Module 13 

  Integrated Financial Modelling → Chapter 1

Introduction to Financial Modelling

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1. 1Introduction to Financial Modelling

2. 2Excel workbook setup

3. 3Historical Data

4. 4Assumptions (Part 1)

5. 5Assumptions (Part 2)

6. 6Revenue model

1.1 – Unusual approach

nd
We are all living in a very uncertain and unprecedented time. Covid 2  wave has been brutally
devastating and has caused a lot of pain and misery to humanity. I hope you are your family are
staying safe. Please double mask if you really have to step out. I hope humanity does not have to
face this situation ever again, and we get out of this situation as quickly as possible.

Let me start this module on Financial Modelling with an apology. I know this module was due
for a while now. I know, I’ve taken a lot of time to get started on this. There were multiple
reasons for the delay, but that’s all behind now. Here we are, all set. I’m super excited to deliver
this module, and I hope you are excited as well 😊

But there are a few things to note before we get started –

Financial modelling as a subject is taught either in the classroom or in a  video format. There is a
reason for this – while teaching this subject, at any given point, we tend to open up multiple
threads and then tie it all together in the end. So in a sense, there are hops, jumps, crisscrossing,
and a bit of number juggling. Given the nature of this subject, it makes sense to teach this online
or via a physical classroom setup.

Think of it as producing a movie. I’m sure you understand that a movie is not shot scene after
scene in a sequential manner. Different scenes are shot, songs are recorded, action scenes are
shot, edited, and then patched together and eventually made to look like the entire movie was
show scene after scene.

In a sense, financial modelling is very similar.  You will understand this better as we dig deeper.

I don’t know if financial modelling is taught in the classic article format. I could make a huge
mistake attempting this task, but I think it is worth the shot.

As I just hinted above, the learning won’t be sequential. We will have multiple threads open;
numbers will crisscross and move from one sheet to another, adding to the non-sequential
learning format. But that’s the way this will go, so please be prepared for it.
As we progress through, you will realise that Financial Modelling is more of an art form than
financial science. We throw in a ton of assumptions while building any financial model. The
assumptions may vary from person to person based on the individual’s experience.

However, the good part is that the model we create will very easily accommodate changes and
updates; this flexibility makes financial modelling a beautiful endeavour.

1.2 – What are you learning and why?

Perhaps an essential question – what is ‘Integrated Financial Modelling’, and why do we need to
learn this?

Think about a typical company; as you can imagine, the company can have several moving parts.
For example, a manufacturing company can have a team procuring raw materials, workforce to
manufacture goods, admin team, finance team, regulators, compliance, marketing, supply chain,
distribution, R&D, and whatnot.

Given the enormity, how do you break a company down into smaller parts and gain meaningful
insights into its functioning?  How do we gauge its efficiency?

Well, this is where financial modelling comes into play. Eventually, whatever the company does,
it all boils down to numbers and metrics.

For example, successful operations lead to revenue generation, successful cost management
leads to operating profits. Good financial practice leads to manageable debt levels; good supply
chain management leads to better inventory management. Good dividend policy strikes a balance
between a company’s growth and shareholder value. So on and so forth.

So the approach we take here is that if we can systematically analyze the numbers presented in
the financial statements, perhaps it opens up a window to understand the company better.
When I talk about understanding financial statements, I’m talking about getting into granular
details; we go line by line. Many often assume that a series of simple financial ratio analysis
results in great insights into the company. Yes, to some extent, it does, but we can do a lot more
to better understand the company.

Better understanding leads us to a better insightful investment decision.

Think about Financial modelling as a systematic way to understand the company. Here is what
the name, ‘Integrated Financial Modelling’, means –

Financial = Indicates that we are working with the company’s financial statements

Modelling = Indicates that we are laying down a company’s financials systematically,

connecting these financial statements and subjecting the same to a bunch of equations. The entire
thing tied together is called a model,  a model with specific input (financial statements) and a
specific output (valuations).

Integrated = Implies that all the numbers are interconnected, and no part of the financial model
is isolated. You will understand this better as we progress through building the financial model.

The end objective of any financial model is to help you build a perspective of valuation. The
final output of the financial models is the company’s share price after factoring in everything that
matters. You take the share price from the model, compare the share price against the market
share price, and figure if the stock is fairly valued, undervalued, or overvalued.

The ultimate satisfaction is when you know that the stock is undervalued and available for a
throwaway price in the market, trust me on that 😊

1.3 – Tools of the craft

Let me break the ‘not so good news’ first – to learn, build, and benefit from a financial model; it
is mandatory to have some background knowledge about the following –

o How to read an annual

report
o How to read the financial
statements of the company
– Balance Sheet, P&L,
Cash Flow
o It would be best if you
were comfortable working
with MS Excel or any
other software similar to
MS Excel
The good part is that you can learn how to read the annual report, Balance sheet, P&L, and Cash
flow in the fundamental analysis module.

Unfortunately, we don’t have a module on MS Excel, so please try and self-study MS Excel. If
you are uncomfortable with any of the three topics mentioned above, please stop right now and
learn these things before learning Financial Modelling.

Please do note, when I say you need to know how to read financial statements, I only mean that
you need to know this from a user’s perspective. As long as you know the basics, that is good
enough.

The same goes with Excel. It would help if you were good enough with essential functions and
formats. I don’t expect you to have the knowledge required to build a complicated dashboard on
excel.

The good news is that when I decided to learn Financial Modelling, I had no clue about the three
things I mentioned above. I had to learn these things first and then get back to financial
modelling. If a person like me can do this, then I’m confident anyone can.

By the way, financial modelling as a concept can be applied to any part of market finance, be it
investing or derivatives trading. Financial modelling is nothing but a structured way of thinking
through a complex problem; some even call this ‘Design thinking’ of sorts.

If you are a regular reader of Varsity, we have dabbled with Financial Modelling in the module
related to Risk management and in the Trading systems module. It’s just that we never called it
‘Financial Modelling’.

This module, however, will be focused on Fundamentals and Financial Modelling for
investments.

1.4 – The steps involved 

At this point, I’d like to share with you a brief overview of the steps involved in creating an
integrated financial model. These steps only give you a sense of direction. We will dig deeper
into each of these steps as we proceed.

These are the steps involved in building a financial model –

Set up a layout – Perhaps the most crucial aspect of financial modelling. I foresee myself
stressing on this several times throughout this module, so bear with me.  A typical Financial
model will have multiple excel sheets within a single workbook. We need to ensure our Excel
workbook is appropriately indexed and formatted and the format stays consistent across the
entire model.

For example, if I’m dealing with 2018 data in column ‘E’ of my excel sheet, I’ll ensure that
column E across all the other sheets will always deal with 2018 data. Or here is another example
of the layout, column A and B will be shrunk to ensure easy indexation across all the sheets.

At this point, this may come across as a bunch of vague statements, but you will appreciate these
points as we progress along.

Historical Data – A rather painful task, but this need to be done. We need to download the
Annual report of the company we are dealing with, preferably for the last five years. We need to
extract the balance sheet and P&L data from the annual report and input this in our excel sheet.
Of course, we will be dealing with consolidated numbers here and not standalone data.

Most importantly, please use the annual report as your primary data source and not any other
rd
3  party data vendors.

Assumption Sheet – Remember I spoke about financial modelling as an art form rather than
financial science? Well, we create an assumption sheet and dump all our assumptions in one
sheet here. We assume things about the company should be close to reality; the further we go
from reality,  the more distorted our model gets. Let me give you an example.
Suppose a company’s revenue is growing at 7% year on year for the last five years; what do you
th
think will be the growth rate for the 6  year? If we have to assume something, it has to be in
the region of 7%, unless you foresee a significant change. Anything higher or lower will distort
the P&L from reality.

Asset and other schedules –Throughout the model, we create something called a ‘schedule’.
We create a schedule with oversized line items. For example, the asset schedule deals with
plants, machinery, and all the company’s fixed assets. We lay down the numbers in a systematic
way and deal with them. For example, we extract the gross block number, depreciation, netblock,
and even the CAPEX figures in the asset schedule.

So a single schedule gives us insights into multiple aspects of the company.

Like the asset schedule, we create other schedules such as – reserves schedule and the debt
schedule.

Projections – Once the assumptions are complete and the schedules, we project the balance
sheet and P&L for either 3 or 5 years forward. This is one of the crucial steps while building the
model.

Cashflow derivation – Again, a very crucial step in financial modelling. In this step, we derive
the cash flow statement using the P&L and Balance sheet data, called the ‘indirect method’, of
cash flow preparation. Note, unlike the Balance sheet and P&L data, historical data of cash flow
is not extracted from the annual report but instead derived. This step can be tricky; it sometimes
works and sometimes does not work due to its complexity.

Hence we will also look at alternatives here.

Ratios – Once all the data is in place, we can quickly draw up ratios and charts for our model.
The ratio sheet will include things like liquidity, solvency, profitability ratios etc.
Valuations – In the valuation sheet, we deploy the discounted cash flow method of valuation and
finally value the company. Think of this step as including a model within a model. Of course, we
will have sufficient checks and balances in places to ensure we are not going way off the mark,
and even if we do, the sensitivity tables that we develop should help us get back on track.

These are roughly the steps involved in developing a full-fledged integrated financial model.
While it makes it seem simple, trust me, it is not.

I’m excited to dig deeper. I hope you are too, so buckle up for the ride 😊

Key takeaways from this chapter

o A financial model takes in

inputs in the form of
financial statements and
gives us an output mainly
in terms of valuations
o Financial modelling
involves a non-sequential
learning path
o Multiple discussion threads
open up while building a
financial model
o Basic working knowledge
of MS Excel, Balance
Sheet, P&L, cashflow is
mandatory before
venturing into financial
modelling
o There are 7-8 steps to
follow while building a
financial model
o The model that we build
has to be flexible to
accommodate changes and
updates.
 Excel workbook setup
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1. 1Introduction to Financial Modelling

2. 2Excel workbook setup
3. 3Historical Data
4. 4Assumptions (Part 1)
5. 5Assumptions (Part 2)
6. 6Revenue model

2.1 – Selecting a company

I never expected such a tremendously positive response for the previous chapter. I’m a bit
overwhelmed, and I also get a sense that there are many expectations from this module. I hope I
won’t disappoint you all, and this module lives up to its expectation. I’ll give it my best shot to
explain what I know about financial modelling.
At this point,  I’d like to spend some time to help you understand the kind of companies to pick
when building a financial model for the very first time.
A common mistake a newbie financial modeller makes is picking a complicated company to
build the first financial model.
When I was trying to learn financial modelling, I picked a company called ‘Hanung Toys’, and
as the name suggests, the company made toys!
The company had no other line of business apart from making toys; it had a simple P&L, simple
balance sheet, no complicated company structure, no complicated financial structure. If you read
the annual report once, you’d get a quick hang of what the company does and the factors that
influenced its growth.
I’m so glad that I picked ‘Hanung Toys’ as my first company to model. It was easy to build a
model due to the lack of complexities involved.
At the same time, a friend of mine picked Hindalco as his first company to model.
Everything about Hindalco was intimidating – the annual report ran into several pages. The
company manufactured Copper and Aluminium, captive power units, complex debt structure,
complex financial statements,  cyclicality in earnings; commodity prices were dependent on
international markets, and whatnot.
Eventually, my friend lost interest to learn financial modelling, and he never really got back to it.
So don’t let this happen to you.
Here is a suggestion, please model the same company that we would model in this module.
Replicate what we discuss here by yourself and post that you can try to model a company
independently.
By the way, just to let you know, an experienced financial modeller would love to model a
company like Hindalco for the same reasons I mentioned above😊
Please note that I may not be able to help each one of you with the model you’d build. I’ll
attempt to teach you a framework in this module; you will have to build on it. I hope you
understand the difficulty of looking at 100’s of different models by the many readers here. It
would be impossible for me 😊
So if you are the first-timer, then keep these points in mind –

o
1. Pick a company that is simple to understand. For example, don’t straight away pick Reliance Industries. It is complex
to model for a first-timer (for an experienced person too)
2. Between a manufacturing and service-oriented company, pick manufacturing. It is easier to understand manufacturing
concepts, i.e. number of units produced, raw material, inventory, etc. Services can be a bit vague.
3. The company should have 1 or 2 products that contribute to the revenue. The higher the number of products, the
higher the complexity involved. Think of an FMCG company; they have 100s of products, which means 100s of
dependencies, making it tough to model such companies.
4. Pick a company that gives out as much information as possible in its annual report. Just to let you know, Infosys is
one of the best companies in terms of information provided in the annual report. The more information the company
provides, the fewer assumptions you have to make in your model, and that’s good news.
5. Ensure the company you pick is consistent in its annual report. Let me explain this. Assume, I pick a company which
manufactures and sells mobiles phone. The company operates in India and Sri Lanka. The company states how many
units sold in India and Sri Lanka in its first-year annual report. The company also reports the revenue generated in
both these countries. In the 2nd year annual report, the company chooses to disclose only the revenue generated from
both the countries but decides not to give the data on the number of units sold. This is an inconsistency in reporting,
and such inconsistencies make it difficult to move ahead with the model
6. Avoid banks, financial services, and NBFCs. They are just too complex and have a ton of regulatory issues. The
model we are about to learn may not work for the BFSI sector, so please be aware of that.
Keep these few points in perspective before you pick a company to model. However, as your
first model, I hope you will consider my suggestion and replicate the model we use in this
module on your own.
Throughout this module, we will have one ‘Main model’ running and few helper models. I want
you to understand the context in which I will use these different models –
o

o The main model – In the main model, we will start with a blank excel workbook and build our model step by step.
We will pick a company and stay with it throughout.
o Helper model – I’ll probably use 1 or 2 different companies to help different sections of the main model slightly
more detailed. The objective of the helper model is to help you understand concepts better.
Think about it as learning how to become a master chef. While the end goal is to create magic
with your cooking, but along the way, you also need to practise your knife silks to cut veggies
efficiently.
By the way, I’d like to thank my ex-student and now a good friend Vishal Vindoorty, for helping
me with this module. Many years ago, I taught him financial modelling and today; he teaches
me.
So I guess life has come a full circle 😊
With that in place, let’s start by taking a baby step in this chapter.

2.2 – Reimagine data presentation

Like I mentioned in the previous chapter, the very first step in building a financial model is to
refer to the annual report, extract the balance sheet and P&L data and input the same in the excel
sheet.
Of course, this is a time-consuming task, but a super important task as the data that you copy
from the annual report acts as the key input to the entire model. So please do this task with at
most devotion. At any cost, resist your temptation to copy-paste numbers from 3  party sources. rd
Different people have a different opinion on how many years of historical data to consider. A
common preference is to either take the last seven years or the last five years of data. I belong to
the five-year camp.
When I usually discuss the first step of financial modelling, i.e. copy the last five-year historical
balance sheet and P&L data from the annual report to an excel sheet, people imagine something
like this –
 

You see above is the usual way people copy the balance sheet data from the AR to their excel
sheet. The image below shows how historical P&L gets copied –
Well, yes, what you see above is technically correct. One has indeed copied the data from the
annual report to an excel sheet, but if you do it this way, as shown above, it’s called a ‘model
suicide.
The data is presented in a very unsystematic manner. So if you had imagined something like this,
then it’s time to let go of that and reimagine how data is presented in a model friendly way.

2.3 – Set up your excel sheet

One has to set up the excel worksheet in a systematic way. The format should be consistent
across all the other sheets within the workbook.
Here are a series of steps to follow, even before we start copying the historical data from the
annual report. Think of this as a sub-step to step 1.
Open a blank excel sheet and save it with whatever name you’d like  –
Index Column A and Columb B, expand Column C, and Index column D. ‘Index’ in this context
means just to shrink the column.  Here is how my excel looks after indexing the columns –

One of the things I like to do is to get rid of the gridlines in excel. The gridlines in a financial
model can be pretty distracting, especially when you have so many numbers and formulas to
manage.
So get rid of it if you can. After getting rid of the gridlines, I’d also like to freeze panes by
keeping my cursor on cell D3.
Here is how my excel looks now –
I hope you are aware of how to get rid of gridlines and freeze panes. These are basic excel skills.
If you are struggling at this point, please stop, maybe refresh your excel skills, and get back to
this later.
We now enter the years from E2 to I2 to indicate the year’s we are interested in. My excel now
looks like this –

We now label this sheet as the P&L statement (in cell A1) as shown below –
I like to keep ‘Profit and Loss statement’, in bold, font size 14. You can see below the line that
I’ve added another line that says that all the numbers stated in this sheet are in INR Crores unless
specified.
So if you see a number like 14.2, then it means that the number is 14.2 Crores Rupees and not
just 14.2. I’ve italicized the line and reduced the font size to make it look better.
What you see above is a basic skeleton of the model. We need a few similar-looking sheets
within the workbook. Remember, we will have other data sheets to include the Balance sheet,
assumption sheet, cash flow sheet, etc. So it’s a good practice to set up multiple sheets with
similar structure in one shot. You can do this in the following way.
Press the Control button in your system, and click on few sheets. By doing so, you’d be selecting
a few sheets in 1 go. When you select multiple sheets, whatever changes you do in one sheet will
replicate in the other sheets as well.
Here is how my sheet looks before I press control and select the other sheets.
As you can see, all the sheets except Sheet 1 are selected. I’ve not selected Sheet 1 since the
sheet is already set up, and I don’t want to mess with it.
Now, in sheet 2, I do all the above steps that we discussed, except –
o

o Freezing panes, because freeze panes do not work when you have selected multiple steps (or at least I don’t know
how to do it)
o Title the sheet (like Profit and Loss statement) because each sheet will be called something different.
After setting up sheet 2 –
Please note, all the sheets continue to be selected. I’ve executed all the steps, except for the ones
I mentioned above. Now excel will deselect the selected sheets the moment you click on a
different (non selected) sheet. So go ahead and click on Sheet 1 to deselect.
Now check sheet 3,4, and 5. These sheets should look precisely similar to Sheet2. In each sheet,
go to cell D3 and free panes.
While at this point I don’t know what I’ll do with Sheet 3, 4, and 5, I do know that Sheet 2 is for
the Balance sheet. So I’ll title it as ‘balance sheet’ (cell A1).

By the way, do notice that I’ve renamed Sheet 1 and 2 as Profit & Loss and Balance sheet,
respectively. You can do this by keeping your cursor on the sheet and right-clicking your mouse.
I’d like you to take a minute to relook at what you’ve done so far.
In fact, this is a big step in your financial modelling journey. What you’ve done so far is to
ensure that you set up your excel in a very systematic way. You have five sheets open, and all
five sheets have a similar structure.
I now know that Column E represents FY16 data, F to FY17, E to FY18, and so forth across the
entire model.
The structure won’t change, and it’s a huge deal. It’s called the ‘ Hygiene factor’ in a model, and
that, in my view, is a super important aspect.
With this note, I’ll end this chapter. In the next chapter, we will copy the data from the annual
report to our excel sheet.
You can download the excel sheet for this chapter from here, and by the way, congratulations for
successfully executing (well, almost) the very first step of financial modelling.
PS: Are you curious to know what happened after I built the financial model for Hanung Toys?
The model suggested that the company was way overvalued, and hence I never invested in it.

I’m so glad I dint.

Key takeaways from this chapter
o

o Pick a company that is easy to model (at least in your initial days of financial modelling)
o The manufacturing sector is slightly better to model compared to the services sector
o Look for reporting consistency in the annual report
o Do not blindly copy data from the annual report onto the excel sheet
o Set up your excel sheet before you can copy the data
o Ensure your excel sheet is consistent
 Historical Data
← Hide

1. 1Introduction to Financial Modelling

2. 2Excel workbook setup
3. 3Historical Data
4. 4Assumptions (Part 1)
5. 5Assumptions (Part 2)
6. 6Revenue model

3.1 – Annual Report recce

Picking up from the previous chapter, now that we have our excel sheet set up, we will extract
the data from the annual report to our blank excel sheet. The excel sheet at this stage should look
like this –

And a similar page set up for the profit and loss statement.
Now, before we start extracting the financial statements data from the annual report to the excel
sheet, we need to conduct a simple survey of the annual report. Remember, for our financial
model; we need the historical financial data from the last five years. We will use the data of the
last five years as the primary input for the model.
It is essential to ensure that the last five years data is consistent and there no missing items in the
statements. Let us understand this with a quick example.
Assume this is the revenue section of the P&L for an imaginary company –
Year 1 –
o

o Gross Income
o Duties
o Net Income
o Other income
Year 2
o

o Net income
o Other income
The company states the Gross income and duties paid in year one, but in year 2, the company
states the net income directly. Inconsistencies like this can be a problem while modelling since it
creates multiple gaps in the model. For this reason, even before we start copying the data from
the annual report to the excel sheet, we need to first look at the last five years annual report and
ensure that the statements are consistent over the years we are interested.
Let us go ahead do this now.
In the previous chapter, we discussed the ‘main model’ and the ‘helper model’. The main model
is the one in which we will build a financial model end to end, and the helper model will help us
understand concepts related to the financial model.
So I guess it’s time to introduce the company which will act as the first ‘Helper Model’.
We would be dealing with Relaxo Footwear. Relaxo is one of the largest manufacturers of
footware in the country.
As a first step, I download the company’s last five years’ annual report and put these in a single
folder. Usually, a listed company puts up the annual report in the ‘Investors’ section of the
website. I’d suggest you download the same from Relaxo’s website.
My folder with the annual reports looks like this (I know this is basic stuff, but I’m posting an
image just for clarification) –

I’ve even renamed these reports in a format that I like. I now go ahead and open all these annual
reports side by side.
Please note, we deal only with the consolidated financial statements and not the standalone
statements.
I’ll start by reviewing the consolidated balance sheet of the company. At the very first
inspection, I can see that company changed the accounting format in 2018. How did I figure this?
Well, take a look at the below screenshots.
Balance sheet as stated in March 2016 –

 
Balance sheet as stated in March 2017 –
You’d probably know that in every annual report, the company states the numbers for the
financial statements for the year in review and the previous Financial year. This is the case in the
above two snapshots. However, for the Financial Year 2018-19 –

The company has restated the Balance sheet for FY 2016, 2017, and 2018. So as a financial
modeller, I’d ignore the financial statement from the 2016, 2017 Annual report and take the
numbers for FY 2016, 2017, and 2018 from the 2018 Annual report.
Next, when replicating the Balance sheet on excel, I’d take the line items as per the latest
financial year. Let me explain why; here is the balance sheet snapshot as per the 2020 Annual
Report –
Under current liabilities, there is a line item called ‘Lease Liabilities’, but this was missing in
2018 and 2019. But because it is present in the 2020 balance sheet, I will have to consider this
line item and include it in my excel sheet; of course, the value against this line item will be 0
from 2016 to 2019, and INR 27.61 Cr in 2020.
I’m trying to suggest that if you take the line items as stated in the latest year annual report,
chances are you’d have covered almost all the line items. But this is just a hack; it may not work
all the time.

3.2 – Data extraction

Alright, with that in place, let’s start extracting the data from the Annual report to the excel sheet
we set up in the previous chapter. Of course, this is a lot of manual work, but there is no other
way around this. Remember, we start with a blank excel sheet; we’ve only set up the skeleton for
now. My sheet looks like this –
 
To start with, on the left-hand side of the excel sheet, I type down the line items of the balance
sheet. The order in which these line items are listed is the same order in which the balance sheet
is reported. Please take a look at the snapshot below; I’ve typed out the assets side of the balance
sheet.

Notice a few things here; I’ve used column A and B as an Index. I’ve typed out the heading and
subheadings in these columns. I’ve highlighted what I mean by main and subheading here –
In column C, I’ve mentioned the actual description of the line item. There are two main reasons
to do this –
o

o Indexing and segregation of heading and subheading is an excellent way to present financial statements. It not just
looks easy on the eye but also captures more information
o Navigation becomes easy
What do I mean by navigation? When you have a lot of data to deal with, you need a quick way
to navigate through it, and excel allows you to do that. I want you to do a small exercise to
appreciate the ease of navigation.
By the way, I’m assuming that at this stage, you’d have entered the asset side of the balance
sheet in your respective excel sheet, in the same way as I’ve done. If not, I’d suggest you do that
quickly before reading further.
Now place your cursor in cell B5, where we’ve typed ‘Non – Current Assets’. Now, press the
control key + the down arrow on your keyboard. The cursor should directly jump to the next
indexed cell, i.e. ‘Financial Assets’.
This quick jump helps you navigate faster and focus on the primary data chunks.
I’ll proceed to set up the liabilities side of the balance sheet as well. So at this point, my balance
sheet sans the values is set up. Here is the snapshot, but please excuse the compressed image;
this is the only way I can present the entire balance sheet in the following image –
Once you’ve reached this stage, the next step is to copy the data from the annual report to the
excel sheet. Please do recollect; I’m looking at the 2018 balance sheet to copy the data for 2016,
2017, and 2018.
Let’s deal with the ‘Non – Current Assets’ first. Here is the snapshot from the annual report –

I’ll go ahead and copy the same onto my excel sheet –

So far, so good, I suppose.

3.3 – Assumptions, facts, and format

In the image above, I’ve deliberately placed my cursor in cell E6 so that you can see that the
number, 462.30, is copied from the balance sheet and not a calculated number. In a sense, this
number is hardcoded.
In the financial modelling world –
o

o The hardcoded number is considered as a fact because we are directly copying the number from the annual report
o A calculated number is considered an assumption since we apply a mathematical operation to arrive at the number.
Given this, it is essential to distinguish between the facts and assumptions in a financial model so
that the user of the model can quickly identify which numbers are flowing directly from AR and
the calculated numbers. Also, you will know where to look in case of an error in your model.
I’ll explain how this can be done, but before that, let’s add up the total non-current assets.
I’ve used the ‘=sum()’ function in excel to calculate the total non-current asset. The calculated
number is treated as an assumption since I’ve calculated this on my own. The easiest way to
distinguish assumptions and facts is to colour code the numbers.
You can easily colour code this by selecting all the hardcoded numbers in one go. Click the
function + F5’ keys on your keyboard; you should get the following pop up –

Now click on special, and select only constants and numbers like shown below –

After you click ok, excel will highlight the hardcoded numbers or the facts.
Now without deselecting the numbers, select a colour of your choice. I prefer light blue for this,
but you can pick whatever you like –

After you select the colour of your choice, you can keep the total non-current assets in bold.
If you have managed to follow the above step, then the rest of it is pretty straightforward. All you
need to do is extract the numbers from the balance sheet and P&L and put them on your excel
sheet.

3.4 – Other things to note

Some of you may wonder about the necessity to add up the numbers and colour code them. For
example, one can copy the total non-current asset as well; why calculate it separately?
We need to calculate these numbers because going further in the model, we will project each line
item in the balance sheet for future years. The total is calculated anyway. Therefore, calculating
it now will maintain consistency in the model.
Before we conclude this chapter, few formatting tips –
o

o Keep the numbers right-aligned

o Extend the decimal points up to two digits
o Keep all the heavy numbers in bold; these are usually the subtotal and main total numbers
o Use double borders for cells wherever necessary
I’ve completed filling up the balance sheet. I want you to pay attention to few last things –
I’ve calculated the total assets on the asset side by adding up the two subtotals, i.e. total non-
current assets and total current assets. I’ve taken a similar approach on the liabilities side as well
–
Lastly, to ensure my balance sheet is balanced, I run a ‘True’ and ‘False’ check. Remember, if
assets = liabilities, that means the balance sheet is balanced.

Since it’s true, the total assets are equal to total liabilities. Hence my balance sheet is balanced.
I’m not going to explain the data extraction method for P&L. It is a similar process. Do let me
know if you get stuck on any of the steps; I’ll be happy to explain. But I do hope your P&L
would look like this –
If you are attempting the P&L, you will notice that the ‘other expense’ in the expenses section is
expanded. I’ve done this deliberately to showcase that when you have a heavy line item in the
P&L, then it probably is not a bad idea to break down its constituents. The reason for doing this
is that we can model these lines items at a more granular level, thus ensuring our model is
realistic.
Remember, Relaxo is the helper model, and this won’t be our main model. We used this to help
us understand how data can be copied from the financial statements to excel. We will move on to
the main model in the next chapter.
By the way, ‘Historical data’ was supposed to be the first step of financial modelling, but I hope
you realise that many tiny little steps are hidden within the main step. You can expect the same
for all the other steps.
As an assignment, I’d suggest you replicate the balance sheet and P&L on your own. I’m sure
the learnings from this exercise will be exciting.
Download the excel sheet used in this chapter here.

Key takeaways from this chapter

o

o Perform an annual report recce before setting up the excel sheet

o It makes sense to take the latest year’s financial statement for the format; the chances are that you will cover all the
line items. But this is only a hack
o Indexing helps in quick navigation
o Differentiate between fact and assumption data points. You can do this by colour coding
o Maintain format hygiene across the sheet
o If need be, breakdown the heavy line to get a better granular view
 Assumptions (Part 1)
← Hide

1. 1Introduction to Financial Modelling

2. 2Excel workbook setup
3. 3Historical Data
4. 4Assumptions (Part 1)
5. 5Assumptions (Part 2)
6. 6Revenue model

4.1 – Model integrity

I want to start this chapter by talking about a super important concept. I may have touched upon
this topic earlier, but I would like to discuss it again with snapshots to emphasise its importance.
In the previous chapter, we set up the balance sheet and P&L for the helper model. Here is the
snapshot of the same –
P&L –

And the balance sheet –

The model design ensures column E represent FY16 data, column F to FY17 so on and so forth.
We do this to ensure that the numbers get identified quickly and linkages between cells are
accurate.
For example, imagine a scenario wherein I want to calculate the ratio of Property, plant, and
equipment to the Total revenue for FY18. If you realize, to calculate this, I need to divide a
balance sheet item with a P&L item, which means I will have to crisscross between sheets to do
the math. This further means that I can easily link the wrong cells without evening noticing it.
Anyway, let us go ahead and do this. I can easily calculate by linking the cells of Column G in
the formula bar –

Now consider a situation where you’ve linked the wrong years while calculating this ratio. You
can spot the wrong linkage easily –

In this case, I know column G in the balance sheet should be linked with column G of P&L. The
moment I see the G and F combination, I know something is wrong.
I’ve quoted a relatively simple example here. But as the model grows and gets more complex,
you’ll understand and appreciate the need to maintain the model integrity.

4.2 – Main model

It’s time to introduce you to the primary model. I’m sure many of you here would expect me to
name the company we’d work on and also name the years under consideration. But I have
different plans 😊
I’d rather keep the name and years under consideration unknown. I’m doing this for two reasons
–

o By not naming the company, I’ll hopefully eliminate biases one may have. For example, if I
use a footwear manufacturing company’s data, some may feel that it may not apply to an
auto component company. So I think it is better to keep it generic to establish the fact that
this model template applies to all companies (except banking and NBFC)
o Hopefully, by not quoting years, someone reading this module five years later will also
understand that the overall structure of a financial model remains the same, no matter when
you decide to learn financial modelling.
But for the sake of your understanding, assume that we are dealing with a simple manufacturing
company’s data.
I’ve used the exact steps detailed in the previous chapter and set up the Balance Sheet and P&L
data. Here is the snapshot of the same –
Balance sheet –
I’ve shrunk my excel sheet to 70% to ensure I capture both sides of the balance sheet; hence the
numbers and format look a little different.
Here is the snapshot of the P&L –
A couple of things here –
o

o The years in consideration is Year 1, Year 2, Year 3 up to year 5 etc. It means the latest 5 years of data. So even if
you read this 10 years later, it won’t matter.
o The data is from the Annual Report, as of March 31st,e. the financial year-end
o Year 1A means Year 1 actual data. Year 6P means the year 6 data projected. The projected data is also as per March
31st. In a sense, this is our vision of how the financial statement will look like future annual reports
You can download the excel sheet from the end of this chapter. In the excel sheet, you’ll find the
raw P&L and Balance sheet data; I’d suggest you use that data and lay it down in the format
we’ve discussed. It will be good practice for you.

4.3 – Assumptions and Projections

Remember, in the first chapter; I mentioned that financial modelling is a bit of art and financial
science?
The art part starts now 😊  
The idea behind a financial model, quite obviously, is to analyse the historical financial
statements and project them forward. The common practice is to project the number to either
three or five years forward. In this model, we will try and deal with five years projections.
To get an initial understanding of this, I’ll post a set of questions and answers –
>>>> How will you project the financial statements for the future years?
>>>> Well, you can project the financial statements by making a set of assumptions.
>>>> How will you assume these things to help you make the necessary projections?
>>>> We can assume the future trends based on historical trends.
>>>> How will you measure historical trends?
>>>>> The measurement of historical trends happens based on individual line items in the
balance sheet and P&L. In most cases; we measure by taking a simple ratio of one line item over
another. At times, we can consider the year on year growth rate as well.
 We will discuss this in greater detail later in this chapter.
>>>> After measuring the historical trend, how will you project the future trend?
>>>> There are two ways to make future projections – historical average or an intelligent guess.
At this point, I just want you to read the above and keep this in the back of your mind. Some
parts may be clear, and some parts may sound confusing, but I hope by the end of this chapter,
you’ll get a clear understanding of this topic.
With that in mind, let us go ahead and make our first assumption for the financial model, but
before that, let’s set up our assumption sheet.
To set up the assumption sheet, please go to a new sheet in the workbook and rename the sheet to
‘Assumption’ at the bottom.

Now, we do the usual, i.e. –

1. Index column A and B

2. Expand column C
3. Index column D
4. Cells E2 to I2 will be Year 1 to Year 5
5. Cells J2 to N2 will be Year 5P to tear 10P
I’ve followed the same steps, and here is how my excel sheet now looks.
The idea with the assumption sheet is to lay down each of the financial statements line items and
project it based on our assumptions. So let us go ahead and lay down these line items. Let me
start with the Balance sheet; take a look at these two lines in the balance sheet, i.e. liabilities and
provisions under the current liabilities section –

Now, recollect this part from the QnA we had earlier –

To measure historical trends, we usually take the line item as a ratio of another line item. For the
balance sheet, usually, the ratio is measured by keeping the ‘Gross Block’ as the denominator.
Gross block, because the gross block is one of the most oversized balance sheet items, also sucks
up the company’s CAPEX.
So, if you were to look at ‘Year 2’, liabilities as a percentage of Gross block,
Liabilities as a % of Gross Block (Y2) = 102.74/310.58
= 33.08%
Of course, we can do this in excel directly –

Notice, I’m dealing with Year 2 data. Hence in the balance sheet, I divide F6 over F34.
You may wonder why I’ve done this for Year 2 and not for Year 1. This is because there will be
instances where we’d need to calculate the year-on-year growth rate, which means our starting
point will be year 2. Hence, for this reason, we ignore Year 1 and directly deal with year 2. You
will notice this pattern in several places throughout this module.
Alright, now that we have calculated  Liabilities as a % of Gross Block, we can drag the formula
across Y3, Y4, and Y5.

As you can see, liabilities as a percentage of gross blow hovers between 27% and 35%
consistently. So, if I were to figure out what this ratio would be for Year 6, I can just take the
historical average and get a perspective.
Let me do the same –

Congratulations! With this, we have projected the very first line item of our balance sheet. Few
things to note here –
o

o I’ve used the simple average function here

o The first average, i.e. for the year 6, is the average of Year 2 to Year 5
o The 2nd average, i.e. for year 7, the average is between Year 3 and Year 6
o We are calculating the rolling average here, so at any point, we consider the latest four years data
o The average which we have calculated hovers within the expected range, i.e. between 27% and 35%, so this is ok.
Whenever you calculate such ratios, it is best if the variance range is narrow. The narrower the
range, the more consistent is the average calculation. The more consistent the average, the tighter
is your model.
I’m not too happy with a range, i.e. 27% to 35%; it could have been better. If you are not too
happy with it, you can try exploring other ratios like ‘labilities as a percentage of total assets or
as a percentage of netblock or something like that.
Wait! So what should you consider? Liabilities as a % of the gross block, or netblock, or total
assets?
Well, this is where the art form kicks in. There is no guiding principle here. There is no rule
which says you have to consider the denominator as gross block only. I’ve taken it because I’m
comfortable with it.
The end objective here is to ensure the calculated numbers are as consistent as possible. Also,
don’t stress too much on this; after all, this is a financial model based on excel. We can change
things at any point during this journey.
I’ll now go to the next line item, i.e. the Provisions under the current liabilities. Again, I’ll
calculate provisions as a percentage of the gross block.

Hopefully, you get the drift by now.

Let us go back to the balance sheet for a bit –
Under the liabilities side, we have projected Provisions and Liabilities. What’s next is
shareholders funds and non-current liabilities. Usually, big-ticket items like these in the balance
sheet should be dealt with separately in the financial model. We deal with it by creating
something called a ‘Schedule’. Of course, we will talk more about schedules later in the module,
but for now, think about schedules as a separate dedicated sheet within the financial model.
So all the things marked is treated in the schedule, where we will also make future projections.
That leaves us with just the deferred tax liabilities on the liabilities side of the balance sheet.
For the deferred tax liabilities, I’ll consider the year on year growth rate. If you look at Y1 and
Y2 numbers, it’s at 13.61 Cr and 16.95Cr. To calculate the year on year growth rate –
(16.95/13.61) – 1
= 25.55%
Note, this is the growth rate for Year 2. On excel –

Of course, you can now drag the cells for the rest of the years, up to Year 5, and take the rolling
average from Year 6 onwards.
We now move to the asset side of the balance sheet. Perhaps, I’ll take it up on the next chapter,
and I promise I’ll put up the next chapter soon 😊
You can download the excel sheet used in this chapter from here; please note, this excel also
includes the raw data. I’d encourage you to use the raw data and build the P&L and Balance
sheet from scratch.

 Key takeaways from this chapter

o Please pay attention to model integrity, as it helps you identify accurate cell linkages
o One can calculate the historical trends either as a growth rate or by taking a simple ratio
o Projections are made by taking averages or by making an intelligent guess
o It is best when the historical trends exhibit a non-volatile range
o Assumptions are an art form; there is no standard method to make assumptions. Your guess
is as good as mine.
 Assumptions (Part 2)
← Hide

1. 1Introduction to Financial Modelling

2. 2Excel workbook setup
3. 3Historical Data
4. 4Assumptions (Part 1)
5. 5Assumptions (Part 2)
6. 6Revenue model

5.1 – Deferred tax  

A gentleman posted an interesting comment in the previous chapter. The company he chooses to
model did not present the gross block data in the way the company we are dealing with has, i.e. –
Gross block – Depreciation = Net block
Instead, the company directly reported the ‘Net block’ data.
Given this, how would one go about building the assumptions with Gross block as the base for
many balance sheet based assumptions?
While the balance sheet reports only the ‘Net block’ number, the associated notes usually carry
the gross block and depreciation numbers. One has to extract these details from the associated
notes and rebuild the gross block.
It may sound a bit complex at this stage, but don’t worry; we will take this up in the next chapter
and lay down the steps involved one at a time.
By the way, I hope you got to look at the raw data of P&L and Balance Sheet and layout the data
in a model friendly manner. Assuming you’ve done that, we will now continue from where we
left off in the previous chapter.

 
The previous chapter calculated the deferred tax’s growth rate from Y2 to Y5 and its average
from Y6 to Y10. While this is ok, it still results in a somewhat volatile set of numbers. There is a
better way to do this, and I’d like to discuss it.
If you understand deferred tax, you’d know that it occurs due to the way depreciation is treated.
Hence deferred tax and depreciation is connected.
So, rather than taking the growth rate of deferred tax, it probably makes sense to consider
deferred tax as a percentage of depreciation.
For Y2, the deferred tax is 16.95Cr, and depreciation is 121.73 Cr. So deferred tax as a
percentage of depreciation for Y2 is –
16.95/121.73
= 13.92%
We can continue this for Y3, Y4, and Y5 on excel –

 
As you see, the numbers look much more stable. I’d request you to please make this change in
your model. Now, for the projections, you need to take the rolling average. For Y6, it would be
the rolling average of Y2 to Y5; for Y7, it’s the rolling average of Y3 to Y6 and likewise.

The resulting percentage range is also relatively stable.

Before you crib and curse me for making you redo the deferred tax bit, I’d like to tell you that
the growth rate method for assumptions is critical, and we will use it in this chapter when we
take up P&L assumptions.
So in that sense, you already have a heads up 😊

5.2 – Dealing with inventory 

With the deferred tax assumption, we also complete the liabilities side of the assumption. Please
note that we have not made any assumptions for share capital and borrowings; these are line
items we will deal with separately by building ‘schedules’.
So we now proceed to the asset side of the balance sheet, and the first line item to consider is the
inventory.
If you look at the inventory data as stated in the balance sheet, you’ll realise the worth of
inventory that’s lying with the company. For instance, for Y1, the inventory worth was 92.17
Crs; for Y2, it’s 194.33 Crs, Y3 it’s 160.83 Crs etc.
Any manufacturing company ends up having inventories in its balance sheet, and as you know,
the inventory is nothing but the company’s finished goods. The objective of the company is to
sell the inventory as quickly as possible. Hence lesser the number of days the company takes to
sell the inventory, the better it is for the company.
Based on the nature of every company, the company takes up a certain number of days to convert
its inventory to sales.
For example, a company manufacturing pressure cooker may convert its inventory to sales in 30
days, but a company manufacturing cars may take 75 days to convert inventory to sales.
When it comes to the inventory assumptions, we take the following approach –
o

o Convert the Rupee value of inventory to the number of days the company takes to convert to sales
o Find the average number of days for the future years
o Convert the average number of days back to the Rupee value for the future years

Sounds complex? Perhaps, but let’s go ahead and execute the above steps in our model and see
how it goes. I’m sure you’ll eventually find it easy 😊
But before we proceed, why even take the pain of doing all the above? Why not directly take the
growth rate of inventory and its average and move ahead (like how we treated deferred tax in the
previous chapter)?
When you convert the Rupee value of inventory into the number of days to sales, you also get
additional insights about the company. These insights help make investment decisions. For
instance, imagine there are two companies manufacturing cameras that are similar in all aspects.
Company A takes 40 days to convert inventory to sales, and company B takes 70 days to
convert. What can you infer from this?
o

o Company A seem to have a better inventory management

o Maybe Company A has a superior product. Hence the market prefer cameras from company A
o Or maybe Company B’s sales incentives for merchants is not as attractive as A’s, so merchants tend to push Company A
o Perhaps, company A have efficient management, meticulously planning these things

You see, the list of insights can go on and on. Hence it makes sense to take that extra effort to
juggle and calculate the inventory number of days and let’s do that right away.
On excel, the inventory number of days is calculated easily by applying a formula. I call it the
conversion formula because it converts the Rupee value of inventory to the inventory number of
days.
For Y1 and Y2, the inventory value is 92.17 Crs and 194.33 Crs, respectively. To convert, we
apply the following formula –
= (Average inventory of Y1 & Y2 / Materials consumed for Y2) * 365
In the denominator, you may ask why we use the materials consumed for Y2 and not Y1. Well,
this is because we are calculating the inventory number of days for Y2. If we were to do this for
Y1, then the formula is –
= (Average inventory of Y0 & Y1 / Materials consumed for Y1) * 365
Since we don’t have the Y0 data, we start with Y2.
So applying the formula for Y1 and Y2 –
= Average (92,17, 194.33)
= 143.25
Material consumed for Y2 (data available in P&L) = 762.86 Crs
=143.25/762.86
= 0.18778
Finally, we multiply the above result with 365 to get the inventory number of days –
= 0.18778 *365
= 68.53
The above number means the company takes about 68 days to convert 143.25Cr of inventory to
sales.
Of course, you can do this in excel in one shot –

Please notice, I’ve included ‘inventory number of days in the assumption sheet and executed the
conversion formula directly. I’d suggest you do the same in your excel.
Once I’ve calculated the inventory number of days for Y2, I can drag the excel to rows Y3, Y4,
Y5 and get the respective values.
Notice, the inventory number of days consistently ranges between 68 to 78 days. To get a sense
of how good or bad this number is, you need to compare it to a company operating in the same
sector, of similar size. For example, Bajaj Auto and Hero Motors are similar companies doing
similar business.
Moving ahead, for the Year 6 to Year 10, we can take the moving average of the inventory
number of days.

We have calculated the historical inventory number of days and projected the inventory number
of days for the future years.
In fact, you can take a similar approach to Sundry Debtor/Account receivables as well i.e. to
convert receivables from Rupee value to receivable number days and then back to receivable in
Rupee value.
In the next chapter, I’ll probably explain the process with the help of the helper model.
For now, let us move ahead with other balance sheets and P&L assumptions.

5.3 – Other Balance sheet assumptions

If you look at the asset side of the balance sheet, these are the line items stated by the company –
We have dealt with the inventories already.
Just like on the liabilities side, we will build a schedule for the gross block. Cash and Bank
balance in current assets will be dealt with in detail in the cash flow statement.
We will make the assumptions for the remaining line items on the asset side. Let me quickly run
you through the thought process before we jump to excel.
o

o Sundry debtors – I’ll consider this as a percentage of Gross block (but remember there is an alternate way i.e. to convert to days and
back)
o Loans, advances, and deposits – As you can imagine, this line item is related to the company’s working capital. Hence I’ll consider
this as a percentage of net sales
o Other current assets – This is a small number for Year 1 and does not exist for the rest of the years, so I’ll ignore
o Capital work in progress – As a percentage of net sales
o Investments – As a percentage of Gross block

Once I calculate the historical percentages, I’ll go ahead and calculate the rolling average for the
future years. Like I’ve mentioned earlier, feel free to change the denominator based on your
understanding of the firm and its financial statements. Remember, assumptions are the art bit in
financial modelling; you are free to experiment, but ensure it is not too way out of wack 😊
So let me go ahead and implement the above in the excel sheet. I’ll post a series of snapshots
hopefully that will be self-explanatory –
I’ve continued on the assumption sheet and lined up the line items in the same sequence as it
appears in the balance sheet. Remember, I’ll do all the necessary calculations starting from Year
2 for consistency with the other assumptions.

I’ve calculated the percentages for Year 2, and I’ve highlighted the loans, advances, and deposits
as a percentage of net sales. You can see both the formula bar as well as the F16 cell. I’ve
highlighted this to showcases the  P&L line item in the denominator.
Hopefully, you will find this as an easy step to implement. Do let me know if you find any
difficulties in implementing this by commenting below.
In the next step, I’ll drag the rows to the right till year five, and from year 6 onwards, I’ll take the
averages.

I’ve highlighted the average calculation for your better understanding. For the last balance sheet
line item, i.e. investment as a percentage of Gross Block, I’ll not calculate the average for Y6 to
Y10. Instead, I’ll assume a constant of 3.5% of the gross block.
Why not the average like other line items? Why 3.5%? Why not 4% or 3%? These are all valid
questions.
The percentage calculated is quite volatile. It ranges from 3% to 11%, I’m not too happy with it,
and therefore I’d like to keep it at a constant 3.5%.
Why not 4 or 3%? Well, that’s the beauty of a financial model. Once the model is complete, I
can change this to any value that I think makes sense. Hence I don’t have to stress on it now and
stick to 3.5% and move ahead.

With this, we have completed the balance sheet side of assumptions. Whatever is left out will be
dealt with in the form of schedules.
We will now move ahead with the P&L assumptions; this should be pretty easy.

5.3 – P&L assumptions

Let us start by taking a look at the P&L –

There is the revenue side, and then the expenses side to the P&L. Revenue side has the sales and
other income data, while the expense has the details on all the expenses incurred during the year.
Making assumptions on the expenses side is super easy; all these line items are calculated as a
percentage of the net sales or the total income. Revenues, on the other hand, is very interesting.
You can either calculate the growth rate or deep dive to build a revenue model.
I want to discuss both these methods. In the primary model that we are dealing with, let us
discuss the growth rate method of revenue forecasting. However, we will take the help of a
helper model to build a revenue model.
Perhaps we can do both the revenue model and the receivable number of days in the next
chapter.
Moving ahead, I’ll create another section in the assumption sheet to accommodate the P&L
assumptions. Just for your clarity, this is how my assumption sheet looks at this stage –

Under the new P&L assumptions section, I will proceed sequentially, in the same order that the
line items are present in the P&L.

Notice, as discussed earlier, I’ve considered the growth rate for net sales, and for the remaining
line items, I’ve considered these as a percentage of net sales. For example, other income is the
percentage of the net sale; and the increase in stock is also a percentage of the net sale. So on.
Let us start with the Net sales growth rate; the growth rate is calculated the same way we
calculated the deferred taxes growth rate in the previous chapter. Here is the snapshot of Net
sales growth rate –
Yes, 81.83% seems high, but it is based on the net sales numbers reported by the company in Y1
and Y2. Here is something interesting that you can do. If you feel the numbers are unusually
high, then you can always cross-reference how the peer companies performed during the same
period.
If a company belonging to a particular sector has done phenomenally well for a particular year,
its peer companies would most likely have performed equally well. For example, if MRF posts a
20% increase in revenue for Y1, you should expect Apolo Tyres to post a 20% increase in
revenue. But for whatever reason, Apollo posts 16%, then you know that MRF probably has the
edge over its competition.
Of course, this is a very rough example, but I’m highlighting this to give you a perspective of
how you can think about companies while building the model.
I’ll go ahead and complete the P&L assumptions. As you can imagine, it is pretty
straightforward, or so I assume because we have done this in the balance sheet assumptions.
I’ve highlighted the Year 6 cell for net sales to showcase that subsequent calculations are all
simple averages. Of course, this excel will be available for you to download and inspect each
cell.
If you look at the P&L, the last two items on the expense side are Depreciation & Amortization
and interest expense. These numbers will flow from the schedules that we will build
subsequently.
The assumption sheet is now complete, and this is how it looks –

I’ve compressed the image to ensure you get to see the entire page.
I hope you followed the steps we’ve discussed in this and the previous chapter. Please do let me
know if you have any queries; I’ll be happy to reply to your queries to the best of my abilities.
In the next chapter, we will take the help of a helper model and understand how to deal with
receivables (assumptions) and set up a revenue model.
Download the excel sheet used in this chapter here.

Key takeaways from this chapter

o

o Deferred tax is as a percentage of depreciation

o Converting inventory data from Rupee value to the number of days helps us develop unique perspectives into the functioning of the
business
o Likewise, with the Receivable data
o A detailed revenue model gives granular insights into the revenue pattern of a company
o All line items belonging to P&L and Balance sheet are assumed in the assumptions sheet. A schedule is built for the items which
cant be assumed directly
o Specific schedules give us granular insights into the specific line item
 Revenue model
← Hide

1. 1Introduction to Financial Modelling

2. 2Excel workbook setup
3. 3Historical Data
4. 4Assumptions (Part 1)
5. 5Assumptions (Part 2)
6. 6Revenue model

6.1 – Common sense approach

In the previous chapter, we built the Balance Sheet and P&L assumption. Within the P&L
assumptions, we dealt with the revenue of the company as well. We did take a rather simplistic
approach to estimate the revenue of the company. The approach is ok as long as you intend to
build a simple financial model.
However, at times, taking efforts to build a dedicated revenue model of a company pays off. 
With a dedicated revenue model, you can identify the key revenue drivers and get some granular
insights into the behaviour of these revenue drivers.
In this chapter, I’d like to discuss the approach you need to take while building a company’s
revenue model. As you can imagine, the revenue model sits within the integrated financial
model, just like the assumption sheet.
Think of the revenue model as a sub-model within the financial model.
I’ll take the example of Bajaj auto in this chapter to explain how one can build a company’s
revenue model.
A sensible way to start building a revenue model is by asking common sense questions about the
company. In most cases, these questions themselves segways into a template for the revenue
model. We will take the same approach to build Bajaj Auto’s revenue model.
So here are a bunch of common-sense questions, and the answers to these questions will help us
build the revenue model.  By the way, the answers to all the questions are in the company’s
annual report.
So let us start.

6.2 – Digging data

As a first step, I download the latest annual report (FY 2020-21) from Bajaj Auto’s website. I’d
suggest you do the same. Like I mentioned, the annual report is where you will find all the
information you’d need.
Usually, from my experience, as the company matures, the annual report also evolves and
provides you with all the necessary information you’d need.
Anyway, let us get started with our common sense QnA. We will begin with a fundamental
question.
What does Bajaj Auto do?
No brainer, we have seen Bajaj Auto’s bikes and autorickshaws flood the Indian streets. So it is
evident that Bajaj manufactures and sells 2 and 3 wheelers. We will cross-check our assumption
from the annual report as well.
 
From their annual report, we can see that our assumption is correct (image above if from the
annual report). Bajaj does manufacture bikes and autorickshaws. The bikes are further segregated
into different segments.
The image below shows the ‘sports segment’ or ’S segment’ bikes. Apart from the S segment,
Bajaj has the Milage or M segment, Supersport or SS segment, Pro biking segment, and scooters.
But the point is Bajaj manufactures’ bikes’ or two-wheelers, so let us stick to that for now and
ignore the segmentation of bikes.
Apart from bikes, they also manufacture autorickshaws’ Commerical Vehicles’ (CV) or the
three-wheeler segment.

The CV category has different segments: passenger carrier (good old autorickshaws) and goods
carrier.
Why are the segments important to a revenue model?
Well, if you know the segments within a category, you can also figure out the segment-wise
revenue.
For example, the S segment is a segment within the bikes category, it will interesting to
understand how much revenue they make segment-wise, and which are their popular segments,
and what drives these segments.
With this information, you can build a granular revenue model. Unfortunately, the segment-wise
revenue distribution is not available in the annual report. Hence we will consider revenue for the
entire category as a whole, i.e. the two-wheeler (bikes) and the commercial vehicle (3 wheelers).
How much does Bajaj Auto manufacture?
I suppose this is also a straightforward question. As a financial modeller (or even an investor),
you need to understand the manufacturing capacity of the company. The reason is simple.
Suppose they manufacture 100 bikes in the year, and if they are selling 60 bikes, then with this
information we can interpret the following –
o

o
o The manufacturing plant operates at 60% capacity utilization. Capacity utilization is a simple ratio of how much they sell versus
how much they manufacture.
o The company has enough manufacturing buffer to meet future demands
o The company is unlikely to spend more money in terms of CAPEX anytime soon

Other perspectives –
o

o Why is the company selling only 60?

o How much do their competitors sell?
o Where does the company stand in terms of competition?
o How big is the industry? How many bikes (across all companies) are sold in a year?
o What is the company’s market share? (company sales divided/industry sales)

These questions will help us size up the company and eventually help the investors in the
valuation process.
Anyway, we will get back to the revenue model.  I found this image in their annual report
interesting –

The image gives us all the information in one shot. Let me list down the information for you –
o

o The company has three manufacturing units (or plants) in India, located in – Pantnagar, Waluj, and Chakan.
o Waluj is the oldest plant (set up in 1984), while the Pantnagar plant is their newest.
o All plants have been operational for a long time now.
o Pantnagar plant has a production capacity to manufacture 1.8M bikes, no commercial vehicles here.
o Waluj plant has a production capacity to manufacture 2.4M bikes and 9.3L commercial vehicles. Waluj is a super important plant
for Bajaj auto since this plant has production of both categories plus this is the only plant to manufacture commercial vehicles.
o Chakan plant has a production capacity to manufacture 1.2M units of bikes.

Since all the manufacturing facilities are old enough, assuming that the company has had a
similar production capacity for the last few years is fair.
Where do they sell?
The question is to help us understand where their target market is. We have seen Bajaj vehicles
across India. But do they sell in other countries apart from India?
Here is an extract from the annual report –

Without reading much into the details, we know –

o

o Bajaj Auto sells within India (domestic market)

o Bajaj Auto also sells outside India (international market)

From the extract, we can quickly note that Bajaj Auto sells around 2M vehicles in the global
market.
How many units of two-wheelers and CVs does Bajaj Auto sell in India and the International
market?
Now that we have established that Bajaj has a domestic and international market, it makes sense
to figure out how many units of bikes and commercial vehicles are sold in India and in the
International market.
From the annual report –
The highlighted data indicates the sale of domestic bikes. For example, in the year 2020, Bajaj
Auto sold 3.9M bikes. The break up of 3.9M across different segments of bikes is not available
(therefore no segment-wise revenue). But that’s ok for now.
Data for Domestic CV sales  –

As far as the exports are concerned, here is the snapshot –

The company has only reported domestic sales numbers across motorcycles (bikes) and CV for
FY20 and FY21. We will have to dig up the older annual reports for historical numbers.
Ok, a quick recap at this point. So far we know –
o

o The product the company sells

o Places where it manufactures the products
o The capacity of each manufacturing plant
o The geographies in which the company sells
o How many units the company sells across all their markets
That’s a fair bit of information. We now have to steer our way to find out details about how
much money the company earns in terms of revenues.
Remember, so far, we collected information by asking ourselves a few common-sense questions.
Once we collect all the necessary information, we make the revenue model on excel, step by
step.
Let us continue our QnA.
How much revenue do they make?
The most crucial question perhaps 😊
Clearly, when we talk about revenue for this company, we need to figure four essential things –
o

o How much revenue is from domestic bikes sales?

o How much revenue is from domestic CV sales?
o How much revenue is from international bikes sales?
o How much revenue is from international CV sales?

If we can collect the above information, we are on track to build the revenue model.
But here is where the challenge occurs; the company does not easily give out this information.
The information we have is –

Revenue is a consolidated number, which includes both domestic and export revenue. But
thankfully, Bajaj Auto gives us the export revenue –

With both these bits of information, we have to back work the details. For example, for FY 2020,
Revenue =Rs.29,111 Cr
Export Revenue = Rs.12,216 Cr
So Domestic revenue must be –
29111 – 12216
= Rs.16,895 Crs.
Once we have the revenue split from domestic and exports, we can do few other things to set up
the revenue model.

6.3 – Connecting the dots

We have now gathered all the info required to build the revenue model. We now have to plug
these values into an excel sheet and give it a logical sequence. Please note that if you are doing
this yourself, as a first step, you will have to get the historical data from the annual report.  In the
section above, I’ve highlighted how the data is collected. Hopefully, that will help you accelerate
your data collection process.
Given the data in hand, here are the steps that I’ll follow to develop the revenue model. As I have
stressed earlier, the steps that I follow make sense to me; if you feel there is a better way, you
should explore. Remember, there is no prescribed methods to build a model.
But I hope these steps will give you a good starting point.
Here is the overview of the steps I’ll carry out on excel –
o

o Organize the capacity data

o Gather the International sales data, i.e. the number of units of bikes and CV sold
o Gather the India sales data, i.e. the number of units of bikes and CV sold
o Add up the sales data to get consolidated bikes and CV sales data
o Input the historical revenue data
o Calculate the average cost of sale of bike and CV
o Identify the trend in change of average cost of sale
o Project the average price of the vehicle and reverse engineer the revenue data from the average prices.

If the steps above confuse you, then don’t worry, we will execute each of the steps, one at a time.
As a first step, we set up our excel sheet with the indexation. I’ve discussed this in the earlier
chapters, so I’ll directly post the snapshot for your reference.

I guess you are reasonably familiar with the layout. Columns A and B are indexed, C expanded,
panes frozen at E3. The actual financial years stated from F1 to J1, and the estimated years from
K1 to O1.
I have organized the manufacturing capacity data. Note I have segregated this in terms of bikes
and CV, but you can also arrange the data from the manufacturing plant perspective.

I have populated the manufacturing capacity numbers –

Note, the numbers are constant historically and for the future years as well.
Next up is the sales data. As I mentioned earlier, I’m interested in identifying the bike and CV
sales in India and Internationally. Once I have the data, I’m also interested in year on year (YoY)
changes in sales data.

As we saw earlier, most of the sales data is available in the annual report, except for the India
sales data for bikes. But this is ok; the company gives us the total bike sales (India +
International) and the total international bike sales data.
If we calculate the difference, we get the India bikes sales data. So a bit of number jugglery that
you will have to do.
Next, we calculate the YoY change (in percentage) bikes and CV sales in the Indian and the
International markets.

The math is simple for the YoY change –

= this year’s sales data/ previous year’s sales data – 1
= year on year change in sales, expressed in percentage.
The idea of calculating the YoY percentage change is to identify consistent trends if any. But
clearly, there is no trend in the data we have.
We could have taken a rolling average of the yoy change and projected for future years if there
was a trend. But now, we have to assume a flat YoY change.
I’ll project the YoY change without thinking much (to move ahead quickly), but of course, if this
were a serious model (based on which you’d invest), then we would have to spend some time
before we make the YoY change assumptions.
You can see the assumption I’ve made for the sales YoY change in percentage. You can also see
the calculation that I’ve made to project the future year’s sale of bikes and CV. I’ve completed
the math, and here is how the excel sheet looks –

Please note, I’ve summed up the bike and CV sales from both the Indian and the International
markets to get the total sales. For your reference, I’ve highlighted the total sales of bikes for
FY22E.
In the next step, we move our attention to the revenue data. I’ve taken the revenue data (India
and International) from the annual report.
Below the revenue numbers, I’ve set up excel to calculate the average sale cost for vehicles
(bikes + CV) across the Indian and the international markets. To calculate this, we need to divide
the India revenue number by the India vehicles sold data.
Let me do this math for FY 17 –
Revenue from India (FY17) = Rs.14,815 Cr
Total vehicles sold in India (bikes+ CV) = 22,54,617
Average selling price of a vehicle = 14815*(10^7)/2254617
= Rs.65,709.61/-
If you wonder why I used 10^7 in the math above, then it is to get the revenue number in Crores.
Here is how it looks on Excel –

I’ve calculated the YoY change in average cost of sale as well. I hope at this stage; you can
figure what to do next. If you do, then I’d be happy to know that my notes are helping you think
ahead 😊
Anyway, here are the last two steps to complete the revenue model.
o

o Assume a YoY change for future years, it could be a rolling average, or it could be a flat assumption
o Project the average cost of sale in the Indian and the International market
o Multiply the avg cost of sale and the number of vehicles sold to get the revenue in the Indian and International market
o Sum up both to get the total revenue.
I’ve executed all the above steps in excel, and here is how it looks –

I have highlighted both the cells so that you can see the formula I’ve used.
Here are few other things that you can do with the revenue model –
o

o We have the total bike and CV sales data. Compare this with the production data. Ensure the company is not selling
more than what it is making. If yes, then our model may be wrong and needs some tweaking
o If the vehicles sold are close to manufactured, the company may have to invest in a CAPEX cycle. This is valuable
information from an overall financial modelling perspective
o Calculate the capacity utilization, i.e. number of vehicles manufacture versus the number of vehicles sold.
o Calculate the market share. You can get the industry bike/CV sales data from an industry report (guess even the
annual report contains this), contrast this with what the company has sold, and get the market share number.
I guess this has turned into a lengthy chapter; I’ll stop it at this. But I hope this chapter has given
you a sense of how you can develop a company’s revenue model using a common-sense
approach. Always remember to start your revenue model by asking few basic questions.
The revenue model we have built here can be used for other auto manufacturing companies like
Hero Motors, TVS, MRF, Maruti, Tata Motors, and even Tesla!
You can download the excel used in this chapter here.

Key takeaways from this chapter

o
o The revenue model is a sub-model within your primary model
o You can build complex revenue models by starting with simple common sense questions
o All the data needed to make a revenue model is usually available in the annual report of the company
o Use the revenue model to extract other information like capacity utilization, CAPEX cycles, and industry market
share.