2 - Financial Modeling

Financial Modeling

Chapter 2

What are the components of a model?

Ben J. Sopranzetti, Ph.D.

Parts of a model getting startedBalance Sheet

Income Statement

Statement of Cash Flows

Ben J. Sopranzetti, Ph.D.

Two kinds of models

Forecasting Model

Transaction Model

Ben J. Sopranzetti, Ph.D.

Forecasting ModelIncludes key operating assumptions how the firm will grow its revenues and operating cash flows under various scenarios

Price increases, growth in unit volume, and cost cuts are key drivers

By changing key operating assumptions, we can test for sensitivities

Ben J. Sopranzetti, Ph.D.

Transaction Model

Starts with a forecasting model and then analyzes the impact of a transaction Sample transactions (also called "deals") include initial public offerings, debt refinancings, mergers and acquisitions.

What is the impact of different deal structures?

Ben J. Sopranzetti, Ph.D.

The guts of a modelCover Page Operating Assumptions Working Capital Assumptions Income Statement Balance Sheet Cash Flow Statement Debt Schedule Valuation Analysis Operating Lookup Capital Structure Lookup

Ben J. Sopranzetti, Ph.D.

Keep things clean and tidyRemember, you might have to revisit the model six months from now.

Ben J. Sopranzetti, Ph.D.

The Cover Page

Summarizes models key information in one place

Ben J. Sopranzetti, Ph.D.

What are the key components?Sources and Uses Table

Summary Valuation

Summary Financial Results

Ben J. Sopranzetti, Ph.D.

Sources and Uses Table

Demonstrates from where a business plans to get financing (the "Sources") and what it plans to do with the it (the "Uses").

Ben J. Sopranzetti, Ph.D.

Summary ValuationWhat is the value of the business

And

How much of that value belongs to shareholders.

Ben J. Sopranzetti, Ph.D.

Summary Financial ResultsSummarizes the projected revenue and cash flow growth of the company

Provides a comparison with historical results.

Also provides information on the company's creditworthiness.

Ben J. Sopranzetti, Ph.D.

Operating AssumptionsGarbage in Garbage out

Your output is only as good as the quality of your assumptions

What are the critical assumptions?Sales, profit margin, growth, etc

What are the engines driving cash flows?

Ben J. Sopranzetti, Ph.D.

Operating AssumptionsHistorical results are often used as a starting point for a forecast.

Economies (dis-economies) of scale

Are historical values good predictors of the future? Use your common sense.

Ben J. Sopranzetti, Ph.D.

Working Capital PageForecast working capital items such as inventory, accounts payable, and accounts receivable.

Would you expect this to change with sales?

Ben J. Sopranzetti, Ph.D.

The Income StatementP&L (profit and loss) statement, shows all the revenue and expenses of the business.

Did the firm make any money?

The Operating Assumptions drive the Income Statement

Ben J. Sopranzetti, Ph.D.

The Balance SheetWhat do we have and how did we pay for it?

It tells us how much "stuff" we have (Assets) and how much of the "stuff" is owed to other parties (Liabilities).

The remainder belongs to the equity holders.

Driven in part by the working capital page

Ben J. Sopranzetti, Ph.D.

Statement of Cash FlowsIt starts with the accountant's record of profits from the Income Statement and reconciles to the bottom line change in Debt and Cash

Ties together the Income Statement and Balance Sheet

Ben J. Sopranzetti, Ph.D.

The Debt ScheduleThe business generates a certain amount of cash.

How much of the cash should be used to repay debt?

How much should be put in the bank?

Ben J. Sopranzetti, Ph.D.

Valuation AnalysisDrives the Summary Valuation results on the Cover Page

The Valuation Analysis calculates the cash flow and determines a business value based on these cash flow forecasts. Usually this is a indirect DCF (unlevered free cash flow) analysis

Ben J. Sopranzetti, Ph.D.

Operating LookupThis section of a financial model allows a user the flexibility to plan for and run various scenarios by simply changing a value in one cell.

This value is called a "trigger

Vary the revenue growth and profitability (COGS) and CAPEX forecasts

Ben J. Sopranzetti, Ph.D.

Capital Structure LookupJust like the Operating Lookup allows the user to vary the revenue and profit forecasts

The Capital Structure Lookup creates the capability to analyze the impact of various financing alternatives

Ben J. Sopranzetti, Ph.D.