Chapter 1 –
Introduction
to Financial
Modeling and
Excel
Learning Outcomes
At the end of the lesson, you should be able to:
• Understand the main ingredients of financial model
• Define financial models
• Understand the types of financial models
• Discuss the advantages and limitations of Excel as a tool for
financial modeling
The main ingredients of a financial model
To Make
Financial
Decision
3 types of financial decision
Investment
Financing
Distribution
or
Dividends
Investment
Purchasing new equipment
Business expansion decision
Financing
Consideration in obtaining finance
Individual
• Interest rates
• Tenor of the loan
• How much you could afford to
contribute
• Amount of monthly repayment
Company
• Cost of finance
• Availability of Finance
• The Risk Inherent in the source
• The desired Debt-to-Equity
Ratio
Distributions or Dividends
Considerations:
• The expectation of shareholders
• The need to retain surplus for future growth
• The desire to maintain a good dividend policy
Understanding Mathematical Models
• The optimum solution is usually measured in monetary terms.
• The uncertainty in the situation leads to assumption making,
hence, mathematical model are used to establish relationships
between the variables
• The models include series of calculation to evaluate the input
information and to clarify and present the various alternatives and
their consequences.
• The model is referred as financial model.
Definition of financial models
• Financial model facilitates the forecasting of future financial
performance by utilizing certain variables to estimate the
outcome of specific financial decision.
• It considers the completed model to be a mathematical
representation of business transactions.
• Excel as primary tool for modeling.
Types of Financial Models
• The 3-Statement Model
• The Discounted Cash Flow Model
• The Comparative Companies Model
• The Merger and Acquisition Model
• The Leveraged Buyout Model
• The Budget Model
• Other Types of Models
The 3-Statement Model
• It includes Balance Sheet, Income Statement and Cash Flow
Statements
Balance
Sheet
Income
Statement
Cash Flow
Statement
The Discounted Cash Flow Model
• Used to consider the value of the company = the sum of all
future cash flow the company can generate
• The cash is adjusted for various obligation  free cash flow.
• Consider time value of money.
• Applies a valuation model to the 3-Statement Model.
The Comparative Companies Model (1)
• Relies on the theory that similar companies will have similar
multiples.
• E.g. comparing the value of company or enterprise value (EV)
• Different level of earnings:
• EBITDA
• EBIT
• PBT
• PAT
The Comparative Companies Model (2)
• Relies on 3 Statement Model  identify 3 – 5 companies with
quoted enterprise value
• Consideration in comparison
• Nature of business
• Size in terms of assets / turnover
• Geographical location
The Comparative Companies Model (3)
• Steps:
1. Calculate the multiples for each the companies (EV/EBITDA, EV/SALES/
P/E Ratio)
2. Calculate mean and median of multiples of comparative companies.
3. Adopt median multiplier for sample and substitute the earnings in following
equation:
EV = Multiple X EBITDA
Depends what
types of earnings
you used (S.16)
The Merger and Acquisition Model
Aim:
• To determine the effect of merger on the acquiring company’s EPS.
• If post-merger EPS increase, the merger is accretive.
Steps:
1. Valuation models are built for the individual companies separately.
2. A model is built for the combined post-merger entity.
3. The earnings per share for all companies are calculated.
The Leveraged Buyout Model
• In LBO, company A acquire company B for a combination of equity
and debt. Debt portion tends to be significant. Company A then
runs company B, servicing the debt, and sells company B after 3 to
5 years.
• LBO will calculate a value for company B and likely return on the
eventual sale of the company.
E.g. Loan Repayment Schedule
The Budget Model
• Financial plan of cash inflows and outflows of a company.
• Builds scenario of required or standard results for turnover,
purchases, assets, debt and more.
• Compare the actual result with the budget or forecast and make
decision based on the results.
• Budget models are typically monthly or quarterly and focus
heavily on the profit and loss account.
Other Types of Models (1)
• Initial Public Offer Model
A financial model created to support a company’s IPO prepared to
attract investors.
• Sum of the Parts Model
In this method of valuation, the different divisions or segments of a
company are assessed separately. The value of the company is the
aggregate of all the parts.
Other Types of Models (2)
• Consolidation Model
This is created by taking the results of several business units or
divisions and combining them into one model.
• Option Pricing Model
This is a model for mathematically arriving at a theoretical price for
an option.
Advantages and Limitation of Excel as
Financial Modeling Tool
Advantages
Disadvantages
•
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• Large datasets
• Data extractions
• Risk management (Human Error &
Error in Assumptions)
Already on your computer
Familiar Software
No extra cost
Flexibility
Portability
Compatibility
Superior Learning Experience
Understanding Data
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