Financial Statement Modeling
& Spreadsheet Engineering
“Training in spreadsheet modeling improves
both the efficiency and effectiveness with which
analysts use spreadsheets”
Steve Powell, Dartmouth College
Understand the Decision
What is the problem? What questions
must be answered?
 What is the time horizon of the problem?
What happens then?
 What kind of output information is
needed?
 Who will use the information? What level
of detail is necessary?

Modules

Data Inputs
Assumptions
 Decision Variables
 Internal Data and Data Structures

Outputs
 Pro-forma statements
 Other structural relationships
 Documentation

Plan Your Layout
On paper, map out the different sections
of your model and their planned
locations within the workbook
 Consider how

readable the model layout will be for the
user
 easy it will be to modify the assumptions
 easy it will be to extend the model to include
more time periods or new line items.

Layout Strategies

Modules on different worksheets
 Stair-step format in same worksheet
 For each strategy,



Consider how difficult it will be to insert or delete a
row or column
Consider how much linking needs to be done
between different modules
Consider linking a data input to the computation
area or output for later reference
Other Layout Considerations

Gaps between logical areas improve
readability

Isolate blocks of similar formulas for safe
and convenient copying

Use styles, fonts and colors with
consistent meanings

Assumptions –vs- decision inputs

Key outputs
Data Inputs

Internal data that describes the current
state of the system
Firm’s financial statements
 Resources and capacities


External data that describes the firm’s
operating environment


Economic conditions such as interest rate,
costs, stock prices
Assumptions about future relationships
Data Input Guidelines

Isolate constants into their own cells
Do not use constants in formulas unless
number has a mathematical foundation (e.g.
p, 1 in percentage calculations)
 Don’t allow an input value to be entered in
multiple places in the model
 Organize decision variables and model
parameter/assumptions logically into separate
physical areas or color schemes
 Use Data > Data Validation

Modeling Sales Forecasts
•
Simple Method: Assume average or different
growth rate for each period
•
Develop detail forecast by product, business
unit, customer or geographic market and
aggregate forecasts
•
Forecast the unit price and volume
•
Forecast size of market and estimate market
share
•
Forecast costs and apply a margin assumption
to derive revenues
Financial Planning Model
Assumptions
•
Items that are functional relationships of sales
–
Percent of sales
•
•
•
Items that are functional relationships of other
financial statement items
–
•
Operating expenses
Working capital and fixed assets
Interest, depreciation, dividends, marketable
securities, cash flows
Items that involve policy decisions (e.g. longterm debt, equity, capital expenditures)
Generating the Income Statement

Expenses in period t

Related to asset and liability balances at the
end of period t – 1
Interest Expenset based on Debtt-1
 Depreciationt based on Gross Fixed Assetst-1

Or
 Related to Sales in period t

COGSt = COGS/Sales * Salest
11
Balance Sheet Sector

Track financial state of firm through time


Results in period (t – 1) become inputs for period (t)
EXAMPLE:
Debtt = Debtt-1 + Debt Issuedt – Debt Repaidt
which feeds into income statement
Interest Expenset = Debtt-1 * Interest Rate
12
The “Plug”

The balance-sheet item which will “close”
or balance the balance sheet model so
that Total Assets will always equal Total
Liabilities & Equity

Models the assumption of how the firm
finances itself

Examples are cash & marketable
securities, debt, debt & equity
To Reduce Formula Errors

Use relative and absolute cell addressing
where appropriate

Set up common structures in different parts of the
model (e.g. same row labels, order and vertical
positioning)
 Use formulae for a cell which are consistent in their
relationship to adjacent cells

Minimize linking formulas across worksheets
 Split complex formulas into multiple
intermediary formulas
Document the Spreadsheet

Use range names to make individual formulas
more readable and module layouts clearer
 Use comments to document assumptions and
modifications in a formula’s logic as well as
sources of data
 Use textboxes to describe portions of the
model’s logic and assumptions as well as
instructions for use
 Create a worksheet to describe the purpose of
the model and document changes
Testing the Model


Compare a second calculation method to verify accuracy
Ask intuitive questions:



Does it balance under different conditions?
Does it make sense?
Extreme growth





Set growth rate to -50% and 50%
Does it still balance?
Do debt or equity go negative?
What happens to excess cash flow?
What happens when Net Income is negative?
16
Circular References
•
Created when expenses in period t refer to
assets and liabilities in period t
• Iterative process is required to produce a
consistent and correct final set of financial
statements
• To solve, use File> Options> Formulas>
Enable Iterative Calculation
• Not all circularities are convergent. Make sure
to verify accuracy!
Verify Formula Reliability

Use Excel’s Auditing Toolbar

Formulas>Formula Auditing
Use [Ctrl] ` to toggle between formulas
and calculations
 Use Conditional Formatting to flag
undesirable results

Highlight cell to be watched and add rule
 Home>Conditional Formatting
