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Financial Modeling
Techniques
By EduCBA
Financial Modeling
• A financial model represents


The financial performance of a company



For both past and future.

• Always advisable to build a financial model in excel.

• Skill sets required by an individual to build a financial model are
 Knowledge of excel
 Knowledge of accounting
 Knowledge of corporate finance
 Understanding the company‟s operations
Historical Data

• Gather right historical data from the right source
• Remember – You are an “Analyst” not an “Auditor”
• Don‟t sit to tally if the annual reports published by

company do not tally
Assumption
• Referred to as „drivers‟ or „inputs‟
• Financial models need to have clear and well defined assumptions
• Should reflect business realities and expectations
• Criteria one should consider while making an assumption are :-

 No bias should get into the assumptions on the business
 Understanding the company's financials
 Clearly understand the expected changes in future performance
 Understand Management expectations

 Check out what other analysts think about the company
Color Coding
Constant / Historical Input = BLUE

Calculations = BLACK

Linkages = GREEN
Features of an effective model
Should be realistic based on reasonable
and defensible assumptions and
projections

Should be flexible and adaptable with
dynamic working schedules (or modules)

Should be easy to follow, should not
intimidate the reader
Circular reference
A circular reference is a series of references where the last object references the first,
resulting in a closed loop.
Year 1
Income heet (Rs m)
Lets understand this with the help of an example
Net Sales
• We need to calculate net income
(-)Direct Costs
• To calculate net income we need to calculate interest
income
• Interest income will be calculated as income rate

Gross Profit
(-)Selling, General & Admin
Costs
EBITDA
(-)Depreciation/Amortisation
EBIT

percentage on the average cash and bank balances

• Over here we are assuming that the entire cash
balance in the bank

(-)Interest Expense
(+)Interest Income
Pretax Income
(-)Income Taxes
Net Income
Circular reference
Cash Flow Statement
Operating Activities

Year 1

• In order to calculate ending cash balance

Net Income
Depreciation/Amortization
Change in Working Capital

Cash Flow from Operating Activities

we will require net income then we will
be able to calculate interest income

Investment Activities

Capital Expenditures
Additions to Intangibles
Cash Flow from Investing Activities
Financing Activities

Issuance/ (Repayment) of Long Term Debt
Issuance/ (Repurchase of) Equity
Cash Flow from Financing Activities
Net Change in Cash
Beginning Cash Balance
Ending Cash Balance

Cash balances

Average Cash Balance
Interest Rate

Interest Income

Year 1
Circular reference
How to do this ???

Step 1 - Calculate net income by considering interest income to be 0
Step 2 - Link this net income to the cash flow statement and find out the ending
cash balance
Step 3 - Link this ending cash balance to the average cash balances and find out the
interest income

Step 4 – Link this interest income to the income statement
Circular reference
Wondering whether the new net income figure will get reflected

in the cash flow statement

Yes through circular reference this entire process will be done
automatically and accordingly the other figures in the income
statement , balance sheet and cash flow statement would also be

changed
Circular reference
Remember
Excel cannot calculate automatically when the model contains a
circular reference
We need to Turn ON “Iterations” in order to resolve the situation

How to turn on Iteration in excel
Go to
File >>> Options >>>> Formulas >>>>> Enable iterative
calculation >>>> OK
Circular reference
For more information:Knowledge is like a line with no ends
so
To know more on this topic click on the link below

https://www.educorporatebridge.com/financialmodeling/financial-modeling-technique/
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Financial modeling techniques

  • 2. Financial Modeling • A financial model represents  The financial performance of a company  For both past and future. • Always advisable to build a financial model in excel. • Skill sets required by an individual to build a financial model are  Knowledge of excel  Knowledge of accounting  Knowledge of corporate finance  Understanding the company‟s operations
  • 3. Historical Data • Gather right historical data from the right source • Remember – You are an “Analyst” not an “Auditor” • Don‟t sit to tally if the annual reports published by company do not tally
  • 4. Assumption • Referred to as „drivers‟ or „inputs‟ • Financial models need to have clear and well defined assumptions • Should reflect business realities and expectations • Criteria one should consider while making an assumption are :-  No bias should get into the assumptions on the business  Understanding the company's financials  Clearly understand the expected changes in future performance  Understand Management expectations  Check out what other analysts think about the company
  • 5. Color Coding Constant / Historical Input = BLUE Calculations = BLACK Linkages = GREEN
  • 6. Features of an effective model Should be realistic based on reasonable and defensible assumptions and projections Should be flexible and adaptable with dynamic working schedules (or modules) Should be easy to follow, should not intimidate the reader
  • 7. Circular reference A circular reference is a series of references where the last object references the first, resulting in a closed loop. Year 1 Income heet (Rs m) Lets understand this with the help of an example Net Sales • We need to calculate net income (-)Direct Costs • To calculate net income we need to calculate interest income • Interest income will be calculated as income rate Gross Profit (-)Selling, General & Admin Costs EBITDA (-)Depreciation/Amortisation EBIT percentage on the average cash and bank balances • Over here we are assuming that the entire cash balance in the bank (-)Interest Expense (+)Interest Income Pretax Income (-)Income Taxes Net Income
  • 8. Circular reference Cash Flow Statement Operating Activities Year 1 • In order to calculate ending cash balance Net Income Depreciation/Amortization Change in Working Capital Cash Flow from Operating Activities we will require net income then we will be able to calculate interest income Investment Activities Capital Expenditures Additions to Intangibles Cash Flow from Investing Activities Financing Activities Issuance/ (Repayment) of Long Term Debt Issuance/ (Repurchase of) Equity Cash Flow from Financing Activities Net Change in Cash Beginning Cash Balance Ending Cash Balance Cash balances Average Cash Balance Interest Rate Interest Income Year 1
  • 9. Circular reference How to do this ??? Step 1 - Calculate net income by considering interest income to be 0 Step 2 - Link this net income to the cash flow statement and find out the ending cash balance Step 3 - Link this ending cash balance to the average cash balances and find out the interest income Step 4 – Link this interest income to the income statement
  • 10. Circular reference Wondering whether the new net income figure will get reflected in the cash flow statement Yes through circular reference this entire process will be done automatically and accordingly the other figures in the income statement , balance sheet and cash flow statement would also be changed
  • 11. Circular reference Remember Excel cannot calculate automatically when the model contains a circular reference We need to Turn ON “Iterations” in order to resolve the situation How to turn on Iteration in excel Go to File >>> Options >>>> Formulas >>>>> Enable iterative calculation >>>> OK
  • 13. For more information:Knowledge is like a line with no ends so To know more on this topic click on the link below https://www.educorporatebridge.com/financialmodeling/financial-modeling-technique/
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