next level.

INDEX returns the value of a cell in a table based on the column and row number.

MATCH returns the position of a cell in a row or column.

Here is an example of the INDEX and MATCH formulas combined together. In this
example, we look up and return a person’s height based on their name. Since name and
height are both variables in the formula, we can change both of them!

# IF combined with AND / OR

Formula: =IF(AND(C2>=C4,C2<=C5),C6,C7)

Anyone who’s spent a great deal of time doing various types of financial models knows that
nested IF formulas can be a nightmare. Combining IF with the AND or the OR function can
be a great way to keep formulas easier to audit and easier for other users to understand. In
the example below, you will see how we used the individual functions in combination to
create a more advanced formula.
# OFFSET combined with SUM or AVERAGE

Formula: =SUM(B4:OFFSET(B4,0,E2-1))

The OFFSET function on its own is not particularly advanced, but when we combine it with
other functions like SUM or AVERAGE we can create a pretty sophisticated
formula. Suppose you want to create a dynamic function that can sum a variable number of
cells. With the regular SUM formula, you are limited to a static calculation, but by adding
OFFSET you can have the cell reference move around.

How it works: To make this formula work, we substitute ending reference cell of the SUM
function with the OFFSET function. This makes the formula dynamic and the cell referenced
as E2 is where you can tell Excel how many consecutive cells you want to add up. Now
we’ve got some advanced Excel formulas!

Below is a screenshot of this slightly more sophisticated formula in action.

As you see, the SUM formula starts in cell B4, but it ends with a variable, which is the
OFFSET formula starting at B4 and continuing by the value in E2 (“3”), minus one. This
moves the end of the sum formula over 2 cells, summing 3 years of data (including the
starting point). As you can see in cell F7, the sum of cells B4:D4 is 15, which is what the
offset and sum formula gives us.

# CHOOSE

Formula: =CHOOSE(choice, option1, option2, option3)

The CHOOSE function is great for scenario analysis in financial modeling. It allows you to
pick between a specific number of options, and return the “choice” that you’ve selected. For
example, imagine you have three different assumptions for revenue growth next year: 5%,
12%, and 18%. Using the CHOOSE formula you can return 12% if you tell Excel you want
choice #2.

# XNPV and XIRR

Formula: =XNPV(discount rate, cash flows, dates)

If you’re an analyst working in investment banking, equity research, or financial planning &
analysis (FP&A), or any other area of corporate finance that requires discounting cash flows,
then these formulas are a lifesaver!

Simply put, XNPV and XIRR allow you to apply specific dates to each individual cash flow
that’s being discounted. The problem with Excel’s basic NPV and IRR formulas is that they
assume the time periods between cash flow are equal. Routinely, as an analyst, you’ll have
situations where cash flows are not timed evenly, and this formula is how you fix that.
# SUMIF and COUNTIF

Formula: =COUNTIF(D5:D12,”>=21″)

These two advanced formulas are great uses of conditional functions. SUMIF adds all cells
that meet certain criteria, and COUNTIF counts all cells that meet certain criteria. For
example, imagine you want to count all cells that are greater than or equal to 21 (the legal
drinking age in the U.S.) to find out how many bottles of champagne you need for a client
event. You can use COUNTIF as an advanced solution, as shown in the screenshot below.

# PMT and IPMT

Formula: =PMT(interest rate, # of periods, present value)

If you work in commercial banking, real estate, FP&A or any financial analyst position that
deals with debt schedules, you’ll want to understand these two detailed formulas.

The PMT formula gives you the value of equal payments over the life of a loan. You can use
it in conjunction with IPMT (which tells you the interest payments for the same type of loan)
then separate principal and interest payments.
Here is an example of how to use the PMT function to get the monthly mortgage payment for
a $1 million mortgage at 5% for 30 years.

#LEN and TRIM

Formulas: =LEN(text) and =TRIM(text)

These are a little less common, but certainly very sophisticated formulas. These applications
are great for financial analysts who need to organize and manipulate large amounts of
data. Unfortunately, the data we get is not always perfectly organized and sometimes there
can be issues like extra spaces at the beginning or end of cells

In the example below, you can see how the TRIM formula cleans up the Excel data.
# CONCATENATE

Formula: =A1&” more text”

Concatenate is not really a function on its own – it’s just an innovative way of joining
information from different cells and making worksheets more dynamic. This is a very
powerful tool for financial analysts performing financial modeling (see our free financial
modeling guide to learn more).

In the example below, you can see how the text “New York” plus “, “ is joined with “NY” to
create “New York, NY”. This allows you to create dynamic headers and labels in worksheets.
Now, instead of updating cell B8 directly, you can update cells B2 and D2
independently. With a large data set, this is a valuable skill to have at your disposal.

# CELL, LEFT, MID and RIGHT functions

These advanced Excel functions can be combined to create some very advanced and complex
formulas to use. The CELL function can return a variety of information about the contents of
a cell (such as its name, location, row, column, and more). The LEFT function can return
text from the beginning of a cell (left to right), MID returns text from any start point of the
cell (left to right), and RIGHT returns text from the end of the cell (right to left).
 2.5 BUILDING THE TEMPLATE:-

Save a workbook as a template

1. If you’re saving a workbook to a template for the first time, start by setting the default
personal templates location:
a. Click File > Options.
b. Click Save, and then under Save workbooks, enter the path to the personal templates
location in the Default personal templates location box.

This path is typically: C:\Users\[UserName]\Documents\Custom Office Templates.

c. Click OK.

Once this option is set, all custom templates you save to the My Templates folder
automatically appear under Personal on the New page (File > New).

2. Open the workbook you want to use as a template.

3. Click File > Export.
4. Under Export, click Change File Type.
5. In the Workbook File Types box, double-click Template.
6. In the File name box, type the name you want to use for the template.
7. Click Save, and then close the template.
2.6 FORECASTING AND FINANCIAL STATEMENTS:-

 Income Statement.
 Balance Sheet.
 Cash Flow Statement.

#The income statement:-

The income statement illustrates a company's profitability. All three statements are presented
from left to right, with at least 3 years of historical results present in order to provide
historical rations and growth rates from which forecasts are based. Inputting the historical
income statement data is the first step in building a 3-statement financial model. The process
involves either manual data entry from the 10K or press release, or the use of an Excel plug
in such as Fact set or Capital IQ to drop historical data directly into Excel.

Forecasting typically begins with a revenue forecast followed by the forecasting of various
expenses. The net result is a forecast of the company's income and earnings per share. The
income statement covers a specified period such as quarter or year.
#The balance sheet:-
Unlike the income statement, which shows operating results over a period of time (a year or a
quarter), the balance sheet is a snapshot of the company at the end of the reporting period.
The balance sheet shows the company’s resources (assets) and funding for those resources
(liabilities and shareholder’s equity). Inputting historical balance sheet data is similar to
inputting data in the income statement. The data is inputted either manually or through an
Excel plug in.

In large part, the balance sheet is driven by the operating assumptions we make on the
income statement. Revenues drive the operating assumptions in the income statement, and
this continues to hold true in the balance sheet: Revenue and operating forecasts
drive workingcapital items, capital expenditures and a variety of other items. Think of the
income statement as the horse and the balance sheet as the carriage. The income statement
assumptions are driving the balance sheet forecasts.
2.7 Cash flow statement
The final core element of the 3-statement model is the cash flow statement. Unlike on the
income statement or the balance sheet, you aren't actually forecasting anything explicitly on
the cash flow statement and it isn’t necessary to input historical cash flow statement results
before forecasting. That’s because the cash flow statement is a pure reconciliation of the
year-over-year changes in the balance sheet.
Every individual line item on the cash flow statement should be referenced from elsewhere in
the model (it should not be hardcoded) as this is reconciliation. Constructing the cash flow
statement correctly is critical to getting the balance sheet to balance.
UNIT-III
3. FINANCIAL ANALYSIS

3.1 Various Approaches to Valuation

Quite simply, business valuation is a process and a set of procedures used to

determine what a business is worth. Sounds straightforward? But the devil is in the
details – to create a credible business valuation you need knowledge, preparation,
and a good deal of thought.

Three approaches to business valuation

So far, so good. But what tools are out there to actually measure what a business is
worth? In fact, there are three:
 Asset approach

 Market approach

 Income approach

Asset approach

Under the asset approach you adopt the view of a business as a set of assets and liabilities.
The balance sheet elements serve as building blocks to create the picture of business value. A
finance professor would tell you that the asset approach is based on the economic principle of
substitution. It answers this question:

What will it cost to create another business like this one that will produce the same
economic benefits for its owners?

The cost here is a bit tricky. Sure, the costs include coming up with the actual business
equipment and machinery, office furniture, and the like. But don't forget that costs also
include lost income as you are staking out the company's position in the market, while an
established competitor is busy raking in the dough.

Plus, you need to account for functional and economic obsolescence of business assets.
Things have a tendency to wear out and need to be replaced at some point.
Intangible assets, such as technology, may be getting a bit long in the tooth. A company still
using vacuum tubes in its products while the competitors are pushing nanotech is behind the
times. Not cool.

So if the company's financial condition is defined by its assets and liabilities, why not just
figure out the values of these and calculate business value as the difference, much like on
the balance sheet.

The idea is simple enough, but the trick is to figure out which assets and liabilities to include
in your valuation and how to measure what each is worth..

Market approach

Under the market approach, you look for signs from the real market place to figure out what a
business is worth. The market is a competitive place, so the economic principle of
competition applies:

What are other businesses worth that are similar to my business?

No business operates in a vacuum. If what you do is really great then odds are there are other
smart people doing the same or similar things.

Looking to buy a business? You need to decide what type of business you want and then look
around to see what the “going rate” is for businesses of this type.

Planning on a business sale? You would do well to check the market to see what similar
businesses sell for.

With all this jockeying for the best deal going on, you would think that the market will settle
to some sort of business price equilibrium – something the buyers will be willing to shell out
and the sellers willing to accept. Enter the fair market value:

The business price that a willing buyer will pay and a willing seller will accept for the
business. Both parties are assumed to act in full knowledge of all the relevant facts, and
neither being compelled to close the sale.
Income approach

The income approach cuts at the core of why people go into business – making money.
Unsurprisingly, the economic principle of expectation prevails here:

If I invest time, money and effort into business ownership, what economic benefits and
when will it provide me?

Observe the future expectation of economic benefit above. Since the money is not in the bank
yet there is a risk you will not see all or part of it when you expect it.

The income valuation approach helps you to figure what kind of money the business is likely
to bring as well as to assess the risk.

The real power of the income valuation is that it lets you calculate business value in the
present. To do so, the expected income and risk must be translated to today. There are two
ways you can do this translation:

 Capitalization
 Discounting
3.2 Financial Ratios and Company Analysis

Ratio Analysis

Over the years, investors and analysts have developed numerous analytical tools, concepts
and techniques to compare the relative strengths and weaknesses of companies. These tools,
concepts and techniques form the basis of fundamental analysis.

Ratio analysis is a tool that was developed to perform quantitative analysis on numbers found
on financial statements. Ratios help link the three financial statements together and offer
figures that are comparable between companies and across industries and sectors. Ratio
analysis is one of the most widely used fundamental analysis techniques.

Activity Ratios

Activity ratios are used to measure how efficiently a company utilizes its assets. The ratios
provide investors with an idea of the overall operational performance of a firm.

The activity ratios measure the rate at which the company is turning over its assets or
liabilities. In other words, they present how many times per year inventory is replenished or
receivables are collected.

Inventory turnover
Inventory turnover is calculated by dividing cost of goods sold by average inventory. A
higher turnover than the industry average means that inventory is sold at a faster rate,
signaling inventory management effectiveness. Additionally, a high inventory turnover rate
means less company resources are tied up in inventory. However, there are usually two sides
to the story of any ratio. An unusually high inventory turnover rate can be a sign that a
company’s inventory is too lean, and the firm may be unable to keep up with any increased
demand. Furthermore, inventory turnover is very industry-specific. In an industry where
inventory gets stale quickly, you should seek out companies with high inventory turnover.

Going forward, a decrease in inventory or an increase in cost of goods sold will increase the
ratio, signaling improved inventory efficiency (selling the same amount of goods while
holding fewer inventories or selling more goods while holding the same amount of
inventory).
Receivables turnover
The receivables turnover ratio is calculated by dividing net revenue by average receivables.
This ratio is a measure of how quickly and efficiently a company collects on its outstanding
bills. The receivables turnover indicates how many times per period the company collects and
turns into cash its customers’ accounts receivable.

Payables turnover
Payables turnover measures how quickly a company pays off the money owed to suppliers.
The ratio is calculated by dividing purchases (on credit) by average payables.

A high number compared to the industry average indicates that the firm is paying off
creditors quickly, and vice versa. An unusually high ratio may suggest that a firm is not
utilizing the credit extended to them, or it could be the result of the company taking
advantage of early payment discounts. A low payables turnover ratio could indicate that a
company is having trouble paying off its bills or that it is taking advantage of lenient supplier
credit policies.

Asset turnover
Asset turnover measures how efficiently a company uses its total assets to generate revenues.
The formula to calculate this ratio is simply net revenues divided by average total assets. Our
asset turnover ratio of 0.72 xs indicates that the firm generates $0.72 of revenue for every $1
of assets that the company owns.

A low asset turnover ratio may mean that the firm is inefficient in its use of its assets or that it
is operating in a capital-intensive environment. Additionally, it may point to a strategic
choice by management to use a more capital-intensive (as opposed to a more labor-intensive)
approach.

Liquidity Ratio

Liquidity ratios are some of the most widely used ratios, perhaps next to profitability ratios.
They are especially important to creditors. These ratios measure a firm’s ability to meet its
short-term obligations.
The level of liquidity needed varies from industry to industry. Certain industries are more
cash-intensive than others. For example, grocery stores will need more cash to buy inventory
constantly than software firms, so the liquidity ratios of companies in these two industries are
not comparable to each other. It is also important to note a company’s trend in liquidity ratios
over time.

Current ratio
The current ratio measures a company’s current assets against its current liabilities. The
current ratio indicates if the company can pay off its short-term liabilities in an emergency by
liquidating its current assets. Current assets are found at the top of the balance sheet and
include line items such as cash and cash equivalents, accounts receivable and inventory,
among others.

A low current ratio indicates that a firm may have a hard time paying their current liabilities
in the short run and deserves further investigation. A current ratio under 1.00x, for example,
means that even if the company liquidates all of its current assets, it would still be unable to
cover its current liabilities. In our example, the firm is operating with a very low current ratio
of 0.91 xs. It indicates that if the firm liquidated all of its current assets at the recorded value,
it would only be able to cover 91% of its current liabilities.

Quick ratio
The quick ratio is a liquidity ratio that is more stringent than the current ratio. This ratio
compares the cash, short-term marketable securities and accounts receivable to current
liabilities. The thought behind the quick ratio is that certain line items, such as prepaid
expenses, have already been paid out for future use and cannot be quickly and easily
converted back to cash for liquidity purposes. In our example, the quick ratio of 0.45 xs
indicates that the company can only cover 45% of current liabilities by using all cash-on-
hand, liquidating short-term marketable securities and monetizing accounts receivable.

The major line item excluded in the quick ratio is inventory, which can make up a large
portion of current assets but may not easily be converted to cash. During times of stress, high
inventories across all companies in the industry may make selling inventory difficult.
Cash ratio
The most conservative liquidity ratio is the cash ratio, which is calculated as simply cash and
short-term marketable securities divided by current liabilities. Cash and short-term
marketable securities represent the most liquid assets of a firm. Short-term marketable
securities include short-term highly liquid assets such as publicly traded stocks, bonds and
options held for less than one year. During normal market conditions, these securities can
easily be liquidated on an exchange.

Solvency Ratios

Solvency ratios measure a company’s ability to meet its longer-term obligations. Analysis of
solvency ratios provides insight on a company’s capital structure as well as the level of
financial leverage a firm is using.

Some solvency ratios allow investors to see whether a firm has adequate cash flows to
consistently pay interest payments and other fixed charges. If a company does not have
enough cash flows, the firm is most likely overburdened with debt and bondholders may
force the company into default.

Debt-to-assets ratio
The debt-to-assets ratio is the most basic solvency ratio, measuring the percentage of a
company’s total assets that is financed by debt. The ratio is calculated by dividing total
liabilities by total assets. A high number means the firm is using a larger amount of financial
leverage, which increases its financial risk in the form of fixed interest payments.

The debt-to-capital ratio is very similar, measuring the amount of a company’s total capital
(liabilities plus equity) that is provided by debt (interesting bearing notes and short- and long-
term debt). Once again, a high ratio means high financial leverage and risk. Although
financial leverage creates additional financial risk by increased fixed interest payments, the
main benefit to using debt is that it does not dilute ownership.

Debt-to-equity ratio
The debt-to-equity ratio measures the amount of debt capital a firm uses compared to the
amount of equity capital it uses. A ratio of 1.00 xs indicates that the firm uses the same
amount of debt as equity and means that creditors have claim to all assets, leaving nothing for
shareholders in the event of a theoretical liquidation.

Interest coverage ratio

The interest coverage ratio, also known as times interest earned, measures a company’s cash
flows generated compared to its interest payments. The ratio is calculated by dividing EBIT
(earnings before interest and taxes) by interest payments.

With interest coverage ratios, it’s important to analyze them during good and lean years.
Most companies will show solid interest coverage during strong economic cycles, but interest
coverage may deteriorate quickly during economic downturns.

Profitability Ratio

Profitability ratios are arguably the most widely used ratios in investment analysis. These
ratios include the ubiquitous “margin” ratios, such as gross, operating and net profit margins.
These ratios measure the firm’s ability to earn an adequate return. When analyzing a
company’s margins, it is always prudent to compare them against those of the industry and its
close competitors.

Margins will vary among industries. Companies operating in industries where products are
mostly “commodities” (products easily replicated by other firms) will typically have low
margins. Industries that offer unique products with high barriers to entry generally have high
margins. In addition, companies may hold key competitive advantages leading to increased
margins.

Gross profit margin

Gross profit margin is simply gross income (revenue less cost of goods sold) divided by net
revenue. The ratio reflects pricing decisions and product costs. The 50% gross margin for the
company in our example shows that 50% of revenues generated by the firm are used to pay
for the cost of goods sold.

For most firms, gross profit margin will suffer as competition increases. If a company has a
higher gross profit margin than is typical of its industry, it likely holds a competitive
advantage in quality, perception or branding, enabling the firm to charge more for its
products.

Operating profit margin

Operating profit margin is calculated by dividing operating income (gross income less
operating expenses) by net revenue. The operating margin in is 18%, which suggests that for
every $1 of revenues generated, $0.18 is left after deducting cost of goods sold and
operational expenses. Operating expenses include costs such as administrative overhead and
other costs that cannot be attributed to single product units.

Net profit margin

Net profit margin compares a company’s net income to its net revenue. This ratio is
calculated by dividing net income, or a company’s bottom line, by net revenue. It measures a
firm’s ability to translate sales into earnings for shareholders. Once again, investors should
look for companies with strong and consistent net profit margins.

ROA and ROE

Two other profitability ratios are also widely used—return on assets (ROA) and return on
equity (ROE).
Return on assets is calculated as net income divided by total assets. It is a measure of how
efficiently a firm utilizes its assets. A high ratio means that the company is able to efficiently
generate earnings using its assets. As a variation, some analysts like to calculate return on
assets from pretax and pre-interest earnings using EBIT divided by total assets.

Conclusion

Ratio analysis is a form of fundamental analysis that links together the three financial
statements commonly produced by corporations. Ratios provide useful figures that are
comparable across industries and sectors. Using financial ratios, investors can develop a feel
for a company’s attractiveness based on its competitive position, financial strength and
profitability.
3.3 Company Analysis

Company analysis is a process carried out by investors to evaluate securities, collecting info
related to the company’s profile, products and services as well as profitability. It is also
referred as ‘fundamental analysis.’ A company analysis incorporates basic info about the
company, like the mission statement and apparition and the goals and values. During the
process of company analysis, an investor also considers the company’s history, focusing on
events which have contributed in shaping the company.
Also, a company analysis looks into the goods and services proffered by the company. If the
company is involved in manufacturing activities, the analysis studies the products produced
by the company and also analyzes the demand and quality of these products. Conversely, if it
is a service business, the investor studies the services put forward.
How to do a company analysis
It is essential for a company analysis to be comprehensive to obtain strategic insight. Being a
thorough evaluation of an organization, the company analysis provides insight to rationalize
processes and make revenue potentials better.
The process of conducting a company analysis involves the following steps:
 The primary step is to determine the type of analysis which would work best for your
company.
 Research well about the methods for analysis. In order to perform a company analysis, it
is important to understand the expected outcome for doing so. The analysis should
provide answer about what is done right and wrong on the basis of a thorough
evaluation. It is, therefore, important6 to make the right choice for the analysis methods.
 The next step involves implementing the selected method for conducting the financial
analysis. It is important for the analysis to include internal and external factors affecting
the business.
 As a next step, all the major findings should be supported by use of statistics.
 The final step involves reviewing the results. The weaknesses are then attempted to be
corrected. The company analysis is used in concluding issues and determining the
possible solutions. The company analysis is conducted to provide a picture of the
company at a specific time, thus providing the best way of enhancing a company,
internally as well as externally.
3.4 Sensitivity Analysis

Sensitivity analysis is the study of how the uncertainty in the output of a mathematical
model or system (numerical or otherwise) can be apportioned to different sources of
uncertainty in its inputs.A related practice is uncertainty analysis, which has a greater focus
on uncertainty quantification and propagation of uncertainty; ideally, uncertainty and
sensitivity analysis should be run in tandem.

Example

Salary 1500

Selling price 100

Variable cost 50/unit

Fixed cost 50000

Calculate the following:

1. Quantity changes 1000-1500 and impact on profit.

2. Fixed cost changes from -15% to 15% and impact on profit.

3. Variable cost changes from 40 to 60 and quantity changes from 1000 to 1500 and its
impact on profit.
1) Quantity changes 1000-1500 and impact on profit.

2) Fixed cost changes from -15% to 15% and impact on profit.

3) Variable cost changes from 40 to 60 and quantity changes from 1000 to 1500 and its
impact on profit.
3.4 Probabilistic Analysis of the Best and the Worst Case Scenario

In analysis of algorithms, probabilistic analysis of algorithms is an approach to estimate

the computational complexity of an algorithm or a computational problem. It starts from an
assumption about a probabilistic distribution of the set of all possible inputs. This assumption
is then used to design an efficient algorithm or to derive the complexity of a known
algorithm.

This approach is not the same as that of probabilistic algorithms, but the two may be
combined.

For non-probabilistic, more specifically, for deterministic algorithms, the most common types
of complexity estimates are the average-case complexity (expected time complexity)and the
almost always complexity. To obtain the average-case complexity, given an input
distribution, the expected time of an algorithm is evaluated, whereas for the almost always
complexity estimate, it is evaluated that the algorithm admits a given complexity estimate
that almost surely holds.

In probabilistic analysis of probabilistic (randomized) algorithms, the distributions or

averaging for all possible choices in randomized steps are also taken into an account, in
addition to the input distributions.

Best case

The term best-case performance is used in computer science to describe an algorithm's

behaviour under optimal conditions. For example, the best case for a simple linear search on
a list occurs when the desired element is the first element of the list.

Development and choice of algorithms is rarely based on best-case performance: most

academic and commercial enterprises are more interested in improving Average-case
complexity and worst-case performance. Algorithms may also be trivially modified to have
good best-case running time by hard-coding solutions to a finite set of inputs, making the
measure almost meaningless.
Worst-case

Worst-case performance analysis and average-case performance analysis have some

similarities, but in practice usually require different tools and approaches.

Determining what best input means is difficult, and often that average input has properties
which make it difficult to characterise mathematically (consider, for instance, algorithms that
are designed to operate on strings of text). Similarly, even when a sensible description of a
particular "average case" (which will probably only be applicable for some uses of the
algorithm) is possible, they tend to result in more difficult analysis of equations.

Worst-case analysis has similar problems: it is typically impossible to determine the exact
worst-case scenario. Instead, a scenario is considered such that it is at least as bad as the
worst case. For example, when analysing an algorithm, it may be possible to find the longest
possible path through the algorithm (by considering the maximum number of loops, for
instance) even if it is not possible to determine the exact input that would generate this path
(indeed, such an input may not exist). This gives a safe analysis (the worst case is never
underestimated), but one which is pessimistic, since there may be no input that would require
this path.
3.5 Market Based Methods

A market approach is a method of determining the appraisal value of an asset, based on the
selling price of similar items. The market approach is a business valuation method that can be
used to calculate the value of property or as part of the valuation process for a closely held
business. Additionally, the market approach can be used to determine the value of a business
ownership interest, security, or intangible asset. Regardless of which asset is being valued,
the market approach studies recent sales of similar assets, making adjustments for differences
in size, quantity or quality.

Earnings per Share (EPS)

Earnings per share (EPS) are the portion of a company's profit allocated to each share of
common stock. Earnings per share serve as an indicator of a company's profitability. It is
common for a company to report EPS that is adjusted for extraordinary items and potential
share dilution.

The Formula for EPS Is

EBITDA
EBITDA is a measure of profits. While there is no legal requirement for companies to
disclose their EBITDA, according to the U.S. generally accepted accounting
principles (GAAP), it can be worked out and reported using information found in a
company's financial statements.
The usual shortcut to calculate EBITDA is to start with operating profit, also called earnings
before interest and tax (EBIT) and then add back depreciation and amortization. However, an
easier and more straightforward formula for calculating EBITDA is as follows:

The earnings, tax and interest figures are found on the income statement, while the
depreciation and amortization figures are normally found in the notes to operating profit or on
the cash flow statement.

EV / SALE

Enterprise value (EV) is a measure of a company's total value, often used as a more
comprehensive alternative to equity market capitalization. EV includes in its calculation the
market capitalization of a company but also short-term and long-term debt as well as any
cash on the company's balance sheet. Enterprise value is a popular metric used to value a
company for a potential takeover.

The Formula for EV Is

UNIT-IV
4. OTHER MODELING TECHNIQUES

4.1 Time Value Money

The time value of money (TVM) is the concept that money available at the present time is
worth more than the identical sum in the future due to its potential earning capacity. This core
principle of finance holds that, provided money can earn interest, any amount of money is
worth more the sooner it is received. TVM is also sometimes referred to as present
discounted value.

Breaking Down Time Value of Money - TVM

The time value of money draws from the idea that rational investors prefer to receive money
today rather than the same amount of money in the future because of money's potential to
grow in value over a given period of time. For example, money deposited into a savings
account earns a certain interest rate and is therefore said to be compounding in value.

Further illustrating the rational investor's preference; assume you have the option to choose
between receiving $10,000 now versus $10,000 in two years. It's reasonable to assume most
people would choose the first option. Despite the equal value at time of disbursement,
receiving the $10,000 today has more value and utility to the beneficiary than receiving it in
the future due to the opportunity costs associated with the wait. Such opportunity costs could
include the potential gain on interest were that money received today and held in a savings
account for two years.

Basic Time Value of Money Formula

Depending on the exact situation in question, the TVM formula may change slightly. For
example, in the case of annuity or perpetuity payments, the generalized formula has
additional or less factors. But in general, the most fundamental TVM formula takes into
account the following variables:

 FV = Future value of money

 PV = Present value of money
 i = interest rate
 n = number of compounding periods per year
 t = number of years
Based on these variables, the formula for TVM is:

FV = PV x [1 + (i / n)] (n x t)

Time Value of Money Example

Assume a sum of $10,000 is invested for one year at 10% interest. The future value of that
money is:

FV = $10,000 x (1 + (10% / 1) ^ (1 x 1) = $11,000

4.2 Capital Budgeting Models

Companies generally don't have unlimited money, so they must be strategic in how they
spend the resources they do have. Capital budgeting is a process by which companies decide
which projects or purchases are worth the cost involved. Companies use capital budgeting to
determine whether they should expand their operations, invest in new equipment, or pursue
other projects with the potential to bring in additional profits.

There are various capital budgeting methods companies can employ to aid in the decision-
making process. The most common methods are outlined below.

Payback period
The payback period method of capital budgeting allows companies to calculate how long it
will take to recoup the outlay for an investment. The payback period is calculated by taking
the total cost of a project and dividing it by its anticipated annual revenue. If a company
needs to spend $50,000 on new equipment but anticipates that it will generate additional
revenue of $25,000 per year as a result, then the payback period would be two years.

Net present value

The net present value method of capital budgeting shows companies the difference between
the cost of a project and the cash flow it is expected to bring in. It works by taking the initial
investment amount and comparing it to the present value of the future cash flow generated by
moving forward with that investment.

Net present value is based on the idea that future cash is not worth as much as present cash:
Because cash in hand can be used for revenue-generating purposes, the sooner cash is
received, the more it's actually worth. For this reason, in a net present value calculation,
future cash flow is assigned a discounted or reduced rate to make up for its lower value. This
method of capital budgeting is similar to the payback period method in that it requires a
company to estimate the revenue a given project will bring in from year to year. Once that's
determined, the value of that anticipated revenue must be discounted to see whether the
investment is worthwhile or not.

Example: Business makes an investment of rs.10000 and will receive an annual income of rs.
3000, rs.4000 and rs.6800 in the three years that follow; an annual discount rate of 10%.

Calculate NPV and XNPV.

Internal rate of return

The internal rate of return method of capital budgeting is a way of measuring the rate at
which an investment breaks even. It works by setting the net present value of all cash flows to
zero and taking external factors such as inflation out of the equation. The goal of this method
is to identify projects whose internal rate of return is higher than the cost of implementation:
Theoretically, a project whose internal rate of return is higher than its cost will be profitable.
The higher the internal rate of return, the more profitable a project is likely to be.

Example: Business makes an investment of 10000 and will receive an annual income of
3000, 4200 and 6800 in the three years that follows an annual discount rate of 10%.
Reinvestment rate is 7%. Calculate IRR and MIRR.
Profitability index
Also known as the profit investment ratio or value investment ratio, the profitability index
method of capital budgeting works by examining the relationship between the costs of
pursuing a project and its anticipated benefits. It is calculated by taking the present value of
future cash flows and dividing it by the initial investment cost. A profitability index that's
lower than 1.0 indicates that a project's present value of future revenue is lower than the cost
of the initial investment, which means it's not worth pursuing. On the other hand, a
profitability index that's greater than 1.0 means that a project may be worthwhile from a
financial perspective, and the higher the profitability index, the more financially attractive the
project will be.
4.3 Cost of Capital

The definition of cost of capital simply means the cost of funds the company uses to fund and
finance its operations. The cost of capital is often divided into two separate modes of
financing: debt and equity.

Cost of capital tells the company its hurdle rate. The hurdle rate refers to the minimum rate of
return the company must achieve to be profitable or to generate value.

Each company has its own cost of capital. Different factors influence the cost of capital and
these include things such as the operating history of the business, its profitability and credit
worthiness.

The figure is one of the most essential parts of a business’ financing strategy, as it can help
the company to make better funding and investment decisions and thus boost its overall
financial health.

In case the company is solely financed through equity, the cost of capital would refer to the
cost of equity. On the other hand, companies funded by debt alone have cost of capital refer
to the cost of debt.

As most companies rely on a combination of debt and equity, their overall cost of capital is
derived from a weighted average of all capital sources. This refers to the average cost of
capital (WACC).

Weighted Average Cost of Capital

As we mentioned above, company financing hardly ever relies on a single source. Therefore,
the cost of capital is often calculated by using the weighted average cost of capital (WACC).
Since it analyses both equity and debt financing, it provides a more accurate picture of how
much interest the company owes for each operational currency it finances (per each US
dollar, British pound and so on).

It gives a proportional weight to the different costs of capital, such as equity and debt, to
derive a weighted average cost. Each capital component will be multiplied by its proportional
weight and the sums will be added together.

When companies refer to the cost capital, they often would have calculated it based of the
WACC method. The following sections will look at the calculations methods in more detail,
but here’s a quick example of what WACC means.

Consider that a business has a lender, which requires a 10% return on its money.
Furthermore, the shareholders of the business require a further minimum of a 20% on their
investments. On average then, the company’s capital must have a return of 15% to satisfy
both the debt and equity holders, meaning the WACC or cost of capital is 15%.

This means the company would need to invest in projects that would provide an annual return
of 15% in order to continue paying back to both their shareholders and creditors.

CALCULATING THE COST OF CAPITAL

Now that you understand the definition of cost of capital and the importance of calculating it,
it’s time to look at the calculating methods.

First, we’ll go through the formulas for calculating both the cost of equity and debt, as they’ll
be used in the final calculations of WACC. Naturally, if the business only uses either debt or
equity alone, you can also use the formulas as the basis for calculating the cost of capital.

Calculating the cost of debt

First, lets look at how you can calculate the cost of debt. Debt in this formula includes all
forms of debt the company uses in order to finance its operations. These could be various
bonds, loans and other such forms of debt.
As mentioned earlier, there are two formulas for calculating the cost of debt. This is because
it deals with interest, which can be deducted from tax payments. Thus, the alternatives are to
calculate the cost of debt either before- or after-tax. Generally, the after-tax cost is more
widely used.

The before-tax rate can be calculated by two different methods. First, you can calculate it by
multiplying the interest rate of the company’s debt by the principal. For instance, a $100,000
debt bond with 5% pre-tax interest rate, the calculation would be: $100,000 x 0.05 = $5,000.

The second method uses the after-tax adjusted interest rate and the company’s tax rate.

Even if you use the after-tax rate, you’ll still need the above before-tax rate. The formula for
calculating the after-rate tax is:

Cost of debt (after-tax rate) = before-tax rate * (1 – marginal tax rate)

Keep in mind the before-tax rate is also often referred to as the yield-to-maturity on long-
term debt.

Calculating the cost of equity

There are also two ways of calculating the cost of equity: the more traditional dividend
capitalization model and the more modern capital asset pricing model (CAPM).

The dividend capitalization model uses the following formula:

Cost of equity = (dividends per share [for next year] / current market value of stock) + growth
rate of dividends

More recently, many companies have started to the use the CAPM method. Under this
method, the idea is that investors need a minimum rate of return, which is equal to return
from a risk-free investment, as well as a return for bearing extra risk.

The formula is as follows:

Cost of equity = risk free rate + beta [i.e. risk measure] * (expected market return – risk free
rate)
Calculating WACC

If the company has used different methods of financing, then the cost of capital is calculated
by the weighted average cost of capital. The above formulas are also needed in this method.

The method for calculating WACC is often expressed in the following formula:

WACC = percentage of financing that is equity * cost of equity + percentage of financing

that is debt * cost of debt * (1 – corporate tax rate)

In order to calculate the percentage of financing that is equity, you need the following
formula:

Percentage of financing that is equity = market value of the firm’s equity / total market value
of the firm’s financing (equity and debt)

To calculate the percentage of financing that is debt, you can use the following formula:

Percentage of financing that is debt= market value of the firm’s debt / total market value of
the firm’s financing (equity and debt)

The WACC will increase if the beta (risk measure) and the rate of return on equity increase.
This is because a growing WACC denotes a drop in valuation and a growth in risk.
4.4 Forecasting Methods

Forecasting is the process of making predictions of the future based on past and present data
and most commonly by analysis of trends. A commonplace example might be estimation of
some variable of interest at some specified future date. Prediction is a similar, but more
general term. Both might refer to formal statistical methods employing time series, cross-
sectional or longitudinal data, or alternatively to less formal judgmental methods. Usage can
differ between areas of application: for example, in hydrology the terms "forecast" and
"forecasting" are sometimes reserved for estimates of values at certain specific future times,
while the term "prediction" is used for more general estimates, such as the number of times
floods will occur over a long period.

Risk and uncertainty are central to forecasting and prediction; it is generally considered good
practice to indicate the degree of uncertainty attaching to forecasts. In any case, the data must
be up to date in order for the forecast to be as accurate as possible. In some cases the data
used to predict the variable of interest is itself forecasted.

Moving Average

A moving average is a technique to get an overall idea of the trends in a data set; it is
an average of any subset of numbers. The moving average is extremely useful for forecasting
long-term trends. You can calculate it for any period of time. For example, if you have sales
data for a twenty-year period, you can calculate a five-year moving average, a four-year
moving average, a three-year moving average and so on. Stock market analysts will often use
a 50 or 200 day moving average to help them see trends in the stock market and (hopefully)
forecast where the stocks are headed.
An average represents the “middling” value of a set of numbers. The moving average is
exactly the same, but the average is calculated several times for several subsets of
data. For example, if you want a two-year moving average for a data set from 2000, 2001,
2002 and 2003 you would find averages for the subsets 2000/2001, 2001/2002 and
2002/2003. Moving averages are usually plotted and are best visualized.
Exponential Smoothing
Exponential smoothing of time series data assigns exponentially decreasing weights for
newest to oldest observations. In other words, the older the data, the less priority (“weight”)
the data is given; newer data is seen as more relevant and is assigned more weight.
Smoothing parameters (smoothing constants)— usually denoted by α— determine the
weights for observations.
Exponential smoothing is usually used to make short term forecasts, as longer term forecasts
using this technique can be quite unreliable.

 Simple (single) exponential smoothing uses a weighted moving average with

exponentially decreasing weights.
 Holt’s trend-corrected double exponential smoothing is usually more reliable for
handling data that shows trends, compared to the single procedure.
 Triple exponential smoothing (also called the Multiplicative Holt-Winters) is usually
more reliable for parabolic trends or data that shows trends and seasonality.

Trend Analysis Forecasting

Trend analysis uses a variety of statistical tools, all of which are accessible to business
owners. At the most basic level, you can plot data points for visual identification of trends to
clarify relationships between variables and identify “outliers,” or random points that don't fit
a pattern. Data points can then be converted into moving averages to smooth random
fluctuations. A business owner can use spreadsheet software to “fit” trend lines on charted
data or build regression models. These allow her to include more variables to predict sales
more accurately and forecast the impact of rising interest rates and seasonal changes.