CHAPTER ONE

Introduction to Financial Modeling

and Valuation
 INTRODUCTION TO TOPIC
ACCOUNTING FINANCE VALUATION

SCIENCE ART The hybrid of art

What Happened Creating The And Science ($)
In The Past Future
 Accounting
• Past
• Income statement,
• Balance sheet and
• Cash flow statement.
Finance
• Predicting the future
• Ratio analysis
• Trend Analysis
Valuation
• Value based on time, and prices.
 Introduction to Financial Modeling
• Financial Modeling is the process of creating summery of
company’s expenses and earnings in the form of spreadsheet that
can be used to calculate the impact of future event or decision.
• Financial Modeling is a forecast for a specific business of key
financial information, that is uses a set of assumption, in order to
see the financial effect of decision making. Usually done in MS
Excel.
• Financial Modeling is show a prediction about the future
financial performance of a company
• Financial Modeling is a tool that can be used to forecast a picture
of a company future financial performance.
• Financial modeling is the construction of spreadsheet
models that illustrate a company likely financial
results in quantitative terms.
• Financial models can simulate the effect of specific
variables so that the company can plan a course of
action should they occur.
• Financial modeling is the process by which a firm
constructs a financial representation of some, or all,
aspects of the firm or given security.
Why Build Financial Projection Models?
• Internal Reasons
• Project future financial needs
• Create Business Plans
• Provide Information to Investors for decision making
• Credit Analysis
• Choose whether to lend or not.
• Figure out whether a company can produce enough
excess cash over the term of the loan to repay.
• Corporate and Stock Valuation
• Predict Future Free Cash Flows, dividends earnings
• Use valuation models to estimate stock price and
equity returns
• Mergers & Acquisitions,
• Value Companies / Divisions
• Model transactions
• Project the position of the resulting company
Users of Financial Model
• Managers of company– effect of financial decision
• Investment analysts– to understand the future
potential earning and dividend of the company
• Financiers – who need to predict the ability of
company to repay loan
• Potential investors – who want to understand the
existing profits and cash flow and potential company
growth
 Benefit of Financial Model
• Business owners and managers need forward looking
information, to make decision.
• Financial model is a key financial decision, want to
understand future cash flows.
• Key to any major capital investment, want to understand
the return on capital invested
• Important in a sale of business or raising capital – investors
want to understand future benefit profits and cash flows
future estimate share price and dividend stream
Building a Financial Projection Model
Step 1: Make forecasting assumptions
• Most Financial Statements models are sales driven
• Start with an assumption for sales revenue, make assumptions for other items.
Example: Account Receivable of the firm as direct percentage of sales
Distinguish Between:
• Items that vary with sales (E.g. COGS)
• Items that vary with other items (E.g. Interest expense)
Step 2: Make Financial Policy Assumptions
• Mix between debt and equity
• What happens with excess cash?
• How do we cover financial needs?
Step 3: Use assumptions from step 1 and step 2 to predict financial statements
 BUILDING MODEL
A) Gather key financial information, typically;
• Sales volume (units and monetary )
• Product cost
• Variable cost – costs that are vary depending on sales volume
• Example: sale commission, and delivery expense
• Fixed cost – costs that do not vary on sales volume
• Example: rent, salaries of manager
• Sales - volume and price
• Gross profit margin
• Cost of sales
• Inflation
• Interest rate and Tax rate
 B) Determine Assumption
• Sales growth - volume and price
• Gross profit margin
• Variable cost (% of sales)
• Fixed cost – current cost + Inflation
• Planned capital expenditures) (new machine)
• Planned changes – new staff, new premises
• Interest rate
• Tax rate
• Constraint – how much you can sell and manufacturer
• Example. Expand by 10% .
 Overview of excel Functions for modeling
• The aim of this excel book is to present some important
financial models and to show how they can be solved
numerically and/or simulated using Excel.
• Financial Modeling covers standard financial models in
the areas of corporate finance, financial statement
simulation, etc..,
• Excel is one of the most accessible and powerful tools
available for this purpose.
• Financial Modeling makes extensive use of data tables
 Ribbon

Cell Names FORMULA BAR

Cell

Work sheet
Enable iterative calculation from
excel formula
Basic Financial Calculation By Using Excel
• The most basic financial calculation is
• To compute the Present value (PV) and Net present
value (NPV) and future value of a single cash flow or
series of cash flows
• To compute the return on an investment
• To use a financial calculator and/or spreadsheet to solve
time value problems
• To compute the IRR and Loan repayment schedule
 Understand Time Value of Money
• A sum of money today is worth more than a sum of money future.
• Interest is a fee (charge) to borrow money.
Example
• If you were to invest $100,000 at 5-percent simple interest for one
year, your investment would grow to $105,000.
=$5,000 would be interest ($100,000 × .05) by simple interest.
$100,000 is the principal repayment ($100,000 × 1)
$105,000 is the total due. It can be calculated as:
$105,000 = $100,000×(1.05)
Future Value
• The total amount due at the end of the
investment is call the Future Value (FV).
• The formula for FV can be formulated as:
FV = PV×(1 + r)T
Where:
- PV0 is cash flow today (time zero), and
- r is the appropriate interest rate.
 Present Value
• The amount that a borrower would need to set aside
today to be able to meet the promised payment of
$100,000 in one year is called the Present Value (PV).
• If you were to be promised $100,000 due in one year when
interest rates are 5-percent, your investment would be
worth $95,238.1 in today’s dollars.
$100,000
$95,238.10 
1.05
Note that $100,000 = $95,238.10×(1.05).