2. 2
Table of Contents
I. Introduction
II. Spreading Historical Financial Statements
III. Deriving Historic Ratios, Trends and Variables
IV. Financial Statement Projections
V.
Integration of Financial Statement Projections / Revolver
Modeling
3. 3
Introduction
Uses for Financial Models in Investment Banking and Private Equity:
Models begin with inputting historical results, and then making
projections for future years, linking the income statement, balance
sheet, and cash flow statement
Examples of a model’s use:
– Acquisition or sale of an entire company or division
– Merger of equals
– Leveraged buyouts / Management buyouts
– Public or private placement of new equity or debt capital
– Restructuring / Bankruptcy
The associate or analyst will construct and maintain the model, and
set the model up so that any changes in financial projections or the
deal terms can be quickly entered, and the result seen immediately.
Creating a robust model is imperative.
4. 4
Introduction
Tips for Setting Up the Financial Model:
Keep historic and projected income statement, balance sheet and
cash flow on same worksheet
Have Historic Ratios / Assumptions for Projections on the same
worksheet but separate from the worksheet that has income
statement, balance sheet and cash flow
Formatting is very important in investment banking:
– same font and letter size throughout model
– clearly labeled pages
– blue text usually denotes an input that is a driver
– black text is usually output
– convention is one decimal point for $ amounts; 0 or 1 decimal points for
percentages
– Set print ranges and preferences
– Footnote all sources and assumptions clearly
Keep it as simple as you can
5. 5
Table of Contents
I. Introduction
II. Spreading Historical Financial Statements
III. Deriving Historic Ratios, Trends and Variables
IV. Financial Statement Projections
V.
Integration of Financial Statement Projections / Revolver
Modeling
6. 6
Spreading Historical Financial Statements
3 to 5 year history for income statement, balance sheet and cash flow
usually sufficient
Source of historic financial statements:
Publicly traded companies’ financial statements must be filed with the
SEC on a quarterly (10-Q) and annual basis (10-K) and are publicly
available
Private companies: audited financial statements provided by company
Adjust historical income statement for one-time, extraordinary, non-
recurring items such as restructuring charges or sale of business
division
When spreading the historic financial statements: keep it simple!
7. 7
Deriving Historic Ratios, Trends and Variables
Goal is to intuit historical trends, margins, growth rates for making
projections. Remember that the past is not always a guide to the
future, but sometimes it is.
Important ratios needed for historical results in the income
statement:
Revenue growth
Gross margin: (revenue – cost of goods sold) / revenue
SG&A margin: SG&A / revenue
Operating margin: operating income / revenue
EBITDA margin: (operating income + D&A) / revenue
Operating income growth (AKA EBIT) and EBITDA growth
Depreciation as a percentage of gross P,P&E
Effective tax rate: income tax / pre-tax income
Other income/expense: read the notes to statements to see if there is a trend
– Depreciation schedules can also be used; for purposes of this model, we are
using Depreciation as % of Gross PP&E; Depreciation Schedule available for
illustrative purposes.
8. 8
Deriving Historic Ratios, Trends and Variables
Important ratios needed for historical results in the balance sheet:
Accounts receivable, Inventory, and Accounts Payable are expressed in
terms of number of days (e.g. DSOs are 30 days):
Days in Accounts Receivable: Average A/R Balance / Revenue * 360 days
Days in Inventory: Average Inventory Balance / COGS * 360 days
Days in Payables: Average A/P Balance / COGS * 360 days
• Days in accounts receivable is also called “days in receivables” or “days
sales outstanding” (DSOs)
• Other assets and liabilities can be expressed either as a percent of revenue
or COGS, it all depends on what they are most correlated with
• Capital Expenditures (CAPEX) is expressed as a % of revenue
• Asset Dispositions should be explored in notes to statements, to see if
there is a trend or if they are one-time (non-recurring) items.
9. 9
Table of Contents
I. Introduction
II. Spreading Historical Financial Statements
III. Deriving Historic Ratios, Trends and Variables
IV. Financial Statement Projections
V.
Integration of Financial Statement Projections / Revolver
Modeling
10. 10
Income Statement Projections
Revenue projections are based sometimes on historical growth if a
mature or cyclical company, or more on market intelligence and
judgment if a fast growing company
Revenue = price x quantity. Break them out, maybe you have a good
handle on future unit sales, or price. Does the company have power
to pass through future cost increases? Is the sector expanding
capacity, which may pressure prices?
For a restaurant chain, if average revenue per store were stable, and
we knew the number of new stores they planned to open, we can
project revenue.
COGS projections - what percent of COGS is fixed v. variable? Variable
costs go up in line with their % of unit volume, but fixed costs stay the
same unless capacity is expanded. What are Capex plans? D&A is a
component of COGS.
Break out COGS as detailed as possible. 2/3 of a chemical
manufacturer’s COGS is energy, what is our outlook for natural gas
prices? An aircraft engine maker sources metals, are miners
expanding or shrinking capacity (impacts prices).
11. 11
Income Statement Projections
S,G&A expenses are projected as a % of revenue (e.g. hard key 15%,
then make the expense projection = 15% x projected revenue),
however a portion is a fixed cost and will not increase in line with
revenue.
Interest income and expense are projected based on debt and cash
balance projections. Is there debt coming due, and if/when rolled
over, will rates be higher or lower?
Other income / expense is hard to project unless there is a recurring
trend. If not, project zero.
Income tax expense is projected as a % of pre-tax income, based on
past rates as long as constant. Be mindful of future use of “net
operating loss” (NOL), which reduces tax rates.
12. 12
Balance Sheet Projections - Assets
Cash: this is the one item on the balance sheet that will be linked FROM
the cash flow statement (beg of yr cash + net cash flow = end of yr cash)
Accounts Receivable: in an assumptions sheet, you will hard key DSOs
based on trends, if 30 days, then AR balance will = 30 / 360 * revenue
projection
Same methodology for Inventory and Accounts Payable, except multiply
by COGS projection instead of revenue
Other Assets: discern if there are trends or not, could be hard keyed or
tied as a % of revenue
Goodwill: is not amortized, it sits there unless there is an impairment,
which one cannot project.
Amortization: Financing fees from acquisitions can be amortized, but not
investment banking fees (to be discussed in the LBO section). You can
project this for past expenses, but rarely do you project future
acquisitions, unless maybe if you work in corporate development as an
in-house banker.
13. 13
Balance Sheet Projections – Assets
Property, Plant & Equipment (P,P&E)
Gross P,P&E = beg balance + capex – asset sales
Capex projection: discern historical capex (from cash flow statement) as
% of revenue
Asset sales projection: discern trends, read notes. Often you will project
$0.
Then project depreciation expense (from historical cash flow statement)
as % of gross P,P&E historically.
Add each year’s projected depreciation to the accumulated depreciation
balance.
Net P,P&E = gross – accumulated depreciation.
14. 14
Balance Sheet Projections
Liabilities:
Accounts payable projection, if 40 days in payables = 40 / 360 * COGS
projection
Accrued liabilities and other: discern trends, express either as absolute
hard keyed value, or as % of COGS
Debt: read the debt schedule in the filings, is there debt coming due?
Shareholders’ Equity:
Retained earnings projection = beg balance + net income (after dividends)
Liabilities and Shareholders Equity
15. 15
Cash Flow Projections
All Changes in all Balance Sheet Accounts must be run through the cash
flow; otherwise the balance sheet totals will not balance
All Non-cash items in the income statement must be added back /
deducted from the operating cash flow
Operating Cash Flow = sum of….
Net Income: take from income statement
Depreciation and Amortization: take from income statement
Add back / deduct any other non-cash expenses / income from the income
statement (examples are non-cash interest expense, any non-cash
restructuring charges, amortization of capitalized accounts, etc.)
Changes in working capital
– Current Assets: previous period balance – current period balance
– Current Liabilities: current period balance – previous period balance
Changes in other assets / other liabilities
– Other Assets: previous period balance – current period balance
– Other Liabilities: current period balance – previous period balance
16. 16
Cash Flow Projections
Cash Flow from Investing Activities = sum of….
Capital Expenditures are outflows
Acquisitions are outflows
Sale of Assets are inflows
Cash Flow from Financing Activities
Driven by debt and interest schedule, which integrates the cash and debt
balance sheet accounts, interest expense and interest income on income
statement, and the cash flow statement
An increase in debt or equity is a cash inflow
Ending Cash Balance = Beginning Cash Balance + Cash Flow during Period
17. 17
Debt and Interest Schedule Projections
Create a section just for debt and interest, all tranches
The notes to financial statements contain info on amortization,
maturity, and rates.
Ending debt balance = beg balance + drawdowns – amortization,
paydowns, or maturing debt that is not rolled over
Interest expense projection = average debt balance x interest rate
After projecting each debt tranche in the separate table, link the
beginning and ending balances to the balance sheet
Link the interest expense to the income statement’s interest expense
Link projected interest income to the income statement’s interest
income, because a cash balance earns interest.
18. 18
Table of Contents
I. Introduction
II. Spreading Historical Financial Statements
III. Deriving Historic Ratios, Trends and Variables
IV. Financial Statement Projections
V.
Integration of Financial Statement Projections / Revolver
Modeling
19. 19
Revolver Modeling
The revolver is a short-term bank line that can be drawn on or
paid down daily.
We will learn how to write a formula so that any excess cash flow
will automatically be used to pay down as much of the revolver as
possible, or so that any cash flow deficits will use the revolver to
maintain sufficient working capital for operations.
The following slide is a snapshot of how that will appear in the
model we will create……
20. 20
Revolver Modeling
Cash Flow Before Revolver =
Operating CF + Investing CF +
CF from Change in Term Loan + CF
from Change in Unsecured Debt +
Beg Cash Position
(Paydown)/Drawdown=
-MIN (Cash Flow before Revolver,
Beginning Revolver Balance)
1. If negative cash flow before
revolver, company borrows up to the
amount of its cash flow deficit.
Balance sheet cash is zero after
borrowing.
2. If positive cash flow AND a
revolver balance, company can pay
back the revolver, but ONLY up to
the amount of positive cash flow it
generated.
3. If company has positive cash
flows but NO revolver balance, then
the positive cash flow goes
to balance sheet cash.
Cash Flow
Net Income $23.4 $26.4 $29.4 $32.7 $36.2
Plus / (minus):
Depreciation and Amortization $7 $7 $7 $8 $8
Changes in Working Capital
Accounts Receivable ($0.6) ($0.5) ($0.6) ($0.6) ($0.6)
Inventory ($0.2) ($0.2) ($0.2) ($0.2) ($0.2)
Other Current Assets $0.0 $0.0 $0.0 $0.0 $0.0
Accounts Payable $0.2 $0.2 $0.2 $0.2 $0.2
Accrued Liabilities $0.1 $0.1 $0.1 $0.1 $0.1
Other Current Liabilities $1.3 $0.1 $0.1 $0.1 $0.1
Change in Other Liabilities $0 $0 $0 $0 $0
Cash Flows from Operations $31.3 $33.3 $36.5 $40.0 $43.7
Cash Flows from Investing
Capital Expenditures ($8.8) ($9.3) ($9.7) ($10.2) ($10.7)
Asset Dispositions $0.0 $0.0 $0.0 $0.0 $0.0
Cash Flows from Investing ($8.8) ($9.3) ($9.7) ($10.2) ($10.7)
Cash Flows from Financing
Change in Revolver ($10.6) $0.0 $0.0 $0.0 $0.0
Change in Term Loan ($25.0) ($25.0) ($25.0) ($25.0) ($25.0)
Change in Unsecured Debt $0.0 $0.0 $0.0 $0.0 $0.0
Total Cash Flows from Financing ($35.6) ($25.0) ($25.0) ($25.0) ($25.0)
Total Cash Flow ($13.1) ($0.9) $1.8 $4.8 $8.0
Beginning Cash Position $86.9 $73.7 $72.8 $74.6 $79.4
Change in Cash Position ($13.1) ($0.9) $1.8 $4.8 $8.0
Ending Cash Position $73.7 $72.8 $74.6 $79.4 $87.3
Cash Flow Before Revolver $84.4 $72.8 $74.6 $79.4 $87.3
Debt and Interest Schedule
Revolver
Beginning Revolver Balance $10.6 $0.0 $0.0 $0.0 $0.0
(Paydown) / Drawdown ($10.6) $0.0 $0.0 $0.0 $0.0
Ending Revolver Balance $0.0 $0.0 $0.0 $0.0 $0.0
Interest Rate 6.25% 6.50% 6.75% 7.00% 7.25%
Interest Expense $0.3 $0.0 $0.0 $0.0 $0.0
21. 21
Revolver Modeling
Calculate the interest expense on the revolver as:
interest rate x avg of beginning and ending revolver balance
Link the revolver balance back into the balance sheet, the interest
expense on the revolver back into the income statement, and adjust the
changes in revolver in the cash flow
Once the revolver has been properly modeled, the ending cash balance
should properly calculate in the cash flow, and this can be linked into
the cash balance in the balance sheet