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Building a 3 Statement Financial Model in Excel

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Building a 3 Statement Financial Model in Excel Building a 3 Statement Financial Model in Excel corporatefinanceinstitute.com corporatefinanceinstitute.com What is a financial model? “ A financial model is a tool used to forecast a business’ financial performance into the future based on historical data and assumptions corporatefinanceinstitute.com Why do we build financial models? For anyone pursuing a career in corporate development, investment banking, FP&A, equity research, commercial banking, or other areas of corporate finance, building financial models is part of the daily routine. Corporate Investment Corporate Project Finance Transactions Decisions Decisions Whether to invest in a Company performance, Mergers & Valuation, equity project strategic planning acquisitions, capital research, portfolio raising management corporatefinanceinstitute.com Types of financial models Three Statement Model Option Pricing DCF Model Model Merger Forecasting Model Model (M&A) Financial Models Initial Budget Public Model Offering (IPO) Model Leveraged Consolidation Buyout Model (LBO) Sum of the Model Parts Model corporatefinanceinstitute.com Hierarchy of financial modeling Income statement, balance sheet, cash Three Statement Model flow statement Discounted cash flow analysis to value a DCF Analysis business Estimate changes in the value of a Scenario Analysis business in different possible scenarios Evaluate how sensitive an investment is Sensitivity Analysis to changes in drivers Evaluate the attractiveness of potential M&A Analysis merger, acquisition or divestiture Analyze the pro forma impact of raising Capital Raising debt or equity Determine how much leverage can be LBO Analysis used to purchase a company corporatefinanceinstitute.com Financial Modeling Best Practices corporatefinanceinstitute.com Key structure for model building Good models clearly separate inputs, processing, and outputs. Inputs Processing Outputs • Clearly identified • Processing should • Quickly accessible • Should only ever be transparent be entered once • Broken down into simple steps • Easy to follow corporatefinanceinstitute.com Modeling best practices • What problem is the model meant to solve? • Who is the end user? 1. Clarify • What are users supposed to do with the model? corporatefinanceinstitute.com Modeling best practices 1. Clarify • What is the minimum 2. Simplify number of inputs and outputs to build a useful model? corporatefinanceinstitute.com Modeling best practices 1. Clarify 2. Simplify • Plan how inputs and outputs will be laid out 3. Plan • Keep all inputs in corporatefinanceinstitute.com one place Modeling best practices 1. Clarify 2. Simplify • Consider using Excel tools such as: “Data validation” and “Conditional formatting” 4. Integrity 3. Plan corporatefinanceinstitute.com Modeling best practices 1. Clarify • Use test data to ensure the model works as expected 5. Model Testing 2. Simplify 4. Integrity 3. Plan corporatefinanceinstitute.com Modeling best practices 1. Clarify 5. Model Testing 2. Simplify 4. Integrity 3. Plan corporatefinanceinstitute.com Tension: complex vs. simple models Complex Simple Models Models • High detail Best • Basic • Precise • Easy to follow • Hard to model Models • Lack of precision • Prone to error • Overly simplified Keep things as simple as possible while providing enough detail for decision making corporatefinanceinstitute.com Model inputs Inputs Processing Outputs corporatefinanceinstitute.com Model inputs Inputs Objectives Achieving objectives • Accurate • Enter each data once • Reasonable data ranges • Use color to differentiate inputs and outputs • Easy to use • Use data validation & • Easy to understand conditional formatting • Easy to update data • Use comments corporatefinanceinstitute.com Model processing Inputs Processing Outputs Do you try to put all your processing calculations into as few cells as possible? Do you hide your processing cells or worksheets? corporatefinanceinstitute.com Model processing Objectives Achieving objectives Processing • Easy to maintain • Break down complex calculations • Accurate processing • Use comments and annotations • Transparency • Use formatting • Calculate final figures which will go onto the output reports corporatefinanceinstitute.com Model outputs Inputs Processing Outputs corporatefinanceinstitute.com Model outputs Objectives Achieving objectives Outputs • Provide key results to • Make outputs modular aid decision-making • Consider creating a summary • Easy to understand section with only the most important key model outputs • Unambiguous corporatefinanceinstitute.com Model structure and layout Multi-spreadsheet Single spreadsheet corporatefinanceinstitute.com Financial forecasting framework Assumptions & drivers Historical ratios and figures which drive the forecast Income statement Summarizes the company’s profit and loss Displays the company’s assets, liabilities and Balance sheet shareholders’ equity Cash flow statement Reports the cash generated and spent by a company Breaks down longer calculations such as PP&E and debt Supporting schedules schedule corporatefinanceinstitute.com Financial forecasting approach Historical Forecast Assumptions & drivers B C Income statement A D Balance sheet A D Cash flow statement A D Supporting schedules A D corporatefinanceinstitute.com Financial modeling steps Assumptions and Drivers Income Statement Balance Sheet Cash Flow Statement Supporting Schedules corporatefinanceinstitute.com Financial modeling steps Assumptions 1 Historical data and Drivers Income Statement Balance Sheet Cash Flow Statement Supporting Schedules corporatefinanceinstitute.com Financial modeling steps Assumptions 1 Historical data and Drivers 2 Assumptions and drivers Income Statement Balance Sheet Cash Flow Statement Supporting Schedules corporatefinanceinstitute.com Financial modeling steps Assumptions 1 Historical data and Drivers 2 Assumptions and drivers Income Statement 3 Forecast revenues down to EBITDA Balance Sheet Cash Flow Statement Supporting Schedules corporatefinanceinstitute.com Financial modeling steps Assumptions 1 Historical data and Drivers 2 Assumptions and drivers Income Statement 3 Forecast revenues down to EBITDA 4 Forecast working capital Balance Sheet Cash Flow Statement Supporting Schedules corporatefinanceinstitute.com Financial modeling steps Assumptions 1 Historical data and Drivers 2 Assumptions and drivers Income Statement 3 Forecast revenues down to EBITDA 4 Forecast working capital Balance Sheet 5 Forecast capital assets (PP&E, capex, depreciation, etc.) Cash Flow Statement Supporting Schedules corporatefinanceinstitute.com Financial modeling steps Assumptions 1 Historical data and Drivers 2 Assumptions and drivers Income Statement 3 Forecast revenues down to EBITDA 4 Forecast working capital Balance Sheet 5 Forecast capital assets (PP&E, capex, depreciation, etc.) Cash Flow Statement 6 Forecast capital structure Supporting Schedules corporatefinanceinstitute.com Financial modeling steps Assumptions 1 Historical data and Drivers 2 Assumptions and drivers Income Statement 3 Forecast revenues down to EBITDA 4 Forecast working capital Balance Sheet 5 Forecast capital assets (PP&E, capex, depreciation, etc.) Cash Flow Statement 6 Forecast capital structure 7 Complete cash flow statement Supporting Schedules corporatefinanceinstitute.com Model Setup and Assumptions corporatefinanceinstitute.com The case Your boss has just emailed you about about something the executive team would like to look at ASAP You need to create a financial forecast for a business, with limited information You only have a set of historical financial statements and some guidance from the company’s management team, as well as a template model from a colleague You must link the historical financial statements and create a well built 5-year forecast as fast as possible corporatefinanceinstitute.com Historical data Assumptions 1 Historical data and Drivers Income Statement Balance Sheet Cash Flow Statement Supporting Schedules corporatefinanceinstitute.com Assumptions, drivers and forecasting methods Assumptions 1 Historical data and Drivers 2 Assumptions and drivers Income Statement Balance Sheet Cash Flow Statement Supporting Schedules corporatefinanceinstitute.com Forecasting methods Top-Down Bottom-Up Regression Year-over-Year Analysis Analysis Analysis Growth Rate • Start with total • Start with most basic • Analyze the • Most basic form of addressable market drivers of the relationship between forecasting (TAM) business (units) revenue and other • Calculate the year- factors using the • • over-year change in Work down from Build up the analysis regression analysis in revenue there based on all the way to Excel market share and revenue segments until arriving at revenue corporatefinanceinstitute.com Forecast Revenues Down To EBITDA corporatefinanceinstitute.com Financial modeling steps Assumptions 1 Historical data and Drivers 2 Assumptions and drivers Income Statement 3 Forecast revenues down to EBITDA Balance Sheet Cash Flow Statement Supporting Schedules corporatefinanceinstitute.com Forecasting operating revenues and profits Income statement • Revenues EBITDA • Direct operating cost • Indirect operating cost Net income • Depreciation and amortization • Cost of debt • Taxes corporatefinanceinstitute.com Forecasting revenues Complex Simple Models Models First principles Quick and simple • Retail (bottom up) – forecast # of • Use historic figures and trends to stores, size, and derive revenue per sq. predict future growth (e.g. last ft. year plus 5%) • Telco (top down) – Forecast
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