Financial Statement Modeling
MGT 4850
Spring 2008
University of Lethbridge
Topics
• Pro forma Financial Statement
– Firm valuation and its securities
– Credit analyses (how much financing will be
needed)
– What if scenarios
• Mathematical structure
– Simultaneous linear equations predict both
the balance sheets and the income
statements
How Financial Statements Work
• Models are sales driven
– Functional relationships and policy decisions
The “Plug”
• Balance sheet item that “closes” the model
• The firm sells no additional stock, doesnot
raise or retire debt, therefore financing
comes from the cash and marketable
securities
Projecting Next Year Inc. St.
Projecting Next Year Bal. Sh.
Recalculating the statements
• Go to Tools/Options/Calculation click
iteration
Extending the model to more years
• Copy and paste the columns
Free Cash Flows
Reconciling the Cash Balances
• Consolidated statement of cash flows
explains the increase in the cash account
in the balance sheet as a function of the
cash flows from the firm’s operating,
investing and financing activities
Cash and marketable securities
Using the FCF to Value the firm
and its Equity
Enterprise Value of the Firm
• The value of the firm’s debt, convertible
securities and equity or PV of the firm’s
future anticipated cash flows.
• Example: WACC=20%, FCF projection for
5 years plus terminal value.
• Terminal Value – after 5 years the cash
flows will grow at 10%
– FCF5*(1+growth)/(WACC-growth)
Terminal Value
• Terminal Value=Year5 book value of debt
+ Equity (assumes book value correctly
predicts market value)
• Terminal Value=(Enterprise market/book
ratio)*(Year5 book value of debt + Equity)
• Terminal Value=P/E *Year5 profits +Year5
book value of debt
• Terminal Value=EBITDA ratio *Year5
anticipated EBITDA
Cash and Marketable Securities in
the Valuation
• Add in initial (year 0) cash and mkt. securities
(assumptions)
– They are not needed to produce the FCF
– They are “surpluses” that could be drawn down or
paid out to the shareholders without affecting future
performance
• Can be treated as negative debt
Half-Year Discounting
• Cash flows occur smoothly throughout the year
Sensitivity Analysis
• What is the effect of the sales growth rate on
the equity value?
Sensitivity Analysis
• Effect on equity valuation of the sales growth and
the WACC
Debt as a “Plug”
• Increased sales growth, current and fixed assets
requirements, dividend payouts → needs of
more financing (p. 73)
Proforma balance sheet
Cash and marketable securities turning negative
p.73
DEBT test
• Current assets + Net Fixed assets>Current
Liabilities + Last year’s debt + Stock +
accumulated retained earnings – we need to
increase debt to finance the firm’s productive
activities
• Current assets + Net Fixed assets<Current
Liabilities + Last year’s debt + Stock +
accumulated retained earnings – there is no
need to increase debt (cash and marketable
securities are positive)
No Negative Cash p.74
Incorporating a Target Debt/Equity Ratio
Project Finance
• Borrowing money to finance a project may
entail:
– No dividends should be paid out until the debt is paid off
– No new equity issue
– Pay back the debt over a specific period
• A new project set in year 0
• Firm assets -2,200; current liab. =100; debt=1,000
and equity = 1,100
• Debt will be paid in equal installments over 5 years
Debt Repayment Schedule p.77
• Repayment reflected in debt balances
Constant Fixed Assets p.78
Credit Analysis p.79
Return on Equity
• Book Value of the firm at year 5 is:
Profit/NI5+Accumulated Retained Earnings+Stock
• If we decrease the initial equity investment we can
increase the return on equity (leverage effect)
ROE and Initial Equity Investment