Chapter Two
Financial Statement Modelling
Objectives
• Link the 3 core financial statements together
• Understand model building best practices
• Build a financial projection model with historical data and
assumptions
• Review and audit your model for potential errors
What is a financial model?
• A financial model is a tool built in a spreadsheet that’s used to forecast a
business’s financial performance into the future and make business decisions.
•
Types of financial models
Financial Statement Modeling
• Financial statement modeling is a key step in the process of valuing
companies and the securities they have issued.
• Is the starting point for most valuation models
• Valuation estimates can be made based on a variety of metrics, including free cash
flow, EPS, EBITDA, and EBIT.
• Pro-forma financial statements, are the bread and butter for much
corporate financial analysis.
Financial Statement Forecasting Framework
Financial Statement Modeling Steps
Assumptions and Forecast revenues Forecast Working
Historical Data
Drivers down to EBITDA capital
Forecast Capital
Complete Cash Forecast Capital Assets (PP&E,
Flow Statement Structure Capex,
depreciation)
Financial Modeling Steps
Model Set-up and Assumptions
The Case
Historical Data
DATA
Assumptions, Drivers and Forecasting
Methods
Assumptions and Drivers
Forecasting Methods
Forecasting Operating Revenues and Profits
• Construction of pro-forma income statements is composed of four
forecasting steps:
✓revenue,
✓COGS,
✓other operating expenses, and
✓non-operating items.
Forecasting Operating Revenues and Profits
Forecasting Revenues
Forecasting Revenues
• The change in revenue is driven by volume, price, and when appropriate
foreign currency estimates.
✓We usually use historical trends and adjust it for expected deviations from trend.
• Changes in revenue attributable to volume or price/mix are organic growth.
Forecasting Gross Margin and SG&A Expenses
Forecasting Gross Margin and SG&A Expenses
Forecasting Gross Margin and SG&A Expenses
We may have a
separate schedule
that builds the
indirect costs with a
lot of detail, a hybrid
of fixed and
variable; some
components are a
percentage of
revenue, and some
components are
fixed birr costs.
Modelling EBITDA
Modeling EBIT
Modelling Balance Sheet (Working Capital)
Having forecast the
revenues and costs of an
operation, the next step
is to consider the
working capital required
to generate them.
Forecasting Working Capital
Forecasting Working Capital
• Working capital accounts are modeled by projecting working capital
ratios such as:
• days of inventory,
• days sales outstanding,
• days payable outstanding
Forecasting Working Capital
Forecasting Working Capital
Forecasting Working Capital
Forecasting Working Capital
Forecast Balance Sheet (PP&E, Capex,
Depreciation, Amortization)
Forecast non-current capital assets :
• PP&E
• Capex
• Depreciation
• Intangibles
Forecasting Non-Current Assets
Forecasting Non-Current Assets
First principles approach
• Forecast property, plant, and
equipment requirement directly (e.g. “Quick and simple” approach
store expansion) • Forecast depreciation &
• Forecast depreciation/amortization amortization as a percentage of
based on stated opening PP&E balance or percentage
depreciation/amortization policies. If of revenue • Forecast PP&E balance
deprecation policies are not available, based on a capital asset turnover ratio
divide gross assets by the depreciation
expense to get average asset life.
Forecasting Non-Current Assets
Forecast Capital Structure
The financing structure
affects both the balance
sheet and the income
statement (i.e. interest)
Forecast Capital Structure
Forecast Capital Structure
Approaches to modeling capital structure
(debt/equity)
Debt & Equity Debt/Equity X
Values Held Ratio Held
Constant Constant
Debt/Equity
Change Over
time based on
cash flow
Approaches to modeling capital structure
(debt/equity)
Approaches to modeling capital structure
(debt/equity)
Pro Forma Statement of Cash Flows
❖The forecast statements of cash
flows begin with forecasted net
income and other amounts from
the forecast income statement,
and
✓then typically require estimates for
capital expenditures, depreciation
and amortization, working capital,
and dividends.
Statement of Cash Flows Projection Process
Forecasting Cash Flows
Forecasting Cash Flows: Operating
Forecasting Cash Flows: Investing
Forecasting Cash Flows: Financing
Auditing Techniques
Auditing techniques
