Mastering Cash Flow and Valuation Modelling (The Mastering Series)
Inflation is an important vari- able which has been omitted to simplify the model. The features included in the model are shown in Figure 5. SUMMARY The chapter has reviewed a case study of an outsourcing example as a vehicle to demonstrate the stages in layering Excel features and tech- niques. Each model follows the design procedure outlined in Part A to provide templates for study and further development.
The starting point is the publicly available information organizations produce in the form of annual reports. The level of detail depends on corporate governance and legal require- ments in the country where the company resides. Private companies often produce very little information and indeed the trend in the UK is to demand less information and even dispense with a third-party audit.
Mastering Cash Flow and Valuation Modelling by Alastair Day | Waterstones
The report also details the accounting standards and conventions used by the company in drafting the report and accounts. This is important since it is often difficult to compare companies across borders due to differing standards.
For example, accounting profit can be enhanced by increasing the depreciation period for assets or changing the method of valuing stock. Analysing performance depends on standardizing the information available so that the raw data can be processed to provide information on the performance of the company.
Unfortunately, the information usually lies in a number of sections. To understand the figures, you have to continually flip from one section to another. The figures tend to overpower the reader with the wealth of detail.
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Most people are not proficient at handling large quantities of numbers and immediately understanding the relationships between them. If you are going to lend money to the company or understand its performance, you need to decide if the organization is becoming more or less risky. The base information will also provide the data for further information on cash flow, forecasting and company valuation. The company is the fic- titious organization Technology Sales Limited.
The first stage of the exercise is to produce a model which contains sched- ules for the income statement and balance sheet. The model allows up to five years of results in order to ascertain the trends. The cash flow and some ratios can be derived from this information. The model also tries to build on the good practice discussed in the first five chapters.
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However, it could be made more complex with the addi- tion of more lines to display an increased level of detail. Fig 6. The input cells are marked blue and the totals are in bold green. The latter cells only add up the cells above, which all adhere to the cash flow rule. Cash received is positive while cash outflows are entered as negative numbers.
It can be a problem understanding the source of the cell results. The levels of profit are clearly marked as in Table 6.
Table 6. Again the format corresponds to international notation and is split into current and fixed assets see Figure 6. Again, you could increase the detail by adding columns for more share types such as preference shares. There is no real programming here and Excel is used to ensure that the columns add correctly. The formatting of the numbers, colours, columns and general appearance is common throughout the application.
Similarly, all reports are formatted ready for printing with custom head- ers and footers inserted using a macro called SetUpSheet. In this form, you can look along the rows and try to pick out trends. The percentage views assist, but eventually you need to look more closely by calculating ratios which can be tedious with a pocket or financial calculator.
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However, this process is straightforward using Excel. RATIOS The purpose of this section is to outline some of the ratios used by analysts and their purpose rather than an in-depth analysis of the accounts in the example. Financial analysts tend to dis- count luck and concentrate on the results through ratio analysis. Figure 6. The first stage is to define the purpose of the investigation.
The problem is to decide if the company can survive and generate earn- ings, so next one would study the industry and its competitive position. Some industries can build barriers around them that ensure that they can generate profits over a long period. Other industries possess advantages such as patents or brands which enable them to produce superior profits over time. Companies such as Microsoft would fall into this category, where its position, as a dominant player, has allowed it to grow quickly over the last decade and protect many of its markets from competition. The three areas of risk determine the quality and quantity generated by the organization.
The decisions of what and how much to produce are underpinned by the management. Operating cycle. The company delivers the goods, invoices its customers and has to wait for the customer to pay. If it cannot sell its goods, then they will sit in the warehouse and have to be funded from the operating cycle, bank finance or new equity.
This is termed business risk.
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Performance risk means profitability, which in turn usually equates to cash flow. In the long term, a lack of profits usually means that a company will be uncompetitive, go bust or will be taken over by businesses that are more aggressive. Where you have profits, but no cash, then you need to examine the accounting standards used or investigate creative accounting practices.
For example, costs moved to the balance sheet such as research and development mean that cash has been spent, but is being recorded in the profit and loss account over a number of periods. This increases profits in the short term at the expense of the long term. Financial risk is concerned with the structure of the balance sheet together with who provides the finance facilities to the company. The essential difference between debt and equity is that dividends do not have to be paid, while bankers require payment. As the proportion of debt increases, so does the interest burden and therefore the amount of finan- cial risk.
Ratios in this section illustrate the proportion of the company owned by the shareholders and degree of financial burden. The ratios considered in this book are listed in Figure 6. This is considered the most impor- tant since this ratio computes the return to shareholders who risk their capital in the enterprise. This directs the user at the lines that need investigation or further atten- tion. If the number of days or the gap increases, this means that the com- pany has to find more resources to fund the cycle.
In each formula, the possibility of an error caused by a zero number is handled by an IF statement. The answer is multiplied by since the application standardizes on numbers rather than a mixture of numbers and percentages. M10 ,0, Income!
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More risk should demand a greater return to shareholders. The value of equity may be better presented by the market value of debt and the market value of equity enterprise value. Profitability depends on strategy and the market. Competition means that companies are not free to make as much profit as they wish. Companies with strong brands can be expected to produce superior profits whereas small companies are often dependent on one or two products or on sub- contracts from a larger company. Asset turnover depends on the sector and the assets needed in the busi- ness. Software houses invest in people as the major asset in developing competitive advantage as opposed to a car manufacturing company that requires a high level of fixed plant and equipment.
Asset leverage depends on the uncertainty of cash flows. In a risky business, such as pharmaceuticals, shareholders are normally expected to fund research and development. British Biotechnology plc has returned to the market several times since inception in the mid s in order to fund new product development.