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 market size and use current market share and competitor analysis to predict revenue • Regression
corporatefinanceinstitute.com Forecasting gross margin and SG&A expenses
Revenue 100%
Cost of goods sold 80% Use historic figures or trends to forecast GrossGross marginmargin 20% future margins SG&A 5%
Operating margin 15%
corporatefinanceinstitute.com Forecasting gross margin and SG&A expenses
Revenue 100%
CostCost ofof goods goods sold sold 80%(80%) Consider factors such as economies of scale Labor + materials + and learning effects Inflation %
Gross margin 20%
Complex Simple Models • Based on inputs • Based on a margin Models • Per unit • Easy to model corporatefinanceinstitute.com Forecasting gross margin and SG&A expenses
Revenue 100%
Cost of goods sold 80% Forecasted as a percentage of revenue Gross margin 20% or as a fixed cost (plus an inflator) IndirectSG&A 5%(5%) or $xx
Operating margins 15% Often includes marketing, sales, general and administrative expenses
corporatefinanceinstitute.com Forecast Working Capital and PP&E
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 • Accounts receivable • Cash Flow Inventories Statement • Accounts payable
Supporting Schedules
corporatefinanceinstitute.com Forecasting financial statements
Having forecast the revenues and costs of an operation, the next step is to consider the working capital required to generate them.
Assets Liabilities & Shareholders’ Equity Current assets Current liabilities Cash Accounts payable payable Accounts receivable receivable Other current current liabilities liabilities Inventory Long term liabilities
Non-current assets Shareholders’ equity Operating (non-current) assets Common shares Retained earnings
corporatefinanceinstitute.com Forecasting working capital
Detailed approach “Quick and simple” approach
• Account/client detail • Historical trends •Inventory management • A % of sales based on trends detail
High complexity Low complexity Moderate approach
• Receivable days • Inventory days • Payable days
corporatefinanceinstitute.com Working capital equations
Receivable days
Payable days
Inventory days
corporatefinanceinstitute.com Working capital equations
Receivable days Accounts Accounts receivable = X 365 receivable days Sales Payable days
Forecast accounts Receivable days = X Sales receivable 365 Inventory days
corporatefinanceinstitute.com Working capital equations
Receivable days Accounts payable Accounts payable = X 365 days Cost of sales Payable days
Forecast accounts Payable days = X Cost of sales payable 365 Inventory days
corporatefinanceinstitute.com Working capital equations
Receivable days Inventory Inventory days = X 365 Cost of sales Payable days
Forecast Inventory days = X Cost of sales inventory 365 Inventory days
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 non-current capital assets Cash Flow • PP&E Statement • Capex • Depreciation Supporting • Intangibles Schedules
corporatefinanceinstitute.com Forecasting financial statements
Assets Liabilities & Shareholders’ Equity Current assets Current liabilities Cash Accounts payable Accounts receivable Other current liabilities Inventory Long term liabilities
Non-current assets Shareholders’ equity OperatingOperating (non (non-current)-current) assets Common shares assets / PP&E Retained earnings
corporatefinanceinstitute.com Forecasting property, plant and equipment (PP&E)
First principles approach • Forecast property, plant, and equipment requirement directly (e.g. store expansion) • Forecast depreciation/amortization based on stated depreciation/amortization policies. If deprecation policies are not available, divide gross assets by the depreciation expense to get average asset life.
“Quick and simple” approach • Forecast depreciation & amortization as a percentage of opening PP&E balance or percentage of revenue • Forecast PP&E balance based on a capital asset turnover ratio
High complexity Low complexity
corporatefinanceinstitute.com Forecasting property, plant and equipment (PP&E)
Capital Asset Turnover Ratio
Sales / PP&E (end of period)
or
Sales / PP&E (average)
corporatefinanceinstitute.com Forecast Capital Structure
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 Forecasting financial statements
The financing structure affects both the balance sheet and the income statement (i.e. interest)
Assets Liabilities & Shareholders’ Equity Current assets Current liabilities CashCash Accounts payable Accounts receivable Income taxes payable
Inventory Non-current liabilities Long termterm debt debt
Non-current assets Shareholders’ equity Operating (non-current) assets Common shares shares Retained earnings earnings
corporatefinanceinstitute.com Forecasting financial statements
Cash
Other Current Liabilities
Long term Liabilities Common Shares Retained Earnings
corporatefinanceinstitute.com Approaches to modeling capital structure (debt/equity)
Do we want to model the status quo, or do we ? want to model a different capital structure?
Debt & Equity $ Values Debt/Equity x Ratio Held Debt/Equity Change Over Held Constant Constant Time Based on Cash Flow
corporatefinanceinstitute.com Forecasting the capital structure
What should be the split between equity and debt financing?
Leverage ratios Coverage ratios
Interest Debt Equity EBIT Expense
• Financial covenants dictate maximum leverage and minimum coverage • Consider management’s willingness to take on debt • Use the company’s current access to the debt and equity capital markets
corporatefinanceinstitute.com Compounding vs non compounding interest ?Is the debt (and interest expense) compounding or not?
IF YES IF NO
There will be a circular There will not be a circular reference in the model reference in the model
corporatefinanceinstitute.com Circular references
Opening Debt Balance
+/- Additions/Repayments
+ Interest
= Closing Debt Balance
corporatefinanceinstitute.com Complete Cash Flow Statement
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
Forecasting financial statements
A cash flow forecast can be derived from the balance sheet and income statement
Operating activities (e.g. revenues, operating expenses)
Net Cash Movement Investing activities (e.g. sale/purchase of assets)
Financing activities (e.g. issuing shares, raising debt)
corporatefinanceinstitute.com Cash flows from operating activities
Net income 100 Depreciation 20 From income statement Other non-cash items - Trade and other receivables (10) Inventory (20) From balance sheet Trade and other payables 45 Changes in operating assets and liabilities 15
Cash from operating activities 135
corporatefinanceinstitute.com Cash flows from investing activities
From specific fixed asset forecasts
Capital expenditures (additions to PP&E) (120) CAPEX Proceeds from disposals of fixed assets 10 Payments for investment in businesses 0 Proceeds from disposals of businesses 0
Cash from investing activities (110)
corporatefinanceinstitute.com Cash flows from financing activities
From balance sheet and supporting schedules Issuance of common stock 100
Dividends paid in the year (5)
Increase/(decrease) in long-term debt 15
Increase/(decrease) in short-term debt (10)
Cash from financing activities 100
corporatefinanceinstitute.com Review and Audit
corporatefinanceinstitute.com Auditing techniques
Sanity Checks Trace (Assumptions GoTo Special Precedents and and Drivers) Dependents
Error Messages View Formulas Excel Settings and Alerts
corporatefinanceinstitute.com Summary
corporatefinanceinstitute.com Final thoughts
“ A financial model is a tool that
relies on a set of assumptions
corporatefinanceinstitute.com A modular approach to building models
Assumptions and Drivers
Income Statement
Balance Sheet
Cash Flow Statement
Supporting Schedules
Discounted Cash Flow (DCF) Analysis
Sensitivity Analysis
LBO or M&A corporatefinanceinstitute.com DCF models, sensitivity, M&A, LBO, and more
Three Statement Model
DCF Analysis Business Valuation Modeling Course Scenario Analysis Scenario & Sensitivity Analysis in Excel Course Sensitivity Analysis Advanced Financial Modeling (AMZN Case Study) Course M&A Analysis Mergers & Acquisitions (M&A) Modeling Course Capital Raising
Leveraged Buyout LBO LBO Analysis Modeling Course
corporatefinanceinstitute.com Additional Case Study
corporatefinanceinstitute.com Overview
Practice your skills Solution and demonstration
• A “real” example of something • Highlight the main steps to you’d be asked to do at work building the three statement model • Take raw data (PDF) and blank Excel model provided • Step-by-step demonstration
• Build the three financial • Add commentary about statements from scratch, why things are modeled as including the historical they are results and a 5-yr forecast
corporatefinanceinstitute.com Steps for building the three statement model
1. Copy and paste raw 2. Format and link 3. Calculate historical data into the blank historical subtotals ratios model
4. Make assumptions 5. Start the income 6. Start the balance based on the guidance statement sheet provided
8. Build the cash flow 7. Build supporting statement and 9. Create charts, schedules complete the I/S and graphs, and outputs B/S
corporatefinanceinstitute.com Practice your skills
• You can find these links on the attachment tab
1. Download the Case Study – Financial Statements & Future Prospects for raw data and assumptions
2. Open the Case Study – Three Statement Model – Blank and build a three statement model
corporatefinanceinstitute.com Case study wrap up
corporatefinanceinstitute.com Business valuation modeling course
Business Valuation Modeling
DCF Analysis
corporatefinanceinstitute.com Conclusion
Key messages from this session:
Understand the key Make sure the three structure for building a 01. 04. statements are properly linked financial model in Excel
02. Follow modeling best practices 05. Practice your skills
Build a model step by step 03. as outlined in this course
corporatefinanceinstitute.com FMVA® Certification
corporatefinanceinstitute.com