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Financial Modeling Fundamentals
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Contents
Edition 2022
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Financial Modeling - Fundamentals part 11
Financial Modeling - Fundamentals part 225
Copyright Adkins Matchett & Toy Limited
(“AMT”) 2008–2022. All rights reserved
AMT owns legally and beneficially all of the
Intellectual Property Rights in the content of
this document.
No reproduction, copy or transmission
whatsoever of any part of the document may
be made without prior written permission.
Please be advised AMT will vigorously
prosecute any unauthorised use.
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Disclaimer
Whilst every effort has been made to ensure accuracy regarding the
content of these slides/notes, Adkins Matchett & Toy cannot be held
responsible in any way for consequences arising from the information
given.
No decision should be taken on the basis of information included in the
slides/notes without reference to specialist advice.
© AMT Training 2008–2022

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© AMT Training 2008–2022
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Financial Modeling - Fundamentals part 1
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Financial Modeling Fundamentals part 1
© AMT Training 2008–2022
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Financial Modeling - Fundamentals part 1
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© AMT Training 2008–2022
Financial Modeling - Fundamentals part 1
Contents
Best practice settings and shortcuts
Model design
Building an integrated three-statement model
Checking the model
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Financial Modelling: Fundamentals 1
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Financial Modeling - Fundamentals part 1
Time-saving techniques
Focus areas
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Settings and shortcuts
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Key Excel settings
Model navigation
Data selection
Data manipulation
Key formulae for financial modeling
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© AMT Training 2008–2022
Financial Modeling - Fundamentals part 1
Excel settings for financial modeling
Key settings for financial modeling
• The default Excel settings are not
optimized for financial modeling
• Adjust your settings to maximize
efficiency
• File, Options
Category
Setting
Formulas
Enable iterative calculation: Deselect *
Formulas
Enable background error checking: Deselect
Advanced
After pressing enter, move selection: Optional
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Excel options and settings
Advanced
Enable AutoComplete for cell values: Deselect
Advanced
Advanced
Extend data range formats and formulae: Deselect
Enable automatic percent entry: Select
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– ALT, F, T
Allow editing directly in cell: Deselect
* Recommended when modelling without circular formulae
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Model navigation
Tips and shortcuts
Alt
Arrow
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• Set up one (or more) narrow navigation column(s) as a default
• Build a navigation pathway to the most-utilised sections
Invokes keyboard shortcuts
Move by one cell
Ctrl + Arrow
Move by blocks of cells
PgUp or PgDn
Move one screen up or down
Ctrl + PgUp or Ctrl + PgDn
Move to prior or next worksheet
Alt + PgUp or Alt + PgDn
Move one screen left or right
Home
Move to left most cell in row
Ctrl + Home or Ctrl + End
Move to upper left or lower right
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Financial Modeling - Fundamentals part 1
Data selection
Shift can be added to the navigation shortcuts to enable rapid selection
Extend selection by one cell
Ctrl + Shift + Arrow
Selection by blocks of cells
Ctrl + Space
Select column
Shift + Space
Select row
Ctrl + A
Select region around active cell. Press twice to select whole sheet.
Alt + 
Show dropdown list options
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Shift + Arrow
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Data manipulation
Tips and shortcuts
Ctrl + C
Ctrl + X
Ctrl + V
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• To move data: Copy/paste or Cut
• Use AutoSum whenever possible
Copy
Cut
Paste
Ctrl + Alt + V
Paste special
Ctrl + R or D
Autofill (Fill right or down)
Ctrl + Z or Y
Undo or redo last action
Alt + =
AutoSum
Ctrl + ‘
Copy formula above
Ctrl + "
Copy value above
Ctrl + Enter
Fill selection
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Financial Modeling - Fundamentals part 1
Formulae for financial modeling
Forecasting
Growth formula
Current year = previous year * (1 + growth %)
Profit
Profit = sales * profit margin %
Relationship – Example 1
COGS = sales * (COGS as % of sales)
Relationship – Example 2
Inventories = COGS * (inventories as % of COGS)
$ Increase – Example 1
Current year = previous year + $ increase
Current year = previous year + $ change
Current year = previous year - $ reduction
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$ Increase – Example 2
$ Increase – Example 3
Note: COGS = Cost of Goods Sold
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Formulae for financial modeling
Ratios
Growth % = (current / previous) – 1
Profit margin
Profit margin % = (Profit / sales) * 100%
Relationship – Example 1
COGS as % of sales = (COGS / sales) * 100%
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Growth rate
Relationship – Example 2
Inventories as % of COGS = (Inventories / COGS) * 100%
$ Increase – Example 1
$ Increase = Current year – previous year
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Financial Modeling - Fundamentals part 1
Model design
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Focus areas
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Practical construction options
Design-led modeling
Model structure
Formula auditing and checking
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Financial Modeling - Fundamentals part 1
Design-led modeling
Key design choices
–
–
–
–
Reflects the underlying business
Structure: tower or matrix?
Sign convention
Level of aggregation
Length of forecast
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Characteristics of a well designed
model
Easy to change
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Easy to understand
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Design - Tower vs matrix
Matrix
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Tower
IS
IS
BS
BS
CFS
CFS
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Financial Modeling - Fundamentals part 1
Design - Tower vs matrix
When to use which structure
Tower
Matrix
•
•
•
•
•
•
•
•
•
– Small models
– Divisional models
– Merger models
More time-consuming
Easier to navigate
Easier to customize sections
Easier to print
Uses:
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Easy and quick to build
No cross-sheet links
Easier to see and check links
Uses:
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– Most models
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Design – Matrix integrity
Advantages
• Ensure columns match across
worksheets in your workbook
• Easier to build
• Easier to examine
• Easier to spot errors
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Consistent columns
– Same time periods
• Ensure columns match within each
worksheet
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3rd Year
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Financial Modeling - Fundamentals part 1
Design – Sign convention
Make a clear decision on how to present positive/negative values
Positive presentation
Positive / negative presentation
12,500.0
12,690.0
Sales
12,500.0
12,690.0
COGS
7,652.0
8,360.0
COGS
(7,652.0)
(8,360.0)
Gross profit
4,848.0
4,330.0
Gross profit
4,848.0
4,330.0
Beginning balance
250.0
252.0
Beginning balance
250.0
252.0
Capital expenditure
25.0
27.0
Capital expenditure
25.0
27.0
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Sales
23.0
25.0
Depreciation
(23.0)
(25.0)
Ending balance
252.0
254.0
Ending balance
252.0
254.0
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Depreciation
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Design – Financial statements layout
Examples of alternative income statement layouts
2,500.0
Sales
2,500.0
Sales
2,500.0
COGS
(1,750.0)
COGS
(1,750.0)
COGS
(1,750.0)
750.0
SG&A
(365.0)
Depreciation
(25.0)
EBITDA
410.0
Gross profit
750.0
Depreciation
(25.0)
SG&A
(365.0)
Amortization
(10.0)
Amortization
(10.0)
EBIT
375.0
EBIT
375.0
Non-recurring items
(12.3)
Depreciation
25.0
Interest income
10.0
Amortization
10.0
(12.3)
Interest expense
(36.0)
EBITDA
410.0
Interest income
10.0
Profit before tax
336.7
Interest expense
(36.0)
Non-recurring items
(12.3)
Profit before tax
336.7
Tax expense
(117.8)
Interest income
10.0
Net income
218.9
Interest expense
(36.0)
Profit before tax
336.7
Tax expense
(117.8)
Net income
218.9
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Sales
Gross profit
SG&A
(375.0)
EBIT
375.0
Depreciation
25.0
Amortization
10.0
EBITDA
410.0
Non-recurring items
Tax expense
(117.8)
Net income
218.9
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Financial Modeling - Fundamentals part 1
Design – Assumptions layout
Decide how to arrange your assumptions
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Two examples of ‘threaded’ assumptions
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Formula building - Assumptions
Structuring formulae efficiently
Key shortcuts
• Place your key assumption at the
beginning of a formula
• Facilitates quick selection, editing &
checking
CTRL + [
Select precedent cell(s)
F5 + Enter
Return to original cell
F2
Edit cell, but also traces ‘on-sheet’
dependent cells
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Best practice
Examples
Sales
= (1 + Assumptions!D6) * D5
COGS
= Assumptions!D7 * IS!D6
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Financial Modeling - Fundamentals part 1
Formula auditing and checking
Shortcuts to audit formulae
Critical checks
F2
Toggle edit / enter mode
Ctrl + [
Ctrl + ]
Select direct precedent(s)
Select direct dependent(s)
Ctrl + {
Ctrl + }
Select all precedents
Select all dependents
F5 or Ctrl + G
Open Go To window
Shift + F2
Esc twice
Insert comment
Exit comment after editing
F9
Shift + F9
Calculate formulae in workbook
Calculate formulae on active
sheet only
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Sanity check
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Matrix check
Stress test
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Building an integrated three-statement model
Overview
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Financial Modeling - Fundamentals part 1
Components of a 3-statement forecast model
•
•
•
•
Historical data
Historical ratios
Forecast assumptions
Forecast financials
Historical
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– Income statement
– Balance sheet
– Cash flow statement
Forecast
financials
and analysis
Historical
ratios
Forecast
assumptions
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• Ratio analysis
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Model map
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Historical
financial
statements
Forecast
assumptions
Historical
ratio
analysis
Analysis (ratios,
valuation, etc.)
Forecast
financial
statements
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Financial Modeling - Fundamentals part 1
Building an integrated 3-statement forecast model
Steps
1. Income statement
• Leave out interest
2. Balance sheet
3. Cash flow statement
• Use income statement and balance sheet data
4. Balance the balance sheet
5. Integrate interest into the model
• Build debt schedule
• Link up interest to income statement
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• Plug balance sheet using cash flow statement output
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• Leave out cash and revolver (plugs)
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Modeling steps
Detail
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Financial Modeling - Fundamentals part 1
Step 1: Historical data
Input balance sheet and income statement historicals
Cash flow statement historicals usually are not necessary
Calculate totals/subtotals (do no hard-code)
Check that net income matches source data
Include balance sheet check line
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Use the SUM function to calculate
historical subtotals whenever possible:
ALT =
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Step 2: Historical ratios
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• Calculate ratios using the income statement and balance sheet historical
numbers
• Historical ratios are often used as a forecast basis
– Examples:
– If forecasting sales using a growth rate, calculate a historical growth rate ratio
– If forecasting COGS as a % of sales, calculate the COGS / sales historical ratio
• Historical ratios also help identify trends
– Helps to validate forecast assumptions
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Financial Modeling - Fundamentals part 1
Step 3: Formulate forecast assumptions
These forecast assumptions have been set
equal to their historical values
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• Input your forecast assumptions for each balance sheet and income
statement item
• Use historical ratios (step 2) to guide/check your forecast assumptions
• (Forecast assumptions are pre-set in this model)
These forecast assumptions deviate from
historical trends. When this happens, provide
explanations (use cell comments)
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Step 4: Income statement forecast
Place the assumption first when writing a formula
Work vertically – focus on the first forecast year
Use secondary calculations as necessary
Copy subtotals across – do not recalculate them
Copy across section by section (not line by line)
When finished, sanity check thoroughly
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Financial Modeling - Fundamentals part 1
Step 5: Balance sheet forecast
• Place the assumption first when writing a formula
• Leave out the plug accounts (e.g. cash)
• Use SUM formulas for totals
• Use secondary calculations as necessary
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– BASE analysis for PP&E, equity, debt, etc.
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– Do not include blank rows
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Step 6: Cash flow statement forecast
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• Structured in three sections
– Operating
– Investing
– Financing
• Calculate change in every balance sheet item using the rules of cash:
– Assets up = cash down
– L&E up = cash up
and vice versa
• If necessary, split the change in a balance sheet account into separate items.
Examples:
– Change in retained earnings: Net income and dividends
– Change in PP&E: Capex and depreciation
• Include cash reconciliation (at the bottom of the cash flow statement)
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Financial Modeling - Fundamentals part 1
Step 7: balance the balance sheet
Plug accounts
• The forecast balance sheet is made
to balance using one or more
designated accounts
The plug ensures that
the balance sheet
balances
– ‘Plugs’
– The cash account is often used
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Assets
Liabilities
and
equity
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• Link cash from the cash flow
statement
• If it does not balance, stop and
resolve
Plug
Stress testing
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Examples
• Does the model function as
expected?
• Change forecast assumption values
and check how the model responds
• If the model does not respond as
expected, examine the links to
understand why
• If the dividend payout ratio decreases
from 20% to 10% of net income:
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Concept
– Cash balance should rise
– Retained earnings should rise
– Balance sheet should remain in
balance
• If the debt repayments were increased:
– Cash balance should fall
– Debt should fall
– Balance sheet should remain in
balance
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Financial Modeling - Fundamentals part 1
Managing the plug accounts
What if cash were to be negative?
Funding
gap
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Assets
Negative cash represents a funding gap.
This gap is usually resolved in a model by
using a short-term debt line,
such as Revolver.
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Liabilities
and
equity
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Managing the plug accounts
Year
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Separating cash and revolver
1
Helpful functions
2
3
4
5
14
10
7
(3)
(20)
Cash
14
10
7
-
-
Revolver
-
-
-
3
20
• IF(test, action if true, action if false)
On cash flow statement:
Cash (Revolver)
– If cash / revolver > 0
•
•
On balance sheet:
If true: show cash
If false: show 0
• MAX(list of cells)
– MAX shows the largest number
– MAX(cash / revolver,0)
•
•
Cash / revolver > 0: returns cash
Cash / revolver < 0: returns 0
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Financial Modeling - Fundamentals part 1
Step 8: Wiring the interest
Interest calculation options
• Interest on cash / debt can be estimated in different ways:
– Beginning balance of cash / debt
– Ending balance of cash / debt
– Average balance of cash / debt
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• The appropriate method depends on the timing of any cash / debt
movements during the period
• Using the ending or average basis can result in circular formulae
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Interest based on beginning balances
Calculation
• A company has a loan outstanding
of 1,000 at the beginning of the
year
• Interest on the loan is 10%
• A loan repayment of 600 is due to
be paid on the last day of the year
• An amount of 1,000 is outstanding
for the whole year
• Therefore, the interest can be
calculated using the beginning
balance
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Example
Beginning balance
Ending balance
1,000)
1,000)
(600)
)
400)
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Financial Modeling - Fundamentals part 1
Interest based on ending balances
Calculation
• A company has a loan outstanding
of 1,000 at the beginning of the
year
• Interest on the loan is 10%
• A loan repayment of 600 is due to
be paid on the first day of the year
• An amount of 400 is outstanding for
the whole year
• Therefore, the interest can be
calculated using the ending balance
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Example
Ending balance
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Beginning balance
1,000)
(600)
400)
400)
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Interest based on average balances
Calculation
• A company has a loan outstanding
of 1,000 at the beginning of the
year
• Interest on the loan is 10%
• A loan repayment of 600 is due to
be paid, but the timing of the
repayment is uncertain
• Standard practice is to assume that
the repayment occurs
half-way through the year
• Therefore, interest is calculated
using the average balance during
the year
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Example
Beginning balance
Ending balance
1,000)
400)
Average balance
= 700
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Financial Modeling - Fundamentals part 1
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Checking the model
Modeling checklist
Troubleshooting
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Good construction
• Construct model with
iterations off
• Ensure model has
matrix integrity
• Build one section at a
time
• Link assumptions first
• Totals should be
formulas
• Never hard-code in
formulas
• Sanity check
• Stress test
• Matrix check
User friendly
• Leave audit trail
• Insert comments
• Beauty save
• Include a cover sheet
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Financial Modeling - Fundamentals part 1
London | New York | Hong Kong
Please visit us on: www.amttraining.com
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Please note:
All materials are the intellectual property of AMT Training.
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Financial Modeling - Fundamentals part 2
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Financial Modeling Fundamentals part 2
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Financial Modeling - Fundamentals part 2
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Financial Modeling - Fundamentals part 2
Contents
Review of 3-statement model structure
Operating cash vs excess cash
Building a cash flow statement from scratch
Building a debt schedule
Interest calculations
Working with circular formulae
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Financial Modelling: Fundamentals 2
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Financial Modeling - Fundamentals part 2
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Model map
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Review of 3-statement model structure
Historical
financial
statements
Forecast
assumptions
Historical
ratio
analysis
Analysis (ratios,
valuation, etc.)
Forecast
financial
statements
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Financial Modeling - Fundamentals part 2
Building an integrated 3-statement forecast model
Steps
1. Income statement
• Leave out interest
2. Balance sheet
3. Cash flow statement
• Use income statement and balance sheet data
4. Balance the balance sheet
5. Integrate interest into the model
• Build debt schedule
• Link up interest to income statement
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• Plug balance sheet using cash flow statement output
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• Leave out cash and revolver (plugs)
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Design-led modeling
Key design choices
AM
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Characteristics of a well designed
model
•
•
•
•
Reflects the underlying business
Structure: tower or matrix?
Sign convention
Level of aggregation
Length of forecast
Easy to understand
Easy to change
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Financial Modeling - Fundamentals part 2
Operating cash
Operating cash
The minimum cash level needed to operate a business on a day-to-day basis
Rarely disclosed in the financial statements
Often estimated as % of sales
Can be treated as a component of Operating Working Capital
Total cash = Excess cash + Operating cash
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•
•
•
•
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Operating vs excess cash
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Financial Modeling - Fundamentals part 2
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Deriving a cash flow statement
Building a cash flow statement
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Steps
Categorize
the change
in each BS
account
Cash flow categories
• Operating
• Investing
• Financing
Use BASE
analysis if
needed
Examples
• PPE
• Retained earnings
Apply rules
of cash
Build CFS
structure
• Asset  Cash 
• Asset  Cash 
• L&E  Cash 
• L&E  Cash 
• CFO
• CFI
• CFF
• Cash reconciliation
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Financial Modeling - Fundamentals part 2
Rules of cash
• Assets: uses of funds
• Inverse relationship with cash flow
• Calculate BS delta as follows:
Remember these 4 rules
Asset Down
Cash Up
L&E Up
Cash Up
L&E Down
Cash Down
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• Liabilities and equity: sources of cash
• Direct relationship with cash flow
• Calculate BS delta as follows:
Cash Down
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– = Last year – This year
or
– = (This year – Last year) * -1
Asset Up
– = This year – Last year
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Building the cash flow statement from scratch
Example
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Start by capturing the change in equity by linking the related items
(net income, dividends, etc.) from the Calcs sheet
Remember the 4 rules
Asset Up
Cash Down
Asset Down
Cash Up
L&E Up
Cash Up
L&E Down
Cash Down
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Financial Modeling - Fundamentals part 2
Building the cash flow statement from scratch
Example (cont.)
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Continue capturing the change in each balance sheet item.
For example, the change in PP&E is composed of capital expenditure and
depreciation (linked from the Calcs sheet)
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Remember the 4 rules
Asset Up
Cash Down
Asset Down
Cash Up
L&E Up
Cash Up
L&E Down
Cash Down
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Building the cash flow statement from scratch
Example (cont.)
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Link amortization from the income statement or assumptions sheet
Remember the 4 rules
Asset Up
Cash Down
Asset Down
Cash Up
L&E Up
Cash Up
L&E Down
Cash Down
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Financial Modeling - Fundamentals part 2
Building the cash flow statement from scratch
Example (cont.)
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• Change in operating working capital accounts
• Issuance/repayment of long-term debt
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Remember the 4 rules
Asset Up
Cash Down
Asset Down
Cash Up
L&E Up
Cash Up
L&E Down
Cash Down
Consider grouping the
OWC accounts into one line
item
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Building the cash flow statement from scratch
Example (cont.)
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Add subtotals and calculate net cash flow
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Financial Modeling - Fundamentals part 2
Building the cash flow statement from scratch
Example (cont.)
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• Derive the balance sheet plugs (cash and revolver)
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Link from the historical balance sheet.
Net cash against the revolver balance
• Link the projected ending balances back to the balance sheet
– Use MAX/MIN or IF
• Check that the balance sheet balances
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Debt and interest
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The debt schedule
Importance
Components
• Company’s capital structure
• Most financial models require a
detailed debt schedule
Short-term debt issuance / repayment
Long-term debt issuance / repayment
Summary of debt and interest expense
Summary of cash and interest income
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• Number of unique debt items
depends on company’s capital
structure
• Key outputs: total debt and
net debt
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– Can be very large
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Interest calculation options
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• Interest on cash / debt can be estimated in different ways:
– Beginning balance of cash / debt
– Ending balance of cash / debt
– Average balance of cash / debt
• The appropriate method depends on the timing of any cash / debt
movements during the period
• Using the ending or average basis can result in circular formulae
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Financial Modeling - Fundamentals part 2
Using the AVERAGE function
Watch out for blank cells
Correct:
= AVERAGE(C14:D14) * D15
= AVERAGE(C14,D14) * D15
• Blank cells have NULL value (not
even zero!)
• An average of 0 and 10 =
5
• An average of a blank cell and 10 =
10
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Error:
= AVERAGE(C14 + D14) * D15
= AVERAGE(C14) + D14 * D15
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Errors to avoid
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Circular references
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Financial Modeling - Fundamentals part 2
Circular references
What is a circular formula?
Circular reference warnings
• A formula becomes circular when it
uses itself as an input
• The formula below in A3 is adding
itself into the total, which causes a
circularity
• If iterations are off:
– A warning message appears
– Circular formulae are not calculated
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• If iterations are on:
– No warning message
– Circular formulae are calculated
(using an automatic iterative process)
1
1
2
2
3 =SUM(A1:A3)
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• Status bar messages:
A
– On this sheet:
– In an open workbook:
– If iterations are on:
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When does interest create a circular reference?
No circular loop – example
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Interest based on beginning balance
If interest is calculated on the
beginning balance then no circular
formula is created
Revolver
beginning
balance
Interest
expense
Net income
CFO
Net cash
flow
Revolver
ending
balance
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When does interest create a circular reference?
Interest based on ending balance
Potential circular loop – example
• If interest is calculated on the
ending balance then a circular
formula is created whenever the net
cash flow drives the ending balance
• This is an issue for residual items
(plugs) such as revolver and cash
Revolver
ending
balance
Interest
expense
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Net cash
flow
Net
income
CFO
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When does interest create a circular reference?
Potential circular loop – example
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Interest based on average balance
• If interest is calculated on the
average balance then a circular
reference is created whenever the
net cash flow drives the ending
balance
Revolver
average
balance
– Exactly the same as when using the
ending balance (previous page)
• This is an issue for residual items
(plugs) such as revolver and cash
Revolver
ending
balance
Interest
expense
Net cash
flow
Net
income
CFO
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Financial Modeling - Fundamentals part 2
Iterative process
• Iteration settings (File, Excel options, Formulas)
• When the iteration switch is turned on, Excel uses an iterative process to
calculate the result of a circular formula
• Iteration recalculates the formula multiple times
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– Each time starting from the answer obtained in the previous recalculation
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• An elegant solution to circular models
Iterations
Example
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•
•
•
•
Calculation
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Assumptions
Loan amount of 100
10% interest rate
Interest must be paid in advance
But no money to pay interest, so it
must be borrowed
• What is the total debt borrowed?
Principal
+
Interest
=
Total debt
100.00
+
?
=
?
100.00
+
10.00
=
110.00
+
1.00
=
111.00
+
0.10
=
111.10
+
0.01
=
111.11
– Principal + Interest
– But interest creates further interest
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Iterations
Advantages
Disadvantages
Convenient solution whenever circular
formulae are needed
• User may not be aware that circular
formulae exist
• Hides accidental circular references
• Potentially destabilizes model
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– Circular formulae are calculated
automatically
– ‘Low maintenance’ solution
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Types of circular formulae
Intentional
• Circular formulae written in error
• Should never be allowed in a model
as they are likely to destabilize it
• Ensure you audit all circularities in
your model
• Circular formulae that have been
deliberately built by the user
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Unintentional
– Often caused by interest
calculations
• Keep to a minimum
– Only use them if absolutely
necessary
– If possible, replace them with
non-circular formulae
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Financial Modeling - Fundamentals part 2
Circularity switch
Concept
Diagram
• A mechanism allowing circular
formulae to be disconnected
• Uses an IF function
• Allows working with a
circularity-free model
• Helps to clean errors out of the
model
Revolver
average
balance
Revolver
ending
balance
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Interest
expense
Switch
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Net cash
flow
Net
income
CFO
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Circularity switch
Danger! Editing a model with the circular switch on and
iterations active can result in unintentional circularities!
Financial model analysis
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Model construction
Switch
Enable
iterative
calculations
Enable
iterative
calculations
Circular switch
Off
Off
On
On
Set to
0
No tick
Tick
Set to
1
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Financial Modeling - Fundamentals part 2
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Financial Modeling - Fundamentals part 2
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Financial Modeling - Fundamentals part 2
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Financial Modeling - Fundamentals part 2
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