Professional Documents
Culture Documents
May 9, 2015
Financial Modelling
May 9, 2015
Financial Modelling
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Financial Modelling
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Model Objectives
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Financial theory
Mathematical Models
Financial Modelling
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Financial Modelling
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Nicholas Taleb:
In the not too distant past, say the pre-computer days, projections remained
vague and qualitative, one had to make a mental effort to keep track of them,
and it was a strain to push scenarios into the future. It took pencils, erasers,
reams of paper, and huge wastebaskets to engage in the activity. The activity of
projecting, in short, was effortful, undesirable, and marred with self doubt.
But things changed with the intrusion of the spreadsheet. When you put an
Excel spreadsheet into computer literate hands, you get projections effortlessly
extending ad infinitum. We have become excessively bureaucratic planners
thanks to these potent computer programs given to those who are incapable of
handling their knowledge.
Financial Modelling
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Financial Models
A good financial model should:
Be relatively simple
Focus on key cash flow drivers
Clearly convey assumptions and conclusions
Evaluate Risks through sensitivity analysis, break-even analysis, scenario analysis
Alternative Models
Deterministic
Set a number of assumptions and translate into financial ratios and cash flow
Stochastic
Develop a range of possible inputs using Monte Carlo simulation. Used where there is a
good and predictable history for value drivers.
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Input Sheets
Different colors
Arranging of inputs
Set-up Sensitivity
Working Sheets
Debt Schedule
Financial Statements
Income Statement
Tax Calculation
Cash Flow
Balance Sheet
Output Sheets
Financial Ratios
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Inputs:
Historic
Financials
Operating
Drivers,
Financing,
Tax
Debt Schedule of
Existing Issues
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Balance
Sheet
Free
Cash
Flow
Cash Balance,
Debt Balance
Surplus Cash Balance
Equity Balance
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Working Sheet
Historical
Financials
Inputs
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Revenues,
Expenses,
Cap Exp, WC
Depreciation
Existing
Debt
Beginning
Balance Sheet
&
Financial
Statements
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Free Cash
Flow
Outputs
Value
Credit
Quality
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Cash Flow
Statement
Net Income, Depreciation etc.
Debt Maturities
Net Cash Flow
Balance Sheet
Surplus Cash Plug
Other Assets.
Short-term Debt
Fixed Debt
Other Liabilities
Common Equity
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Input Sheets
Different colors
Arranging of inputs
Working Sheets
Depreciation Schedule
Financial Statements
Income Statement
Balance Sheet
Output Sheets
Valuation - IRR
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Inputs
Operating
- Capital Expenditures
- Revenues
- Operating Expenses
- A/R and A/P
Financial and Tax
- Debt Leverage
- Interest Rate
- Debt Repayment
- Tax Rate
- Tax Depreciation
Mechanics
Construction Sources & Uses
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Outputs
Income Statement
IRR Equity
IRR Project
Net Present Value
Return on Investment
Economic Profit
Debt Service Coverage
LLCR
Payback Period
Accounting Earnings
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Inputs:
Operating
Drivers from
Contracts
and Other,
EPC Contract,
S-Curve,
Interest Rate
Tax
Sources and
Uses of Funds
During
Construction
Including
Interest
Roll-up
Debt
Schedule
Fixed
Assets
Interest
Capitalized
Fees and
Other
Balance
Sheet
Equity IRR
DSCR, LLCR
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Inputs
Prices, Costs, Capacity,
Technical Parameters
Working Sheet to
Derive Revenues Expenses
and Working Capital
Source and
Use of Funds
Draw down, IDC, Equity Issues
and Capital Expenditures
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Debt Schedule
Debt Balance From
Drawdown Debt Balance,
Interest Expense
Outputs
Depreciation
Depreciation Expense
Plant Balance
Annual Financials
Income Statement, Cash Flow
CASH WATERFALL
and Balance Sheet
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Input Sheets
Different colors
Arranging of inputs
Working Sheets
Financial Statements
Income Statement
Balance Sheet
Output Sheets
Transaction Multiples
Valuation - IRR
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Inputs
Purchase Price,
EBITDA, Terminal Value
Debt Schedule
Debt Balance From
Drawdown Debt Balance,
Interest Expense
Outputs
Working Sheet to
Derive Revenues Expenses
and Working Capital
Source and
Use of Funds
Purchase Price
and Capital Structure
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Depreciation
Depreciation Expense
Plant Balance
Annual Financials
Income Statement, Cash Flow
CASH WATERFALL
and Balance Sheet
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Inputs:
Operating
Drivers from
History,
Acquisition
Price and
Financing
Sources,
Tax
Sources and
Uses of Funds
Fixed
Assets
Fees and
Other
Goodwill and
Purchase Price
Allocation
Balance
Sheet
Pro-Forma
Balance
Sheet
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Equity IRR
Debt IRR
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Sources and
Uses of Funds
Tax
Fixed
Assets
Fees and
Other
Goodwill and
Purchase Price
Allocation
Balance
Sheet
EPS Accretion
Credit Measures
Pro-Forma
Balance
Sheet
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Transaction &
Source and Use
Analysis
Target
Financials
Consolidated
Financial
Statements
Acquirer
Financials
Goodwill &
Pro-Forma
Balance Sheet
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Outputs
Value
Credit
Quality
Debt Issues
Including Debt
For Financing
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Simple Formulas
The modeling practices are discussed in another sheet named spreadsheet
conventions.
The most important is keeping the formulas simple and making the sheets
transparent and easy to read.
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Corkscrews - Continued
For each account that is modeled, the closing balance of the account
should come from the final balance sheet.
For example:
Plant balance
Closing balance the amount of gross plant in the base year (the
final year before the start of the model)
In the case of debt
The sum of the closing balance that anchor the debt facilities should
sum to the amount on the balance sheet.
You should include a verification check to make sure that the
individual accounts tie to the balance sheet.
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Capital expenditures
Revenues
Operating expenses
When you get a model from someone else find these three inputs and
work backwards
History should be presented along with forecasts for the value drivers
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Once you have the maximum capacity, test the capacity against the
level of sales.
Use the roundup command in excel
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Use to Row
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Debt Schedule
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Debt Sheet
The debt module to model includes the total of all debt derived from the
sources and uses statement.
Each debt issue should show at minimum the beginning debt balance,
debt draws, debt repayments, interest expense and ending debt balance.
Use a separate module and put interest expense and debt
repayments etc. in the financials
Reflect the actual repayment structure and the quarterly or semiannual repayments.
Include interest expense in the income statement from the debt
module - make sure that EBT subtracts interest expense.
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Default Mechanics
Steps in computing default and repayment of default
Compute default in cash flow statement by structuring a cash flow waterfall
Assume all defaulted debt is paid in subsequent period, before any other debt
service
If cash is insufficient to pay debt service and re-payment of default, default
will be larger and will attempt to repay larger default
Example
Default
Year 1
100
Cash Flow
Year 2
-50
Year 2
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Cash flow
Repayment of Default from year 1
Total Cash Flow
Default in year 2
(50)
(100)
(150)
150
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Closing Balance
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Dividends
Cash Sweep
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Waterfall Issues
Defaults and subsequent repayments of defaults before dividend
distributions
Model different priorities of debt
Model cash flow trap mechanisms
Evaluate Pre-payments from covenant violations
Compute Debt service reserve injections and withdrawals
Accumulation of debt service reserve after construction period
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Use HLOOKUP to compute the rate (better than match and index)
Use SUMIF with test on <>#N/A to add all of the amounts
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NOL Example
The following example illustrates modelling of an NOL
To model the NOL use the following:
An if statement the adds to the NOL when the taxes before NOL are
positive
An if statement together with a minimum statement to withdraw from
the NOL balance.
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Expiration of NOL
Generally, the NOL expires after a period of years (in the US this is now a
30 year period).
To model expiration of the NOL, all you have to do is add another line in
the NOL corkscrew:
Add a line for reductions due to loss of NOL
Use the offset command to model expirations the offset command
with a negative parameter for the column can look back
The formula only applies after the period of the NOL
For example in the case of the US, this would be only after year 6 in
the model unless you have data on existing NOLs and how they
arose.
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Expiration of NOL
The following example illustrates programming of the NOL with expiration
after a certain length of time.
The two examples shows how expiration of the NOL can reduce its
benefit if there is volatility in earnings:
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Deferred Tax
Use the following step by step process
Find information on the basis for deferred taxes from the financial
statements and concentrate on the deferred tax arising from
depreciation and from NOL
Derive the tax depreciation from existing plant
Compute the tax depreciation on new plant from a vintage analysis
(shown below)
Create a separate tax calculation after the income statement that
accounts for tax depreciation and NOL
Compute the deferred taxes and accumulated deferred taxes from
the difference between book and tax
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Keep track of shares and allow new debt and equity issues
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To model priorities in a cash flow waterfall the first step is setting up a the cash flow
statement in a model that reflects the actual ordering of cash flow:
Begin with the cash flow after capital expenditures and after all new
financing and acquisitions
Add back interest expense that was deducted because the interest will be
accounted for on an issue by issue basis
Add the beginning balance of cash. Even though it seems odd to add the
cash balances, these cash balances are available to pay off debt.
The sum of these items gives the cash flow for the waterfall as illustrated
below.
Cash Flow After Capital Expenditures
Add: New Debt Issues
Add: New Equity Issues
Cash Flow before waterfall adjustments
Add: Total Interest Expense
Add: Beginning Cash Balance
Cash Flow for Waterfall
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Waterfall Issues
Defaults and subsequent repayments of defaults before dividend
distributions
Model different priorities of debt
Model cash flow trap mechanisms
Evaluate Pre-payments from covenant violations
Compute Debt service reserve injections and withdrawals
Accumulation of debt service reserve after construction period
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Structure of Outputs
Outputs should generally come from the financial statements and should
not affect any of the calculations (you should be able to delete the
outputs page without any impact on the model)
Outputs for comparative graphs can be saved in a separate sheet -- you
can develop a macro using a paste as value method to compare
scenarios
Put macro buttons, spinner boxes, combo boxes and scroll bars on the
summary page.
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Historic Analysis
Step 1
Summarize Historic Income Statement and Balance Sheet (unlike forecast
which is based on income statement and cash flow statement).
Step 2
Input base year data and other assumptions into calculation section of the
worksheet.
Step 3
Compute ratios from historic data that are necessary for making assumptions
such as tax rate, current assets/revenues and payout ratio.
Step 4
Reconcile items such as capital expenditures, movements in investments,
movements in minority interest
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Remove Cash From Current Assets and Notes Payable from Current
Liabilities
Checks
Net income should tie to actual data on the income statement
Balance sheet should reconcile, in particular, the cash balance
should tie to actual levels
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Equity balance does not equal prior balance + net income + equity
issues - dividends
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Reference Slides:
Errors in Modelling
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Structure of Inputs
One should be able to find all of the inputs in an easy manner and
see how the inputs affect the outputs this is why the financial statement
page should not have any inputs
All inputs should have a color convention so it is clear what
numbers can be changed and what should not.
Separate inputs that vary by year (or month) and inputs that are
constant.
Other sheets should have links to the input page where the inputs
are repeated on the top of the page
Examples of problems with inputs are shown in the reference slides
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In the real world, you develop a model with inputs in various places and
then re-structure the spreadsheet to collect the inputs in a single sheet.
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Result of
Hyperlink
Assumption page
with hyperlinks
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By using 50 and 4
the model does
not account for
changing from
quarterly to annual
periods.
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Value Drivers
Basic Motions
Value Drivers are often obvious prices, traffic etc.
Value drivers for revenues
Price
Quantity
Value drivers for operating expenses
Fixed expenses
Variable expenses
Value drivers for capital expenditures
Cost per unit of capacity
Amount of capacity to meet demand
Set up sensitivity analysis and scenario analysis to evaluate the value drivers
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When demand increases, the capacity requirements increase and the capital
expenditures increase.
Example:
Demand for air freight increases
Increased demand causes a need for more planes
Increased planes create the need for increased capital expenditures
Create a table with existing capacity, retirements and required new capacity
Do Not:
Assume revenue growth that is independent of capital expenditures
Assume that cost structure can be maintained with unrealistic capacity
utilization assumptions
Use revenue growth/gross margin models that do not demonstrate price and
quantity drivers
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