Smart Task 02

1. While preparing a financial model what are the assumptions we need to

take. Please list down the list of assumptions with the values, assuming
the project will be set up in India.
Ans. Assumptions are the factors that we don’t get from client but we have to
search on our own and keep a tap on them while preparing our financial model.
These are based upon the location of the project. Some of assumptions that are
taken while preparing a financial model are as follows:

Inflation: It can be defined as a constant rise in the general price level of goods
and services that are of common or daily use (such as clothing, food, fuel,
transport, etc.) which will result in an increase in the cost of living. Inflation is
the actual measure of change in an average price of services and commodities,
done at regular intervals. It indicates the decrease in the purchasing power of a
nation’s currency as the products and services gets more expensive. Basically,
inflation is the difference between the aggregate demand and the aggregate
supply of goods and services. When aggregate demand exceeds the supply of
goods or services at current prices, there will be a rise in the price level. In India
this rate is 6.2% for the year 2020.

DDT: The Dividend Distribution Tax is a tax imposed on dividends that a

company pays to shareholders out of its profits. The Dividend Distribution Tax,
or DDT, is taxable at the source, and is deducted while the company is
distributing dividends. The dividend is the part of profits that the company
shares to its shareholders. The law provides that the Dividend Distribution Tax
to be at the hands of the company, and not at the hands of the receiver i.e.,
shareholder. However, an additional tax would be imposed on the shareholder,
who receives over Rs. 10 lakhs as dividend income in a single financial year.
For India the dividend distribution rate is 15%.

Tax Holiday: This is a government incentive program which offers a tax

reduction or elimination to businesses. Tax holidays are often used as a medium
to reduce sales taxes by local governments, but they are also commonly used by
governments in developing countries to help encourage foreign investment.
This could encourage economic activity and foster growth. Tax holidays are
believed to increase long-term tax revenues, because they help businesses
maintain or grow operations, which creates more taxable revenue for the tax
authority. In India the tax holiday usually ranges from five to ten years and the
percentage of rebate for them varies from 30%, 50% or even 100%

Tax rate: A tax rate is the percentage at which an individual or corporation

would be taxed. The United States (both the federal government and many of
the states) uses a progressive tax rate system, where the percentage of tax
charged increases along the amount of the person's or entity's taxable income
increases. A progressive tax rate will result in a much higher dollar amount
collected from the taxpayers which have greater incomes. Since the U.S. applies
its tax rate on marginal increments basis, taxpayers end up being charged at an
effective tax rate that would be lower than that of the straight bracket rate.
Some other nations also charge a flat tax rate or a regressive tax rate. Corporate
Tax is a direct tax that is imposed on the net income or profit of those corporate
enterprises which they make from their businesses. Companies having turnover
of 400 crore has tax rate of 25% in India.

Debt rate: This is the rate of return that a company will provide to its
debtholders and creditors. The capital providers are required to be compensated
for any risk exposure that comes along with lending to a company for any
purpose. The cost of debt reflects the default risk of any company and also it
reflects the level of interest rates in the market. The interest rate is the amount
that is charged on top of the principal by a lender to a borrower for the usage of
assets. Mostly mortgages use simple interest. However, some loans also use
compound interest, which is applied to the principal but also is an accumulated
interest of previous periods. A loan that is considered to be of low risk by the
lender will have a lower interest rate and a loan that is considered to be high
risk will have a higher interest rate. the national debt of India amounted to about
89.56 percent of the gross domestic product.

Moratorium: A moratorium period is the time during which the borrower is

not required to make any repayment. It is the waiting period before the
repayment of EMIs will resume. Normally, the repayment begins just after the
loan is disbursed and the payments have to be made every month accordingly.
However due to this moratorium period, the payments to be paid will starts after
some time. It is a time period during which the borrower is not obligated to
make any payments. In other words, during a moratorium period, the borrower
is permitted to halt or stop their payments for some particular time. It is most
commonly incorporated in home loans and educational loans. The Reserve bank
of India has allowed a max of 6 months.
Debt tenure: Tenor refers to the length of time remaining before a financial
contract expires. It is sometimes used interchangeably with the term maturity,
although the terms have distinct meanings. Tenor is used in relation to bank
loans, insurance contracts, and derivative products. The term tenor describes the
length of time remaining in the life of a financial contract. By contrast, maturity
refers to the initial length of a contract upon its inception. Higher-tenor
contracts are sometimes considered riskier, and vice versa. Tenor is particularly
important in a credit default swap because it coordinates the term remaining on
the contract with the maturity of the underlying asset. Understanding the tenor
of a financial contract is crucial to analyse the contract's riskiness and maintain
a steady cash flow.

Depreciation: Depreciation is an accounting method of allocating the cost of a

tangible or physical asset over its useful life or life expectancy. Depreciation
represents how much of an asset's value has been used up. Depreciating assets
helps companies earn revenue from an asset while expensing a portion of its
cost each year the asset is in use. If not taken into account, it can greatly affect
profits. Businesses can depreciate long-term assets for both tax and accounting
purposes. Per the matching principle of accounting, depreciation ties the cost of
using a tangible asset with the benefit gained over its useful life. There are
many types of depreciation, including straight-line and various forms of
accelerated depreciation. Accumulated depreciation refers to the sum of all
depreciation recorded on an asset to a specific date. The carrying value of an
asset on the balance sheet is its historical cost minus all accumulated
depreciation. The carrying value of an asset after all depreciation has been taken
is referred to as its salvage value. The depreciation rate for building in India
varies from 10-40%.
USD/INR: The USD/INR pair tells the trader how many Indian Rupees (the
quote currency) are needed to purchase one U.S. dollar (the base currency). An
exchange rate is the value of one nation's currency versus the currency of
another nation or economic zone. Most exchange rates are free-floating and will
rise or fall based on supply and demand in the market. The current exchange
rate for 1 dollar is 74.43 rupees.

Discount: Depending upon the context, the discount rate has two different
definitions and usages. First, the discount rate refers to the interest rate charged
to the commercial banks and other financial institutions for the loans they take
from the Federal Reserve Bank through the discount window loan process.
Second, the discount rate refers to the interest rate used in discounted cash flow
(DCF) analysis to determine the present value of future cash flows. In DCF, the
 discount rate expresses the time value of money and can make the difference
between whether an investment project is financially viable or not. The current
Bank Rate is the same as Marginal Standing Facility rate, i.e., 4.65%.

Construction Time: Construction time can be defined as the elapsed period

from the commencement of site works to the completion time of building to the
client. It is usually specified prior to the commencement of construction. Time
for completion is an important concept in contracts. When a time limit is
attached to an obligation under a contract, failure to complete that obligation
within the time prescribed is usually a “material” breach of contract and the
other party may be entitled to damages. If no time obligation is added, then the
default position is usually that the allowance has to be reasonable, or in some
cases time is said to be “at large” and it is not considered relevant.

MAT: MAT stands for Minimum Alternate Tax and AMT stands for Alternate
Minimum Tax. Initially the concept of MAT was introduced for companies and
progressively it has been made applicable to all other taxpayers in the form. The
objective of introduction of MAT is to bring into the tax net "zero tax
companies" which in spite of having earned substantial book profits and having
paid handsome dividends, do not pay any tax due to various tax concessions
and incentives provided under the Income-tax Law. Companies can reduce their
tax liability through various provisions of the Income-Tax Act, such as
exemptions, deductions, depreciation, etc. There have been instances of some
companies even managing to show nil taxable income despite making
substantial profits and paying out dividends, thanks to the various tax
concessions and incentives. The tax provision known as Minimum Alternate
Tax (MAT) was created to bring these ‘zero-tax paying companies’ within the
ambit of income tax and make them pay a minimum amount in tax to the
government. The present MAT rate as of FY 2019-20 is 15% of book profit
(previously 18.5%) plus applicable cess and surcharge.

2. Explain the function of revenue, cost and debt sheet of the financial model.
Ans. Financial modeling is a tool that can be used to forecast a picture of a security
or a financial instrument or a company’s future financial performance based on the
historical performance of the entity. The purpose of financial modeling is to build a
financial model which can enable a person to take better financial decision. The
decision could be affected by future cash flow projections, debt structure for the
company, etc. All these factors may affect the viability of a project or investment
in a company.
Revenue: it implies that there are 2 cash inflows. In the sample financial model,
one is the rent and the other is the interest earned on the deposits paid by tenants.
This total is the revenue earned.

Cost: It covers all the cost incurred during setting up of the project. In the sample
financial model this includes all the hard cost as rent, interior decoration, furniture,
etc. As well as maintenance cost such as broker fees, stamp duty, CSR, Training,
etc.

Debt schedule: It lays out all of the debt a business has in a schedule based on its
maturity. It is typically used by businesses to construct a cash flow analysis.
Interest expenses in the debt schedule flow into the income statement, the closing
debt balance flows into the balance sheet, and principal repayments flow through
the cash flow statement (financial activities). The debt schedule report can be used
as an instrument to negotiate a new line of credit for the company. Lenders will use
the report and consider the risk/reward before granting new credit.
The income statement shows the revenues and the costs of the company and
indicates if it has profits or losses. It is divided into two parts: operating and non-
operating. If for instance, a software company sells a property, the revenues for the
transaction are non-operating, because real estate does not constitute its core
business. An income statement is quite straightforward. An investor can forecast
growth, the margin evolution, and the cost and their relative weight to the
revenues.
The functions of revenue, cost and debt sheet of the financial model is as follows: -

A. FUNCTION OF REVENUE SHEET IN FINANCIAL MODEL

Revenue sheet functions are as follows:
 To know the total revenue generated from a project.
 Projection of all revenue items.
 To define the different source of revenue or revenue parameters of the
projects.
 To known the interest earned on various investments.
 To known the revenue growth of project during different periods.

B. FUNCTION OF COST SHEET IN FINANCIAL MODEL

Cost sheet function are as follows:
 Estimation of overall cost incurred while completion of project.
 Estimation of CAPEX or capital expenditure of the project.
 Estimation of OPEX or operating expenditure of the project.
  To know the individual cost unit as a percentage to total cost.
C. FUNCTION OF DEBT SHEET
Debt sheet function are as follows:
 For projection of interest expenses.
 Calculation of interest payment.
 Projection of principal amount of debt.

3. Explain in detail the various steps involved (with the importance) in the fin
flows sheet. Why and what the bank needs to check before financing the
project.

Ans. The various steps involved in the preparation of fin flow sheet is as follows:

Step1: Calculate the Total revenue and Operating Expense

Total Revenue: Total revenue is the amount of money that a company earns by
selling its goods and/or services during a period of time (e.g., a day or a week).
Total revenue is the full amount of total sales of goods and services. It is calculated
by multiplying the total amount of goods and services sold by the price of the
goods and services. Total revenue is important because, in the effort to grow
profits, businesses strive to maximize the difference between their total revenues
and total costs

Operating Expense: An operating expense is an expense a business incurs

through its normal business operations. Often abbreviated as OPEX, operating
expenses include rent, equipment, inventory costs, marketing, payroll, insurance,
step costs, and funds allocated for research and development. An operating
expense is an expense a business incurs through its normal business operations.
Often abbreviated as OPEX, operating expenses include rent, equipment, inventory
costs, marketing, payroll, insurance, step costs, and funds allocated for research
and development. The Internal Revenue Service (IRS) allows businesses to deduct
operating expenses if the business operates to earn profits. By contrast, a non-
operating expense is an expense incurred by a business that is unrelated to the
business' core operations.

Step2: Subtract the Total revenue from the Operating expense to obtain
EBITDA
EBITDA: EBITDA, or earnings before interest, taxes, depreciation, and
amortization, is a measure of a company's overall financial performance and is
used as an alternative to net income in some circumstances. EBITDA, however,
can be misleading because it strips out the cost of capital investments like property,
plant, and equipment. This metric also excludes expenses associated with debt by
adding back interest expense and taxes to earnings. Nonetheless, it is a more
precise measure of corporate performance since it is able to show earnings before
the influence of accounting and financial deductions. Simply put, EBITDA is a
measure of profitability. 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 the information found
in a company's financial statements.

Step3: Subtract the interest & depreciation from the obtained EBITDA, to
obtain Net income

Non-Operating Expense: A non-operating expense is a business expense

unrelated to the core operations. The most common types of non-operating
expenses are interest charges and losses on the disposition of assets. Accountants
sometimes remove non-operating expenses and non-operating revenues to examine
the performance of the business, ignoring the effects of financing and other
irrelevant issues. A non-operating expense is an expense incurred from activities
unrelated to core operations. Non-operating expenses are deducted from operating
profits and accounted for at the bottom of a company's income statement.
Examples of non-operating expenses include interest payments or costs from
currency exchanges.

Net Income: Net income (NI), also called net earnings, is calculated as sales minus
cost of goods sold, selling, general and administrative expenses, operating
expenses, depreciation, interest, taxes, and other expenses. It is a useful number for
investors to assess how much revenue exceeds the expenses of an organization.
This number appears on a company's income statement and is also an indicator of a
company's profitability. Earnings per share are calculated using NI. Investors
should review the numbers used to calculate NI because expenses can be hidden in
accounting methods, or revenues can be inflated. NI also represents an individual's
total earnings or pre-tax earnings after factoring deductions and taxes in gross
income.

Step4: Add back the depreciation & CSR to the obtained Net income, to get
the final project cash flow.
Corporate Social Responsibility: Corporate social responsibility (CSR) is a self-
regulating business model that helps a company be socially accountable—to itself,
its stakeholders, and the public. By practicing corporate social responsibility, also
called corporate citizenship, companies can be conscious of the kind of impact they
are having on all aspects of society, including economic, social, and
environmental. To engage in CSR means that, in the ordinary course of business, a
company is operating in ways that enhance society and the environment, instead of
contributing negatively to them. For a company to be socially responsible, it first
needs to be accountable to itself and its shareholders. Often, companies that adopt
CSR programs have grown their business to the point where they can give back to
society. Thus, CSR is primarily a strategy of large corporations. Also, the more
visible and successful a corporation is, the more responsibility it has to set
standards of ethical behaviour for its peers, competition, and industry.