FINANCIAL MODELLING AND

BUSINESS SIMULATION
WEEK 1
 2

AGENDA

01 Introduction to Financial Modeling

02 Business Analysis Techniques

03 Forecasting Using Sales Percentage Approach

 3

1. INTRODUCTION TO FINANCIAL MODELING

 4

INTRODUCTION TO FINANCIAL MODELING

A financial model is a quantitative representation of a company’s

past, present, and future business operations.

A financial model is a required component of nearly any business

This Photo by Unknown Author is licensed under CC
BY-SA plan. Understanding how to build, use, and modify a financial
model is important when:
 starting a new business,
 starting a new line of business within an existing company,
 assessing the operations of an existing or proposed business,
This Photo by Unknown Author is licensed under CC
BY-NC  comparing the operations of two or more businesses.

Reference: Proctor, K. S. (2009). Building financial models with Microsoft Excel: A guide for business professionals (Vol. 532). John Wiley and Sons.
 5

INTRODUCTION TO FINANCIAL MODELING

There are many types of financial models:

1. Three-Statement Model 2. Discounted Cash Flow (DCF) Model

▪ The most basic setup for financial modeling. ▪ Using three-statement model to value a company
based on the Net Present Value (NPV) of the
▪ Three statements: income statement, statement of
business’ future cash flow.
financial position (balance sheet), and cash flow
▪ The DCF model takes the cash flows from the three-
▪ Dynamically linked with formulas in Excel.
statement model, makes some adjustments where
▪ All the accounts are connected. necessary, and then uses the NPV to discount them
▪ A set of assumptions can drive changes in the entire back to today at the company’s Weighted Average
model. Cost of Capital (WACC).
▪ These types of financial models are used in equity
research and other areas of the capital markets.

Reference: https://corporatefinanceinstitute.com/resources/knowledge/modeling/types-of-financial-models/
 6

INTRODUCTION TO FINANCIAL MODELING

There are many types of financial models:

3. Merger and Acquisition Model (M&A) 4. Initial Public Offering (IPO) Model

▪ The M&A model is a more advanced model used to ▪ Investment bankers and corporate development
evaluate the pro forma accretion/dilution of a professionals build IPO models to value their
merger or acquisition. business in advance of going public.
▪ The level of complexity can vary widely. This model ▪ These models involve looking at comparable
is most commonly used in investment banking company analysis in conjunction with an assumption
and/or corporate development. about how much investors would be willing to pay
for the company in question.
▪ The valuation in an IPO model includes “an IPO
discount” to ensure the stock trades well in the
secondary market.

Reference: https://corporatefinanceinstitute.com/resources/knowledge/modeling/types-of-financial-models/
 7

INTRODUCTION TO FINANCIAL MODELING

There are many types of financial models:

5. Consolidation Model 6. Budget Model

▪ This type of model includes multiple business units ▪ This is used to model finance for professionals in
added into one single model. financial planning & analysis (FP&A) to get the
budget together for the coming year(s).
▪ Typically, each business unit has its own tab, with a
consolidation tab that simply sums up the other ▪ Budget models are typically designed to be based on
business units. monthly or quarterly figures and focus heavily on
the income statement.

Reference: https://corporatefinanceinstitute.com/resources/knowledge/modeling/types-of-financial-models/
 8

INTRODUCTION TO FINANCIAL MODELING

There are many types of financial models: Focus of this course

7. Forecasting Model ▪ Master Budget: Operating Budget and a

Financial Budget
▪ This type is also used in financial planning and
▪ Financial Statements: Statement of
analysis (FP&A) to build a forecast that compares to
Financial Position (Balance Sheet),
the budget model.
Income Statement, and Statement of
▪ Sometimes the budget and forecast models are one Cash Flows
combined workbook and sometimes they are totally
▪ Valuation Using Discounted Cash Flow
separate.
Model
and many more… ▪ Sensitivity Analysis

Reference: https://corporatefinanceinstitute.com/resources/knowledge/modeling/types-of-financial-models/
 9

MASTER BUDGET (OVERVIEW)

Reference: Proctor, K. S. (2009). Building financial models with

Microsoft Excel: A guide for business professionals (Vol. 532).
John Wiley and Sons.
 10

MODEL DESIGN METHODOLOGY

Defined Objectives
✓ There should be defined outputs from the model rather than starting with the inputs.

✓ It is often better to start with the required answers rather than trying to define the assumptions.

Modular
✓ Models should be broken down into blocks of code that can be checked and audited.

✓ For example, a schedule of asset depreciation and written down value logically should be situated on one
sheet and loan payments and balances on another.

Reference: Day, A. (2012). Mastering cash flow and valuation modelling. Pearson UK.
 11

MODEL DESIGN METHODOLOGY

Layout – Physical Separation

✓ Each sheet in a model should look broadly the same and conform to standards of layout and
measurement.
✓ The input variables should be placed together in a single area or input sheets rather than spread
throughout the model.
✓ All the calculations should be in modules or blocks with no hard coded formulas (using specific amounts
instead of referenced cells).
✓ The answers should be clearly visible with a summary as close as possible to the inputs.

✓ The printed area should be clear, and any workings not required in the reporting should be in marked
areas outside the printed area.
✓ Workings can be hidden using grouping of hiding the cells.

Reference: Day, A. (2012). Mastering cash flow and valuation modelling. Pearson UK.
 12

MODEL DESIGN METHODOLOGY

Layout Illustration

Reference: Day, A. (2012). Mastering cash flow and valuation modelling. Pearson UK.
 13

MODEL DESIGN METHODOLOGY

Information Flow
If the planning starts from the outputs and
you split the model into physical areas,
information should flow through the model
in a logical manner. Some ‘rules’ that can
be applied:
✓ south and east

✓ left to right, top to bottom

✓ like a book – logical succession of topics

✓ information taken from a left-hand not a

right-hand sheet.

Reference: Day, A. (2012). Mastering cash flow and valuation modelling. Pearson UK.
 14

MODEL DESIGN METHODOLOGY

Technical Formatting
✓ Use informative labels
✓ Use the same dimensions and layout
✓ Color: inputs, outputs, workings and other cell types should be marked in a specific color and format to
ensure that others can understand where to enter data. E.g., blue to mark the control or input area and
(darker) grey for outputs.
✓ Use consistent styles
✓ Use appropriate number formats (positive/negative, percentage, date, etc.)
✓ Printing: fit on the sheet and print correctly
✓ Units and currencies should be clear
✓ Validation for data entry
✓ Self-checks (e.g., assets should be equal to liabilities and equity)

Reference: Day, A. (2012). Mastering cash flow and valuation modelling. Pearson UK.
 15

MODEL DESIGN METHODOLOGY

Technical Formatting (continued)

✓ Avoid complex and difficult formula. It would be better to break it down into multiple cells.
✓ Avoid mixed formula/hard code/’plug’ number in the formula.
✓ Avoid circular reference and links to other files.
✓ Use appropriate charts to help communicate the results.
✓ Provide front sheet to show who developed the model, owner, manager, purpose, last revision date and
any other relevant information.
✓ Use navigation/hyperlinks if there are many sheets in the workbook.
✓ Provide version and documentation for review process.

Reference: Day, A. (2012). Mastering cash flow and valuation modelling. Pearson UK.
 16

2. BUSINESS ANALYSIS TECHNIQUES

 17

BUSINESS ANALYSIS TECHNIQUES – SWOT ANALYSIS

▪ Strength: actions that work well for different problems
and confers the key advantages to the company.
Examples: company name, location, trusted employees,
great reputation, brand name, product, etc.
▪ Weakness: disadvantages which create problems for the
growth or policies of the company. Examples: bad
reputation, incomplete product, lazy employees,
department rivalry, etc.
▪ Opportunities: external facts and figures which have the
potential to provide an advantage or an edge above
competitors. Examples: underserved markets, few
competitors, emerging needs.
▪ Threats: external fact or information that can create a
disadvantage to the company. Examples: changes in
market research and trends, new regulations, new
technology.
This Photo by Unknown Author is licensed under CC BY-SA

Reference: https://www.analyticssteps.com/blogs/8-most-popular-business-analysis-techniques-used-business-analyst
 18

BUSINESS ANALYSIS TECHNIQUES – MOST ANALYSIS

▪ Mission: overall reason for being in business and

what will be the outcomes to accomplish.

▪ Objectives: specific aims for each department to

achieve its mission.

▪ Strategies: actions that should be taken in order to

accomplish organizational objectives. These are the
long-term approach to achieve objectives.

▪ Tactics: designed to carry out strategies in the

organization. These are short-term approach to
complete strategies.

Reference: https://www.analyticssteps.com/blogs/8-most-popular-business-analysis-techniques-used-business-analyst
 19

BUSINESS ANALYSIS TECHNIQUES – PESTEL ANALYSIS

Political factors are those driven by government actions and policies such as: corporate taxation, other fiscal policy initiatives, free
P trade disputes, antitrust and other anti-competition issues.

Economic factors relate to the broader economy and tend to be expressly financial in nature, including: interest rates, employment
E rates, inflation, exchange rates.

Social factors refer to shifts or evolutions in the ways that stakeholders approach life and leisure, which in turn can impact
S commercial activity. Examples: demographic considerations, lifestyle trends, consumer beliefs, attitudes around working conditions.

Technological factors include, but not limited to, automation, how research and development (R&D) may impact both costs and
T competitive advantage, technology infrastructure, cyber security.

Environmental factors emerged as the business community began to recognize that changes to our physical environment can
E present material risks and opportunities for organizations. Examples: carbon footprint, climate change impacts, stewardship of
natural resources (like fresh water)

Legal factors emerge from changes to the regulatory environment, which may affect the broader economy, certain industries, or
L even individual businesses within a specific sector. Examples: industry regulation, licenses and permits required to operate,
employment and consumer protection laws, protection of IP (Intellectual Property).

Reference: https://corporatefinanceinstitute.com/resources/knowledge/strategy/pestel-analysis/
 BUSINESS
MODEL
CANVAS

Reference:
Osterwalder, et. al. 2010
Business Model Generation
 21

BUSINESS MODEL CANVAS

Feasibility
1. The Key Partnerships describe the network of suppliers 2
and partners that make the business model work. 1
Companies forge partnerships for many reasons, and 3
partnerships are becoming a cornerstone of many business
models.
2. The Key Activities describe the most important things a
company must do to make its business model work.
3. The Key Resources describe the most important assets
required to make a business model work. These resources
allow an enterprise to create and offer a Value Proposition,
reach markets, maintain relationships with Customer
Segments, and earn revenues.

Reference: https://www.strategyzer.com/business-model-canvas/building-blocks
 22

BUSINESS MODEL CANVAS

Desirability
1. The Value Proposition describes the bundle of products 2
and services that create value for a specific Customer 1 4
Segment. The Value Proposition is the reason why 3
customers turn to one company over another. It solves a
customer problem or satisfies a customer need.
2. The Customer Relationships describe the types of
relationships a company establishes with specific Customer
Segments. A company should clarify the type of
relationship it wants to establish with each Customer
Segment.
3. The Channels describe how a company communicates with 4. The Customer Segments define the different
and reaches its Customer Segments. Channels are groups of people or organizations an enterprise
customer touch points that play an important role in the aims to reach and serve. Without (profitable)
customer experience. customers, no company can survive for long.
Reference: https://www.strategyzer.com/business-model-canvas/building-blocks
 23

BUSINESS MODEL CANVAS

Viability
1. The Cost Structure describes all costs incurred to operate a
business model. This building block describes the most
important costs incurred while operating under a particular
business model.
1 2
2. The Revenue Streams represents the cash a company
generates from each Customer Segment (costs must be
subtracted from revenues to create earnings).

Reference: https://www.strategyzer.com/business-model-canvas/building-blocks
BUSINESS
MODEL
CANVAS
EXAMPLE
-
AMAZON

Reference:
https://corporatefinancein
stitute.com/resources/kno
wledge/strategy/business-
model-canvas-examples/
 25

PORTER 5 FORCES MODEL

The Porter strategy model may represent a sound basis for
comparing the company’s ability to sustain a ‘competitive
advantage’ and achieve a performance above the sector
norm.
The model shows the potential forces from:
 Supplier power – forcing higher input prices.
 Threat of entry – governed by the cost of entry into the
sector.
 Threat of substitutes – removing a need for the
company’s products.
 Buyer power – forcing down prices or imposing
constraints.
 Rivalry in the sector – either a limited number of
companies control competition and therefore increase
margins, or there are a number of players, but no single
firm has a critical mass that allows it to control the market.

Reference: Day, A. (2012). Mastering cash flow and valuation modelling. Pearson UK.
 26

3. FORECASTING USING PERCENTAGE OF SALES

 27

FORECASTING OBJECTIVES
Investors
• To assess value and consider whether assets are over- or
undervalued.
• Future cash flows and their likelihood are one method of
quantifying potential gains and risk.

FORECASTING Bankers and Lenders

• To consider the ability to pay and the impact of strategic and
Provides expectations economic downturns in the company’s fortunes.
of future performance
for analysis and
decision making
Competitiveness
• To assess the company’s financial strength and ability to grow
and compete with competitors.

Reference: Day, A. (2012). Mastering cash flow and valuation modelling. Pearson UK.
 28

FORECASTING METHOD

The modelling forecast splits into several phases:

▪ sales and costs on the income statement

▪ assets and depreciation

▪ debt, interest payable and split between current and long-term

Will be covered in
portion of debt
more detail in other
▪ tax and tax depreciation sessions
▪ balance sheet current asset and liabilities

▪ cash reconciliation to the balance sheet

▪ model checks to ensure that everything balances.

Reference: Day, A. (2012). Mastering cash flow and valuation modelling. Pearson UK.
 29

FORECASTING METHOD

→ Each stage requires a number of assumptions with varying levels of detail and estimation.

→ The model should be flexible enough to portray the downside and extreme cases.

→ At each stage there needs to be a ‘sanity’ test to review the figures for reasonableness. Example: if the
company has grown at 2 per cent for the last five years, you will need to explain how a 10 per cent
growth can be realized and what strategy will bring this about.
→ There are a number of factors that cannot be estimated directly, such as political influence or
management competence, and you will have to be mindful that the model is a simplification that
cannot take into account all the relationships and complexity of the real world.

Reference: Day, A. (2012). Mastering cash flow and valuation modelling. Pearson UK.
 30

PERCENTAGE OF SALES METHOD

▪ Sales usually drive the forecast since costs, investment and loans depend on the level of sales and sales
volumes.
▪ Sales can be analyzed by different divisions, product areas or geographic regions.

Sales growth consideration:

▪ forecasts available from government, international banks, or other organizations to understand the
potential growth rates
▪ comparison with peer groups
▪ common size analysis to uncover recent trends

Reference: Day, A. (2012). Mastering cash flow and valuation modelling. Pearson UK.
 31

PERCENTAGE OF SALES METHOD

To develop a budgeted set of financial statements we may use the percentage-of-sales method. Each historical expense
is converted into a percentage of net sales, and these percentages are then applied to the forecasted sales level in the
budget period.
For example, if the historical cost of goods sold as a percentage of sales has been 55%, then the same percentage is
applied to the forecasted sales level. The approach can also be used to forecast some balance sheet items, such as
accounts receivable, accounts payable, and inventory.

Basic steps in using percentage-of-sales method for forecasting

1. Determine whether there is a historical 3. Apply the applicable percentage of
2. Estimate sales for the forecast
correlation between sales and the item to be sales to the item to arrive at the
period.
forecasted. forecasted amount.

Advantages: Disadvantages:
• It is the quickest way to develop a forecast. Many expenses and balance sheet accounts are fixed or
• It can yield high-quality forecasts for those items have a fixed component, and so do not correlate with
that closely correlate with sales. sales. Example: rent expense, fixed assets and debt.

Reference: https://www.accountingtools.com/articles/the-percentage-of-sales-method.html
 32

GROUP ASSIGNMENT
 33

GROUP ASSIGNMENT
 Students are assigned into 6 groups
 Each group proposes a business idea and creates a step-by-step financial model
throughout the course
 Two or three groups per week will present their weekly progress (Week# 2-4 and
Week#6-9)
 All groups will present overall progress in week #5 and # 10
Assignment Week #1
 Create a business idea using Business Model Canvas and PESTEL Analysis
 Also provide general information and 5-year strategic planning for your business idea
 The template for assignment is provided, but you can modify it as needed.
 34

Thank You