Corporate finance modelling and analysis : a practical guide [English ed.] 9781843749110, 1843749114

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Corporate Finance Modelling and Analysis A Practical Guide

Corporate Finance Modelling and Analysis A Practical Guide

David Whittaker

E U R O M O N E Y

B O O K S

Published by Euromoney Institutional Investor PLC Nestor House, Playhouse Yard London EC4V 5EX United K ing dom T el: + 44 ( 0 ) 2 0 7 7 7 9 8 9 9 9 or US A 1 1 8 0 0 43 7 9 9 9 7 F ax : + 44 ( 0 ) 2 0 7 7 7 9 8 3 0 0 w w w . euromoneybook s. c om E- mail: hotline@ euromoneyp lc . c om Cop yrig ht © 2 0 1 1 Euromoney Institutional Investor PLC

IS B N 9 7 8 1 8 43 7 4 9 1 1 0

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Note: Elec tronic book s are not to be c op ied, f orw arded or resold. No alterations, additions or other modiic ations are to be made to the dig ital c ontent. Use is f or p urc haser’s sole use. Permission must be soug ht f rom the p ublisher w ith reg ard to any c ontent f rom this p ublic ation that the p urc haser w ishes to rep roduc e ( book s@ euromoneyp lc . c om Libraries and book sellers and ebook distributors must obtain a lic enc e f rom the p ublishers ( book s@ euromoneyp lc . c om) . If there is f ound to be misuse or ac tivity in c ontravention of this c lause ac tion w ill be broug ht by the p ublisher and damag es w ill be p ursued. T yp eset by Phoenix Photosetting , Chatham, K ent

This book is dedicated to the memory of my late friend, David Morrison and my late uncle, John Nolan

Contents About the author Introduction Section 1

Building the forecasting inancial model Financial modelling best practice Scope Designing the inancial model Layout Layout exercise Timeline Timeline exercise Capital expenditure Capital expenditure exercise Financing Financing exercise Sales Sales exercise Operating costs Operating costs exercise Working capital Working capital exercise Accounting Accounting exercise Taxation Taxation exercise Dividends Dividends exercise Equity returns and lenders’ ratios Proit and loss account Proit and loss exercise Cash low Cash low exercise Balance sheet Balance sheet exercise Sensitivities Sensitivity exercise

xi xiii 1 1 4 6 6 8 8 8 8 8 8 9 9 9 9 10 10 10 10 11 11 12 12 12 12 13 13 14 14 14 14 15 19 vii

Con t en t s

Section 2

viii

Checks Checks exercise Summary Summary exercise Finalising the existing business corporate inancial model Exercise inalising the corporate inance model Sources of error Self testing the model Top level analytical review Key output review Flex and sensitivity review Exercise self testing the inancial model Using the model Disclaimers

19 19 19 20 20 22 22 23 23 27 34 34 34 35

Corporate inance decisions Acquisitions Step 1 Undertake due diligence regarding the actual inancial position of the target company Step 2 Place an acquisition value on the target Step 3 Prepare the acquirer actuals and projections Step 4 Prepare the combined co-actuals and projections Acquisitions exercise Mergers Company merger exercise Initial public offering IPO exercise Rights issues Rights issues exercise Disposals Disposal exercise Reinancing Reinancing exercise Capital structures Capital structures exercise Dividend policy Dividend policy exercise Working capital management Stock control exercise

37 37 37 37 45 45 46 47 53 53 55 55 58 58 59 60 60 60 61 61 65 65 69

Con t en t s

Section 3

Other areas for inancial modelling and analysis Project inance as a source of funding Key project inance areas Dividends exercise IFRS (IFRIC 12 concession accounting) Financial asset accounting Fixed asset accounting Revenue recognition Debt sculpting Debt sculpting exercise Private equity as a source of funding Modelling different debt structures Amortised debt schedules Bullet debt schedules Sculpted debt schedules Straight line debt schedules Debt schedules exercise Capital investment appraisals Capital investment appraisal exercise Supplier and partner evaluations Supplier and partner evaluations exercise Business plans Sale and lease back decisions Negotiating by using sensitivity analysis Lease versus buy decisions

71 71 74 75 75 75 79 79 79 83 84 85 85 86 86 86 86 86 88 88 90 90 94 96 96

Section 4

Additional useful Excel functions FV MIRR NPER RATE XIRR XNPV

103 103 103 104 105 106 106

Section 5

Using VBA An introduction to Excel VBA Protect functionality Unprotect functionality Menu functionality Auto open functionality Auto close functionality

109 109 113 113 114 117 118 ix

Con t en t s

Using a timeout facility for demo inancial models Unhide sheets Hide sheets Exercise Excel VBA

118 120 121 121

Section 6

Reviewing and auditing corporate inance models Limited scope inancial model reviews Exercise self-testing your corporate inance model Financial model audits – corporate inance models

123 123 126 126

Section 7

Financial modelling management issues Project management Exercise The use of generic and template inancial models Exercise generic and template inancial models

151 151 151 152 152

Section 8

Other approaches to risk Data tables Scenario manager Goal seek Risk exercise

153 153 153 154 154

Section 9

Financial failure and liquidation Capital reconstruction

155 158

Conclusion

173

Glossary

175

x

About the author

David Whittaker is the D irec tor of M odelling S olutions. He is a Chartered M anag ement A c c oun Prac tising Certiic ate Holder and a inanc ial modelling solutions p rovider, w ho has over six teen years ex p erienc e w ithin inanc ial modelling f or c ommerc e, industry, p ublic sec tor and the big f our inan modelling p rac tic es. He has led several inanc ial modelling training c ourses and seminars f or c orp orat inanc e. M odelling S olutions p rovide Ex c el- based inanc ial modelling servic es to org anisations c orp orate inanc e, p roj ec t inanc e, PPP and PF I. w w w . modelling solutions. c o. uk w w w . david- w hittak er. c o. uk

xi

Introduction

T his book has been sp ec iic ally w ritten to address the inanc ial modelling and analysis needs f or c orp orat inanc e transac tions and p roj ec ts. R eaders may c urrently be at the beg inner or intermediate level. How ever, it is also usef ul f or manag ers w ho req uire a f urther understanding of the p roc ess w ithout having to g throug h the learning c urve of ac tually bec oming hands on. T he maj or areas w hic h req uire analysis a addressed by the use of relevant ex trac ts of a demonstration inanc ial model f or ex amp le p urp oses. R eader w ill be able to g o throug h the p roc ess of building the inanc ial models on a step by step basis w ith ref eren to the ex amp le ex erc ises at their ow n p ac e, p roviding an ex c ellent sourc e of Itskis ills important transf er. to note that the igures or the Ex cel ex ample logic used in this book do not represent any past, current or indeed future corporate inance transactions or proj ects of any kind. The numbers and results contained herein are purely ictional. T his book inc ludes a series of Illustrations. It is imp ortant to note that some Illustrations are p rovided as p art of the book ’s tex t and others are p rovided as Ex c el ex amp les sep arately. T he ap p roac h tak en is to irstly build a inanc ial f orec asting model f or an ex isting unq uoted c omp that w ill help to demonstrate the log ic behind the modules req uired and theref ore p roviding a basis f or the develop ment of eac h of the c orp orate inanc e modelling and analysis p roj ec ts that w ill later be demonstrate in this book .

xiii

Section 1

Building the forecasting inancial model

Financial modelling best practice A rec ommended ap p roac h to inanc ial modelling best p rac tic e ( F M B P) is show n in Illustration 1

Illustration 1 Financial modelling best practice SCOPE

SPECIFY

DESIGN

BUILD

DOCUMENT Version control

TEST

• Purpose

• Sensitivities

• Timescales

• Key outputs

• Functionality

• Periodicity

• Specification document • Sponsors buy in

• Excel?

• Workbooks?

• Modularisation

• Inputs/calcs/outputs

• Unique formula

• Simple formula

• Check sums

• User and technical documentation

• Analytical review

• Data book

• Key outputs review

• Sensitivities

Change control

USE

• Handover session

S ource:M odelling S olutions

A struc tured ap p roac h w hic h should ideally be adop ted is of ten ref erred to as ‘inanc ial modelling be p rac tic e’. It is bec ause the inanc ial modelling f or c orp orate inanc e p roj ec ts is hig h risk due to the f a millions of p ounds are involved w ith a number of c omp lex c alc ulations and arrang ements that a struc tured ap p roac h is desired. I rec ommend that a F M B P ap p roac h is ap p lied to all inanc ial modelling p roj ec ts, not j ust c o inanc e p roj ec ts. 1

Corp orat e F in an ce Mod ellin g a n d A n alysis

How ever in the p ast I have of ten been ask ed ‘isn’t F M B P too rig id? ’ M y answ er to this is that a balanc should ideally be struc k g iven the f ac t that an org anisation is bidding or trying to c lose a transac tion over a reasonably tig ht timesc ale. In f ac t, the vast maj ority of inanc ial c lose models are not p artic ularly w ell desig ned g iven this very f ac t. Let us w alk throug h Illustration 1 and disc uss how F M B P relates to our need to build and rely up on the results to be derived f rom our c orp orate inanc e model. In the sc op ing stag e, w e w ill irstly tak e a look at stating the p urp ose of the model. T he p urp ose o model here is to p rep are f orec asts to p rovide inanc ial p roj ec tions of an ex isting business over a 1 0 year p lanning horiz on. T he log ic and numbers p rep ared f rom this initial model build w ill be used f or various transac tions and illustrations later on in this book . In terms of the k ey outp ut sc hedules that are req uired these w ould be the p roit and loss, c ash low and balanc e sheet w hic h are usually annually over a 1 0 year f orec ast p eriod. T here w ould need to be some k ey outp uts show n w hic h address both the eq uity p roviders’ and lenders’ needs of this ex isting business. ●

●

● ●

●

Sensitivities, that is, the ability to lex the c omp any’s assump tions and observe the imp ac t up on the results in the base c ase should be derived f rom the c omp any’s risk assessment p roc ess. T he maj or business and inanc ial risk s should alw ays be deined as sensitivity c ases and the imp ac t measured and mitig ated ac c ording ly. T hetimescale that you have f or your c orp orate inanc e modelling p roj ec t g iven w here you are is c ritic al g iven the siz e of the sc op e or typ e of resourc e req uired. F or ex amp le, if time is tig ht you m w ant to limit the outp uts of your model to a bare minimum and ensure that you use an ex p erienc ed modeller on the p roj ec t, w ho is able to c lose out the w ork ef ic iently. Functionality ref ers to the need to have sp ec ial f ac ilities in the model over and above the basic c alc ulations. A n ex amp le of this w ould be any req uired op timisation or p erhap s data table f unc tionality A t thespeciication stag e, it is advisable to p rep are a doc ument that c onsiders the p urp ose of the model, k ey outp uts, material c alc ulations and assump tions as hig hlig hted in the sc op ing stag e above. A n ex amp le of a temp late that c an be c omp leted in order to sc op e and sp ec if y the inanc ial model c a be seen by ref erenc ing Illustration 4. M oving on to the design stag e, its of ten imp ortant to c onsider w hether M ic rosof t Ex c el is the best p latf orm f or this modelling and g iven the nature of c orp orate inanc e p roj ec ts the answ er to this p oint is almost alw ays a yes w ith 9 9 . 9 % c ertainty. Consider how many Ex c el w ork book s are req u A nd g iven my k now ledg e and ex p erienc e of c orp orate inanc e modelling , normally the sing le Ex w ork book w ill suf ic e. How ever, a very imp ortant c onsideration is the model’s struc ture and layout. I p ersonally p ref er to adop t a modular ap p roac h relec ting the sheet names w hic h are labelled w ith c om monsense names.

F rom ex p erienc e, I have of ten w itnessed inanc ial staf f and modellers j ump ing straig ht into the build stag e and indeed many best p rac tic e methodolog ies ig nore the other p roc esses or stag es assoc iated w ith F M B outlined in this book . How ever, onc e you are at your k eyboard at your c op y of M ic rosof t Ex c el, I rec ommend that the f ollow ing simp le c onc ep ts are adop ted. T he irst p rinc ip le is to k eep a c lear sep aration of inp uts, c alc and outp uts. M ore simp ly, try to desig n the model so that it reads lik e a book f rom lef t to rig ht. W here you c annot avoid inc luding c alc ulations w ith your inp uts, ensure that you p rotec t the c alc ulation c ells ap p rop ately. T he sec ond p rinc ip le is to only use one uniq ue f ormula p er row . W hat this ex ac tly means is the log p lac ed in the irst c olumn should be c op ied ac ross all c olumns of a time line. T his mak es it easier both f or 2

Sect ion 1 B u ild in g th e forecast in g fin an cial mod el

you and others to review your f ormulae. T hirdly, in order to ensure log ic al ac c urac y along the w ay I rec om mend as many c ross c hec k s and audit c hec k s are p lac ed in the model. S ome obvious ones are balanc e sheet balanc ing , c ash low s eq ualling the movement in the balanc e sheet c ash, net p roits eq ualling the movemen in the balanc e sheet retained earning s, among st many others that c ould be c ited. M y inal p ointer is to try to k eep your f ormula as simp le as p ossible and your labels as c lear as p ossible. How ever, it is also rec og nised that it is of ten dif ic ult to have very simp listic f ormulae w hen a inanc ial model builder is trying to g ain lex ibility in resp ec t of the c alc ulations and assump tions in the inanc ial model. A g ain, I rec ommend that balanc ed ap p roac h is adop ted. D oc umentation ref ers to the need to p roduc e user and tec hnic al doc umentation and a data book w hic is more f ully disc ussed in the sec tion on inalising the model. T he testing and the use of the model w ill also be more f ully disc ussed in the sec tion on testing the model. M y f urther rec ommendations are that both version and c hang e c ontrol log s are k ep t in your model. F irstly, ensure that eac h model version has a seq uentially numbered suf ix at the end of the Ex c el ilename ( f or ex amp le, inanc ialmodelV1 . x ls) and, w here timing p ermits, log the dif f erenc es betw een eac version in the model’s version c ontrol sheet, see Illustration 2 . S ec ondly, you c an use the model’s c hang e req uest log f or c hang es req uested or w ork outstanding and their status, see Illustration 3 .

Illustration 2 Version control Number

File Name

Date

Changes / Comments

Modeller’s Name

1 2 3 4 5 6 7

S ource:M odelling S olutions

3

Corp orat e F in an ce Mod ellin g a n d A n alysis

Illustration 3 Change control Number

File Name

Date

Change Request Details

Modeller’s Name

Status

1 2 3 4 5 6 7 8 9 10

S ource:M odelling S olutions

I w ill now tak e you throug h the p roc ess of building the c orp orate inanc e model. T he ap p roac h th tak en is step by step ref erring to Ex c el inanc ial model ex trac ts. D uring our step by step ap p roac h to ing the inanc ial model w e w ill of ten use Ex c el VB A log ic or mac ros, it’s imp ortant to note that the basic reg arding Ex c el VB A and mac ros are c onsidered beyond the sc op e of this book and ref erenc e should b made to ap p rop riate tex t or training in this rather detailed area. O f c ourse, readers w ith limited Ex c el VB A k now ledg e w ill ind this p rep aration a p rereq uisite f or understanding some of the more advanc ed tec hniq ue used, essential f or our inanc ial modelling and analysis req uirements.

Scope

O bviously, g iven the disc ussions reg arding F M B P outlined above our starting p oint f or the p urp oses of t book is to deine the sc op e of our c orp orate inanc e model build p roj ec t. F irstly, w e need a inanc ial p roj ec tion model that is c ap able of tak ing the latest historic balanc e sheet and integ rating the ac tuals w ith the annual f orec asts w hic h need to be p roj ec ted annually. S ec ondly, w e req uire c redit ratios to be c alc ulated f or lenders. T hirdly, w e req uire internal rates of return ( IR R ) f or the shareholders dividend streams. F ourthly, w e req uire c omp lianc e w ith UK G A A P and UK tax leg islation f or c orp oration tax F if thly, w e req uire a w ell desig ned and laid out inanc ial model that c an be adj usted and up dated f or the p otential c orp orate inanc e transac tions outlined in the c ourse of this book .

4

Illustration 4 Speciication template SPECIFICATION V1 THE FINANCIAL MODEL FOR THE PROJECT XXXXX FORECASTING PURPOSES Contents Objective of the model Users of the model Output schedules required Material calculations Input data Functionality required Appendices

page x page x page x page x page x page x page x

1 Objective of the model The model will be used for ten inancial projections for both shareholders and lender purposes. The objective of the model is to provide 10 years inancial forecasts on a yearly basis. • Cash low ; • Proit and loss account ; • Balance sheet ; • Key ratios both lenders’ credit ratios and shareholders’ equity IRRs. Appendix A shows the outputs outlined above. 2 Users of the model The model will be owned and used by xxxxx xxx and his team. The model will be made available to bank. 3 Output schedules required The output schedule formats are outlined in Appendix A. 4 Material calculations a b c d 5 Input data The inputs are as required to be derived from the models outputs and calculations and MS will deine these. More speciically . continued

Corp orat e F in an ce Mod ellin g a n d A n alysis

6 Functionality required • • • • Appendix A Output schedules • Cash low format

• Proit and loss account

• Balance sheet

• Key output summary

Appendix B Input schedules The inputs are as required from the models outputs and calculations and Modelling Solutions will deine these where they have not been outlined. Source: Modelling Solutions

Designing the inancial model

A g ain, g iven the disc ussions reg arding F M B P outlined above our nex t stag e is to deine the desig n f or o c orp orate inanc e model. It is obvious to us that our inanc ial model c an and w ill be built in Ex c el. A ny version f rom Ex c el 2 0 0 3 onw ards w ill be suitable f or our req uirements. O ne w ork book is all that is req uired and w e w ill desig n o model on a modular basis break ing dow n the k ey areas of the log ic .

Layout T he nex t stag e is to deine the struc ture of the ex isting business c orp orate inanc e model in Ex c el, starting w ith the outp uts and w ork ing bac k to the req uired inp uts. T his enables the modeller to c omp lete the log and deine the inp uts and c ollec t them. T he ex amp le outlined in Illustration 5 ( see Illustration5. x ls) show s a layout of the inanc ial model w hic h w ill allow us to c omp lete the build. T he inanc ial model layout inc ludes administration sheets at the f ront, f ollow ed by yellow sheets f or inp uts, the intermediate c alc ulations sheets are in g reen, and the outp ut sheets are in blue. T he c olour sc heme adop ted visually p resents us w ith an inc rease of c olour shading f rom lef t to rig ht in the f orm of w hite, yellow , g reen and blue. T his is a standardised model layout that I adop t f or all my inanc ial model build p roj ec ts. You w ill notic e that the sheets are org anised on a modular basis g iven the sc op e and p urp ose

6

Sect ion 1 B u ild in g th e forecast in g fin an cial mod el

of the inanc ial model. T he sheet names are c lear and p retty w ell self ex p lanatory. W here there is an ex c tion to this rule p lease ref er to the model layout listing below w hic h ex p lains the p urp ose of eac h she Essentially, the inp ut and c alc ulations are in w ork sheets w here you w ould log ic ally ex p ec t to ind them. w ill notic e that the outp ut sc hedules are already inc luded as at this stag e it is q uite standard to have ag reed these w ith the end c lient by suc h a stag e in the inanc ial model build p roj ec t. W e have inc luded a f ormat f the P& L, Cash low , B alanc e sheet, S ummary, S ensitivities and the Chec k sheet.

Illustration 6 Layout Worksheet name

Description

COVER

This represents the cover with the disclaimer.

VERSION CONTROL

This represents the version control log.

CHANGE CONTROL

This represents the change control log.

General Inputs

The general inputs for the base case projections.

Sensitivity Inputs

The Sensitivity Inputs are entered here.

Sales-Costs-Accounting

This represents the sales, operating costs and accounting.

Financing & W.Capital

This represents the inancing and working capital calculations.

Taxation

This represents the taxation calculations.

Equity Returns & Lenders Ratios

This represents the shareholder returns and lenders credit ratios calculations.

Sensitivity Calcs 1

This represents the holding area for sensitivity calculations.

Sensitivity Calcs 2

This represents the holding area for sensitivity calculations.

Sensitivity Calcs 3

This represents the holding area for sensitivity calculations.

Sensitivity Calcs 4

This represents the holding area for sensitivity calculations.

Sensitivity Calcs 5

This represents the holding area for sensitivity calculations.

Proit & Loss

This represents the P&L forecast over the 10 year forecast period.

Cashlow

This represents the cash low over the 10 year forecast period.

Balance Sheet

This represents the balance sheet over the 10 year forecast period.

SUMMARY

This is a summary sheet for the project.

SENSITIVITIES

This is the summary of each of the sensitivity results against the base case results.

CHECKS

This is the check sheet which ensures that the calculations in the model cross check.

S ource:M odelling S olutions

7

Corp orat e F in an ce Mod ellin g a n d A n alysis

W hen you c ross ref erenc e the narrative above to Illustration 6 it is p lain to see that the names used in our layout ap p ear to be relatively self - ex p lanatory and straig ht f orw ard. T his is w hat one w ould ex p ec t to ind f rom undertak ing suc h an ap p roac h.

Layout exercise You are now ready to start to build your ex isting unq uoted c omp any inanc ial model in your c op y of Ex c el. Prep are the model layout by using the same sheet layout and outp ut sc hedules as used in the ex amp le.

Timeline

W e w ill now c omp ute the timeline f or the ex isting business c orp orate inanc e model. I w ill now tak e throug h the log ic of this module w ith ref erenc e to Illustration 7 ( see Illustration7 . x ls) . T he model start date f or the irst f orec ast date is deined in the G eneral Inp uts sheet by the use of a drop dow n box w hic h has been set up using a date rang e. T he rang e of dates used f or selec tion is loc ated c olumn A I. T he irst date of eac h monthly interval is c alc ulated and link ed to the drop dow n box by selec ting data, validation, allow ing the list and selec ting the rang e. T his w ill allow a dif f erent start date f or eac p roj ec t or c omp any and allow f or ref orec ast of the orig inal c omp any.

Timeline exercise F or the inanc ial model that you have built to date, add the f ollow ing log ic to c omp ute the log ic f or the model’s timeline. Use the ‘EO Month ’ f ormula to automate the yearly timeline f or the g reen c alc ulation modules and the blue c alc ulation modules.

Capital expenditure

W e w ill disc uss the log ic f or the building of the Cap ex module as ap p rop riate. Illustration 8 ( see Illustratio x ls) show s the log ic behind the Cap ex module. W e c an see in the F inanc ing & W . Cap ital sheet that the c ap ital ex p enditure assump tions are link ed the G eneral Inp uts sheet and the inlation index is ap p lied to arrive at nominal terms. In the S ales- Costs- A c c ounting sheet the c ap ital ex p enditure is added to the ix ed asset sc hedule f o dep rec iation ac c ounting p urp oses.

Capital expenditure exercise

B uild a c ap ital ex p enditure c alc ulation using the assump tions inc luded in the ex amp le, that is, the G enera Inp uts sheet. Using 2 . 5% inlation p er annum c alc ulate the nominal terms’ annual c ap ital ex p enditure. Calc ulate the c ash low , p roit and loss and any balanc e sheet results that w ill be link ed to the summary inanc ial statements.

Financing

W e w ill now disc uss the log ic f or the building of the F inanc ing c alc ulations as ap p rop riate. Illustr ( see Illustration9 . x ls) show s the log ic behind the F inanc ing c alc ulations. T he amount to be inanc ed ( that is, the c ap ital ex p enditure and any up f ront c osts) are link ed into row 5 of the F inanc ing & W . Cap ital sheet. T he amounts to be draw n or f unded by long term sourc es of inan are show n in row s 1 3 to 1 6 . In this c ase w e have made an assump tion of 50 % eq uity and 50 % deb 8

Sect ion 1 B u ild in g th e forecast in g fin an cial mod el

eq uity is f rom Parties A and B and the balanc e is a shareholder loan. T he S enior D ebt is simp ly a % of f unding req uirement. In row s 2 0 to 2 6 , the shareholder loan sc hedule is c alc ulated. T he annual interest rate is link ed. T op ening balanc e ref erenc es the p revious p eriod’s c losing balanc e; at the start of the f orec ast the ac tual c ing balanc e is used. T he draw n dow n f unding is inc luded, the p rinc ip al rep aid at a straig ht line basis ove years. T he c losing balanc e simp ly rep resents the op ening balanc e p lus debt draw n less p rinc ip al rep a interest p er annum is c alc ulated, that is, the op ening balanc e p lus averag e draw ing s at the annual interest rate In row s 2 8 to 3 4, the senior loan sc hedule is c alc ulated that has a similar log ic to that desc ribed f or th shareholder loan above.

Financing exercise

F rom the inanc ial model that you have built to date, add to the inanc ing c alc ulations as f ollow s; c omp ute the f unding req uirement, the draw dow ns f or eac h sourc e of inanc ing ( senior debt, shareholder loan an eq uity) , c omp ute the p rinc ip al rep ayment, balanc es and interest p er annum. Calc ulate the c ash low , p roit and loss and any balanc e sheet results that w ill be link ed to the summary inanc ial statements.

Sales

W e w ill disc uss the log ic f or the building of the S ales Calc ulation as ap p rop riate. I ref er you to our illust model ex trac t in Illustration 1 0 ( see Illustration1 0 . x ls) . T he S ales- Costs- A c c ounting sheet show s volumes p er p roduc t p er annum ( see row s 6 to 1 yearly g row th is show n in row s 2 0 to 3 1 . O f c ourse, it is rec og nised that this c an be f urther sp lit volume and p ric e; it has been lef t as a sing le index f or simp lic ity p urp oses. T he index ation is show n in 3 4 to 43 . T he total sales f or the p roit and loss ac c ount are show n in row s 46 to 57 . T his is the sale annum at the g row th index .

Sales exercise

B ased up on the inanc ial model that you have built to date, add the log ic f or the sales sec tion. Ensure that you ref er to the ex amp le p rovided f or f urther g uidanc e. Comp lete the sales f orec asting c alc ulations, sta the revenue at today’s p ric es by p roj ec ting these by p roduc t f or the nex t nine years. Calc ulate the c ash low , p roit and loss and any balanc e sheet results that w ill be link ed to the summary inanc ial statements.

Operating costs

W e w ill disc uss the log ic f or the building of the O p erating Costs module as ap p rop riate. Illustration Illustration1 1 . x ls) show s the log ic behind the op erating c osts module. T he op erating c osts c alc ula inc luded in the S ales- Costs- A c c ounting sheet. T he inlation index is used at row 8 in order to translate real numbers to nominal terms or the money of the day eq uivalent. T his uses a simp previous le year index * ( 1 + annual inlation) . T he c ost c ateg ories or labels in c olumn A have been made lex ible by allow ing these to be entered in the g eneral inp uts sec tion of the inanc ial model. T he op erating ex p enses by typ e c alc ulation are simp ly the inlation index multip lied by the irst year f orec ast at today’s p ric es. T here is, how ever, a simp liic ation here that the c ost base is ix ed over the year and only inc reases w ith inlation, w hic h may or may not be the c ase. 9

Corp orat e F in an ce Mod ellin g a n d A n alysis

Operating costs exercise B ased up on the inanc ial model built to date add op erating c ost c alc ulations, set up the op erating c ost c alc ulations, by c ateg ory ( up to 1 0 ) , over 1 0 years w ith the ability to enter eac h year sep arately. Calc ulate the c ash low , p roit and loss and any balanc e sheet results that w ill be link ed to the summary inanc ial statements.

Working capital

W e w ill disc uss the log ic f or the building of the w ork ing c ap ital c alc ulations as ap p rop riate. Illu 1 2 ( see Illustration1 2 . x ls) show s the log ic behind the w ork ing c ap ital c alc ulation. T he w ork c alc ulations are inc luded in the F inanc ing & W . Cap ital sheet. In row s 9 to 1 1 , the trade debtor’s balanc c alc ulated by link ing the total revenue and the trade debtor’s day’s assump tions. T he c alc ulation ef f ec tively c alc ulates the number of days’ sales outstanding at the end of the inanc ial year. In row s 1 5 to 1 7 , the trade c reditor’s balanc e is c alc ulated by link ing the c ost of g oods sold and the trade c reditor’s day’s assump tions. T he c alc ulation ef f ec tively c alc ulates the number of days’ c ost of sales outstanding at the end of the inanc ial year. In row s 1 9 to 2 3 , the stoc k balanc e is c alc ulated by link ing the c ost of g oods sold and the stoc k hol day’s assump tions. T he c alc ulation ef f ec tively c alc ulates the number of days’ c ost of sales tied up in stoc k at the end of the inanc ial year. In row s 2 8 to 3 0 , the other c urrent assets’ balanc e is c alc ulated by link ing the sales and the other c urrent assets’ day’s assump tions. T he c alc ulation ef f ec tively c alc ulates the number of other c urrent assets outstanding at the end of the inanc ial year. T he summary inf ormation that link s to the p roit and loss, balanc e sheet and c ash low is at the f oot of the w ork ing c ap ital sheet as ap p rop riate. In row 3 7 , the inc rease / ( dec rease) in the c ash low r f rom w ork ing c ap ital f orec ast is show n. Essentially an inc rease in a trade debtor balanc e, a stoc k balanc or other c urrent assets balanc es w ill lead to a reduc tion in c ash low as more c ash is tied up in suc h assets. Conversely, an inc rease in trade c reditors’ balanc es w ill lead to an inc rease in c ash low as less c ash is being p aid to the sup p liers than stated in the p roit and loss on an ac c ruals basis.

Working capital exercise

B ased up on the inanc ial model built to date, link in both the op erating c osts and the revenue f rom the other c alc ulation areas. Use the f ollow ing assump tions to p roj ec t the w ork ing c ap ital balanc es and the movem in the w ork ing c ap ital f or c ash low p urp oses. A ssume trade debtor days at 3 0 days ( days’ sales) , tr c reditor days at 3 0 days ( days’ c ost of sales) , stoc k holding days at 6 0 days ( days’ c ost of sales) and O t Current A ssets at 3 5 days ( days’ sales) . Calc ulate the c ash low and balanc e sheet results that w ill be link ed to the summary inanc ial statements.

Accounting

W e w ill disc uss the log ic f or the building of the ac c ounting module as ap p rop riate. F or this p urp ose you to Illustration 1 3 ( see Illustration1 3 . x ls) . W e w ill outline the main areas af f ec ting the ac c ounting . T he ac c ounting is inc luded in the S ales- C A c c ounting sheet. F irstly, the ix ed asset sc hedule is inc luded in row s 6 to 1 0 . T his show s the op enin anc e being tak en f rom the ac tual c losing balanc e sheet and ref erenc ed at the c losing balanc e of the p reviou p eriod. T he additions f rom the c ap ital ex p enditure are added. T he dep rec iation c alc ulated straig ht line ove 10

Sect ion 1 B u ild in g th e forecast in g fin an cial mod el

a 1 0 year p eriod. T he c losing balanc e eq uals 0 at the end of the year 1 0 as no f urther additions are assum but this may not be the c ase in reality. F rom row s 1 2 to 3 3 , the ac c ounting treatment f or the loan f ees have been c alc ulated. Essentially, arrang ement f ees have been w ritten of f in line w ith the term of the debt. In this c ase, ive years. R ow s 3 5 43 show the summary results f rom this c alc ulation area that w ill link to inanc ial statements.

Accounting exercise

F or your inanc ial model built to date, add the ac c ounting module as f ollow s, dep rec iate all ix ed assets straig ht line over ive years. A mortise all loan f ees over the lif e of the debt rep ayment term. Calc ulate the c ash low , p roit and loss and any balanc e sheet results that w ill be link ed to the summary inanc ial statements.

Taxation

W e w ill now disc uss the log ic f or the building of the tax ation module as ap p rop riate. Illustration 1 Illustration1 4. x ls) show s the log ic behind the T ax ation module. R ow s 5 to 1 1 show the c orp oration tax loss memorandum. T he c orp oration tax loss memoran show s the p osition of the used and unused c orp oration tax losses f or relief p urp oses. T he tax able loss eac h p eriod is added to the op ening balanc e and losses c arried f orw ard are of f set ag ainst tax able p ro f or the year. T he loss available is of f set ag ainst a tax able p roit in the year it is deduc ted f rom the tax loss memorandum balanc e. T his log ic only ap p lies w here the c orp orate tax ation system allow s f or suc h r In the UK at the time of w riting this typ e of tax loss relief w as an elec tion that w as available. Note that in the UK , c orp orate tax is assessed f rom 1 A p ril f or eac h year. T he ac c ounting year e the c omp any in q uestion is 3 1 D ec ember. Conseq uently, you w ill notic e p eriod % ’s being c alc ulate sec ond c orp oration tax p eriods ( that is, alloc ating the liability ap p rop riately f or the ac c ounting years e 3 1 D ec ember) . Cap ital A llow anc es ( that is, the tax relief p rovided f or c ap ital ex p enditure) is c alc ulated in row 6 7 . Essentially the c ap ital ex p enditure is link ed f rom the c ash low and alloc ated to three main c ap ital all anc e c ateg ories ( that is, industrial building and struc tures; p lant and mac hinery; and long lif e assets) . T h are summed and inc luded in the c orp oration tax c omp utation below . R ow s 1 2 3 to 1 3 3 , show s the c orp oration tax c omp utation. T he p roit as p er the p roit and is ref erenc ed. A ny disallow able ex p enditure is added bac k f or tax p urp oses. O nc e disallow able ex is added bac k w e arrive at the tax able p roits. A f ter deduc ting c ap ital allow anc es w e arrive at p roits able to c orp oration tax bef ore loss relief . T he p roj ec t losses utilised f rom the loss relief memorandum are deduc ted f rom the p roits c harg eable to c orp oration tax to the ex tent there is adeq uate p ositive tax able p roi T he c harg e to the p roit and loss ac c ount is made by multip lying the p roits c harg eable to c orp orat tax at the c orp oration tax rate. M arg inal relief log ic is inc luded in row 1 3 2 . T his allow s f or less tax to be p aid by UK c that have less than £1 . 5 million tax able p roits p er annum but are g reater than the small c omp any’s rate limit of £0 . 3 million p er annum. T his is ef f ec tively a reduc tion f rom the main rate w hic h is c harg eab tax able p roits. T he c ash low f or c orp oration tax p urp oses is p aid 1 0 months in arrears. A t the time of w riting the usual arrang ement f or UK c omp anies. T he balanc e sheet liability is eq ual to the op ening balanc e p the p roit and loss c harg e less the c ash p ayment. 11

Corp orat e F in an ce Mod ellin g a n d A n alysis

T he valued added tax ( VA T ) log ic w ill now be ex p lained. T he outp ut VA T is c alc ulated on the sales at 2 0 % in row 1 49 . T he inp ut VA T is c alc ulated on the invoic ed p urc hases at 2 0 % in row 1 amount p ayable or ref undable f rom the UK ’s HM R C is c alc ulated in row 1 57 . T he VA T Control A c show s the net amount p ayable to the UK HM R C or ref undable f rom the UK HM R C. T he VA T liabi p aid q uarterly a month in arrears. R ow s 1 7 0 to 1 7 2 show the c ash low during the year tog ether w balanc e sheet liability or ref und f rom the UK ’s HM R C.

Taxation exercise

B ased up on your ex isting inanc ial model that you have built to date, build the log ic f or the tax ation module. Your tax ation model req uires a c orp oration tax c omp utation w ith a 2 7 % main c orp oration tax rate. Us 2 0 % small c omp any’s tax rate and marg inal relief c alc ulated at a f rac tion of 1 / 40 0 f or tax able p roits b £3 0 0 ,0 0 0 and £1 ,50 0 ,0 0 0 p er annum. You are also req uired to build the log ic f or c orp oration tax l memorandum assuming that losses c an be c arried f orw ard and of f set ag ainst f uture years’ tax able p roits. Calc ulate VA T log ic at a 2 0 % tax rate. Calc ulate the c ash low , p roit and loss and any balanc e sheet results that w ill be link ed to the summary inanc ial statements ( that is, the p roit and loss, c ash low and balanc e sheets) .

Dividends

W e w ill disc uss the log ic f or the building of the dividends module as ap p rop riate. Illustration 1 5 ( se Illustration1 5. x ls) show s the log ic behind the D ividends module. In row s 9 to 1 1 the amount of c ash available f or dividend is c alc ulated. T he c ash available f or dividends is c alc ulated as f ollow s: O p ening c ash balanc e ( p er the balanc e sheet) Plus Cash low g enerated in the p eriod p rior to dividends ( p er the c ash low ) . In row s 1 5 to 1 7 the amount of retained earning s available f or dividend is c alc ulated. T he earning s available f or dividends are c alc ulated as f ollow s: O p ening retained earning s ( p er the balanc e sheet) Plus Proit bef ore dividends ( p er the p roit and loss ac c ount) T he dividend dec lared p er the p roit and loss ac c ount ensures that the c ash available is p aid out to the ex tent that there are suf ic ient distributable reserves ( that is, retained earning s available) .

Dividends exercise F or the inanc ial model that you have built to date add the f ollow ing log ic to the dividends c alc ulations area. A dd c ash and p roit p osition log ic bef ore distribution. Calc ulate the c ash low , p roit and loss and any balanc e sheet results that w ill be link ed to the summary inanc ial statements.

Equity returns and lenders’ ratios

W e w ill disc uss the log ic f or the building of the eq uity returns and lenders c redit ratios module as ap p rop riate Illustration 1 6 ( see Illustration1 6 . x ls) show s the log ic behind the p artic ular module. 12

Sect ion 1 B u ild in g th e forecast in g fin an cial mod el

In the eq uity returns and lenders’ ratios w e c an see several lenders’ c redit ratios. F irstly in row s 1 0 to 2 1 , the debt to eq uity ratio is c alc ulated. T he max imum ratio is c alc ulated. T he max imum ratio is used c omp arison to the lenders targ et levels, the date of the max imum is rep orted along w ith the averag e debt to eq uity ratio. In row s 2 3 to 3 5, the f ree c ash low to debt is c alc ulated. T he minimum ratio is c alc ulated. T he mum ratio is used f or c omp arison to the lenders’ targ et levels, the date of the max imum is rep orted along w ith the averag e f ree c ash low to debt ratio. In row s 3 8 to 50 , the debt to EB IT D A is c alc ulated. T he max imum ratio is c alc ulated. T he ratio is used f or c omp arison to the lenders’ targ et levels, the date of the max imum is rep orted along w ith the averag e debt to EB IT D A ratio. In row s 52 to 6 4, the debt to net assets ratio is c alc ulated. T he max imum ratio is c alc ulated. T he max mum ratio is used f or c omp arison to the lenders’ targ et levels, the date of the max imum is rep orted along w ith the averag e debt to net assets ratio. In row s 6 6 to 7 9 , the interest c over ratio is c alc ulated by using the p roit and loss ac c ount ig ures ( is, earning s bef ore interest and tax to interest p ayable) in the p roit and loss ac c ount. In row s 8 2 to 1 0 6 the shareholder returns are c alc ulated. T hese are show n as f ollow s. T he eq uity IR R in nominal terms, rep resents the investment in the eq uity by the shareholder and the rec eip t in the f orm of an annual dividend stream using the Ex c el IR R c alc ulation ( that is, c omp uting th c ount rate that yields a net p resent value ( NPV) of z ero) . T he eq uity IR R in real terms rep resents the sha holders’ dividend yield in today’s money. It is simp ly divided by the retail p ric e index ( R PI) , disc ounted to ind the internal rate of return. T he blended IR R s are a c ombination of the shareholder loan or subordinated debt and the eq uity c ash low s outlined above. In summary, it is eq uity c ash low s p lus the interest and f ees rec eived f or p roviding th loan to the c omp any. A g ain using the Ex c el IR R f unc tion the net c ash low is disc ounted to ind the di rate w here the NPV eq uals z ero.

Proit and loss account

T his module c omp utes the p roit and loss ac c ount ( P& L) f or the inanc ial model. I w ill now tak throug h the log ic of this module w ith ref erenc e to Illustration 1 7 ( see Illustration1 7 . x ls) . T he maj ority of readers w ill be aw are that a p roit and loss ac c ount rep resents the p roits arising ove the sp ec iic p eriod ( that is, that ac c rued to the p artic ular p eriod p roit is distinc t f rom the c ash low s arise at a c ertain p oint in time but of ten relate to ac tivity f rom another p eriod) . M ore sp ec iic ally, the P& is f orec asted over the lif e of the 1 0 year f orec ast p eriod. T his is a hig h level summarised P& L f ormat g oes f rom sales, g ross p roit, EB IT D A , EB IT , EB T , earning s af ter tax , dow n to the earning s the p eriod. You w ill notic e that simp le link s have been made to the relevant c alc ulation modules in order to c alc ulate the p roit and loss ac c ount.

Proit and loss exercise

F or the c orp orate inanc e model that you have built to date, add the f ollow ing log ic to the p roit and loss ac c ount module. Link in the p roit and loss ac c ount c omp onents to the relevant modules as p reviously c alc ulated and c alc ulate the resulting earning s retained f or the p eriod. 13

Corp orat e F in an ce Mod ellin g a n d A n alysis

Cash low

T his module c omp utes the c ash low f or the f orec ast. I w ill now tak e you throug h the log ic of this mod w ith ref erenc e to Illustration 1 8 ( see Illustration1 8 . x ls) . M ost readers w ill be aw are that a c ash low f orec ast rep resents net of rec eip ts over p ayments throug the c omp any’s bank ac c ount. T he c ash low is c alc ulated on an annual basis. T urning to the c ash low sheet in our ex amp le, w e c see that earning s bef ore interest tax dep rec iation and amortisation ( EB IT D A ) is being link ed f rom the p ro and loss ac c ount. It is imp ortant to note that this rep resents a ig ure w hic h is p re- ac c ounting based only. T here is an adj ustment f or the movement in w ork ing c ap ital f rom the balanc e sheet. T he f unding and servic ing of debt is show n bef ore c alc ulating the c ash low available f or shareholders. T he dividends p aid are made bef ore arriving at the c hang e in c ash and c ash eq uivalents. T he op ening and c losing c ash balanc es ar show n w hic h rec onc ile to the balanc e sheet.

Cash low exercise F or the inanc ial model that you have built to date, add the f ollow ing log ic to the c ash low module, link in the c ash low c omp onents to the relevant modules as p reviously c alc ulated and c alc ulate the resulting c losing c ash balanc e f or eac h p eriod.

Balance sheet

T his module c omp utes the balanc e sheet f or the ten year f orec ast p eriod. I w ill now tak e you throug h the log ic of this module w ith ref erenc e to Illustration 1 9 ( see Illustration1 9 . x ls) . M ost readers w ill be aw are that a balanc e sheet rep resents a statement of assets and liabilities and show s the net w orth of the c omp any. T urning to the balanc e sheet, the ac tual op ening balanc e sheet is added in c olumn B . T he ix ed assets and c ap italised arrang ement f ees are link ed f rom the S ales- Costs- A c c ounting sheets. T he c ash is c alc u by adding the yearly net c ash low f rom the c ash low sheet to op ening balanc e. T he A c c ounts R ec eiv to the A c c ounts Payable is all link ed f rom the F inanc ing & W . Cap ital sheets. T he VA T and tax p ay link ed f rom the tax ation sheet. T he shareholder loan and the senior debt are link ed f rom the F inanc ing & W . Cap ital S heets. T he eq uity is link ed f rom the c ash low f or the year and added to the op ening balanc T he retained earning s are link ed to the retained earning s f or the year and added to the op ening balanc es. A t the bottom of the sheet w e have inc luded a number of rec onc iliation c hec k s inc luding w ork ing c tal days resulting f rom the inanc ial statement f orec asts.

Balance sheet exercise F or the inanc ial model that you have built to date, add the f ollow ing log ic to the balanc e sheet module. Link in the balanc e sheet c omp onents f rom the relevant modules as p reviously c alc ulated; c alc ulate the resulting net assets, eq uity and liabilities. S ome inanc ial modellers p artic ularly at the beg inner or intermediate levels have p roblems rec onc iling the balanc e sheet over the f orec ast p eriod. T he ac c ountants among st readers w ill understand the c onc ep t of double entry and the link betw een the c ash low , p roit and loss and balanc e sheet ac c ording ly. How ever, f or those less f amiliar or indeed less f amiliar w ith p roduc ing integ rated inanc ial statements, I w ill outline some basic g uidanc e on this matter. O nc e you have link ed the log ic f rom the detailed modules to the c ash low , p roit and loss, balanc e sheet and you ind that your balanc e sheet does not balanc e in one or more p eriods then the f ollow ing advic e may help . T ak e the p eriod 14

Sect ion 1 B u ild in g th e forecast in g fin an cial mod el

w here the balanc e sheet rec onc iles as the c lean starting p osition. T ak e the p roit and loss ac c ount balanc e sheet f rom the nex t p eriod. T ic k eac h p roit and loss ac c ount and balanc e sheet item and ensu that they are relec ted in the relevant balanc e sheet movement to c alc ulate the nex t p eriod’s balanc e. Ensure that the movement on the retained earning s is eq ual to the retained earning s f or the p eriod. Lik ew ise ensure that the movement on the c ash at the bank is eq ual to the net c ash low f or the p eriod.

Sensitivities

S ensitivity analysis is deined as the lex ing of k ey assump tions to investig ate the imp ac t up on the p roj ec t’s inanc ial p roj ec tions. T he method f or p roduc ing sensitivities is w here the k ey outp ut mea are c omp ared ag ainst the base c ase results, that is, maintaining the base c ase results. R eaders may be aw are that most inanc ial models that they have enc ountered c annot maintain the base c ase results and to ac tivate the sensitivity c ase it is nec essary to c hang e the inp ut assump tions and save another version of the Ex c el w ork book and c omp are it to the base c ase. In the methodolog y w hic h I am about to ex p lain w e c an c hang e the inp ut assump tions f or a dein sensitivity c ase and observe the ef f ec t up on the k ey outp uts. T he deined sensitivity c ase that w e are about to ex p lain is ‘% c hang e in R PI p er annum’. T he sensitivity is inp ut at a 1 0 % inc rease f rom the base the S ensitivity inp ut sheet. T he mac ro routine is run and the sp ec iic sensitivity number is p lac ed in the sensitivity number box w hic h trig g ers the w ork sheet c ode in the sp ec iic areas in the S ales- Costs- A c c Eq uity R eturns & Lenders’ R atio sheets. F or ex amp le, if you look at the S ales- Costs- A c c ountin c ell c 9 2 you w ill notic e* that IF (“ S ENS ITIV ITY _ NU MB ER = 1 ,( 1 + InlationS ” ex tra inlation ensitivity) ,1 ) af f ec ts the R PI c alc ulations f or sensitivity 1 . T he results f rom the model’s k ey outp uts, that is, IR R ’ lender ratios are c ut and p asted into the S ensitivity Calc s 1 w ork sheet. T he base c ase is reset af ter running sensitivity 1 in the sensitivities by p lac ing a blank in the S ensitivity Number box in the S ensitivity Inp uts sheet. T he S ensitivities sheet p resents the base c ase and sensitivity c ase results side by side, the sensitivity c ases simp ly ref erenc e the results that have been c ut and p asted into the S ensitivity c alc sheets. T he f ollow ing mac ro / VB A c ode outlines the c ode f or S ensitivities. W alk throug h the c ode w enc e to the ex amp les and inanc ial models built to date.

Illustration 20 Runs Sensitivity 1% change in general inlation pa Sub SENSITIVITYCALC() Application.ScreenUpdating = False '(Switches the screen updating off) Application.Calculation = xlCalculationManual '(Switches calculation to manual) Application.StatusBar = "Please Wait Currently Preparing the Sensitivity 1" ' (displays message) '==================================================================== 'RESET EXISTING SENSITIVITY CALC SHEETS '==================================================================== Sheets(“Sensitivity Calcs 1").Select '(Selects the sheet) continued 15

Cells.Select '(selects all cells) Selection.Clear ' (clears all) '==================================================================== 'SELECT CASE '==================================================================== Sheets("Sensitivity Inputs").Select ‘(selects the sheet) Range("SENSITIVITY_NUMBER").Select '(selects the range name) Range("SENSITIVITY_NUMBER").Value = 1 ' (sets to 1) Calculate '(Calculates)

'==================================================================== 'COPY & PASTE KEY OUTPUTS IRRS & NPVS , LENDERS Credit Ratios '==================================================================== '----------------------------------------------------------'Debt to Equity Ratio - Max '=========================================================== Sheets("Equity Returns & Lenders Ratios").Select ' (selects the sheet) Application.Goto Reference:="DebtToEquityRatio" ' (goes to the range name) Selection.Copy '(selects area to copy) Sheets("Sensitivity Calcs 1").Select '(select the sheet) Range("A5").Select ' (selects start of range for pasting) Selection.PasteSpecial Paste:=xlPasteValues, Operation:=xlNone, SkipBlanks _ :=False, Transpose:=False ' (Pastes the results as values) Selection.Columns.AutoFit '(auto its the column width) '================================================================ 'Free Cashlow To Debt - Min '================================================================ Sheets("Equity Returns & Lenders Ratios").Select ' (selects the sheet) Application.Goto Reference:="FreeCashFlowRatio" ' (goes to the range name) Selection.Copy '(selects area to copy) Sheets("Sensitivity Calcs 1").Select '(select the sheet) Range("A9").Select ' (selects start of range for pasting) Selection.PasteSpecial Paste:=xlPasteValues, Operation:=xlNone, SkipBlanks _ :=False, Transpose:=False ' (Pastes the results as values) Selection.Columns.AutoFit ‘(auto its the column width) '================================================================ 'DebtEBITDARatio '================================================================

continued

Sheets("Equity Returns & Lenders Ratios").Select ' (selects the sheet) Application.Goto Reference:="DebtEBITDARatio" ' (goes to the range name) Selection.Copy '(selects area to copy) Sheets("Sensitivity Calcs 1").Select '(select the sheet) Range("A14").Select ' (selects start of range for pasting) Selection.PasteSpecial Paste:=xlPasteValues, Operation:=xlNone, SkipBlanks _ :=False, Transpose:=False ' (Pastes the results as values) Selection.Columns.AutoFit '(auto its the column width) '================================================================ 'Debt To Net Assets - Max '================================================================ Sheets("Equity Returns & Lenders Ratios").Select ' (selects the sheet) Application.Goto Reference:="DebtToNetAssetsRatio" ' (goes to the range name) Selection.Copy '(selects area to copy) Sheets("Sensitivity Calcs 1").Select '(select the sheet) Range("A20").Select ' (selects start of range for pasting) Selection.PasteSpecial Paste:=xlPasteValues, Operation:=xlNone, SkipBlanks _ :=False, Transpose:=False ' (Pastes the results as values) Selection.Columns.AutoFit '(auto its the column width) '==================================================================== 'Interest Cover - Min '==================================================================== Sheets("Equity Returns & Lenders Ratios").Select ' (selects the sheet) Application.Goto Reference:="InterestCoverRatio" ' (goes to the range name) Selection.Copy '(selects area to copy) Sheets("Sensitivity Calcs 1").Select '(select the sheet) Range("A25").Select ' (selects start of range for pasting) Selection.PasteSpecial Paste:=xlPasteValues, Operation:=xlNone, SkipBlanks _ :=False, Transpose:=False ' (Pastes the results as values) Selection.Columns.AutoFit '(auto its the column width) '==================================================================== 'Equity IRR - Nominal, Real and Shareholders Blended '==================================================================== Sheets("Equity Returns & Lenders Ratios").Select ' (selects the sheet) Application.Goto Reference:="EquityReturns" ' (goes to the range name) Selection.Copy '(selects area to copy) Sheets("Sensitivity Calcs 1").Select '(select the sheet) Range("A29").Select ' (selects start of range for pasting) Selection.PasteSpecial Paste:=xlPasteValues, Operation:=xlNone, SkipBlanks _ :=False, Transpose:=False ' (Pastes the results as values) Selection.Columns.AutoFit '(auto its the column width) '==================================================================== ' '==================================================================== continued

Corp orat e F in an ce Mod ellin g a n d A n alysis

'==================================================================== 'RESET BASE CASE '==================================================================== Sheets("Sensitivity Inputs").Select '(selects the sheet) Range("SENSITIVITY_NUMBER").Select '(selects the range name) Range("SENSITIVITY_NUMBER”).Value = "" ' (sets to base case) Calculate '(Calculates) '==================================================================== Sheets("Sensitivities").Select '(selects the sheet) '==================================================================== 'RESET EXCEL ENVIRONMENT '==================================================================== Application.ScreenUpdating = True '(switches on the screen updating) Application.Calculation = xlCalculationAutomatic '(switches the calculation to automatic) Application.StatusBar = "Ready" ' (switches the status bar to normal) End Sub Source: Modelling Solutions

T he results arising f rom the sensitivity analysis c an be seen in Illustration 2 1 .

Illustration 2 1 Sensitivity results SENSITIVITIES

BASE CASE

SENSITIVITY 1 RPI % Increase per annum

Equity IRR – Nominal

163.75%

131.26%

Equity IRR – Real

157.32%

105.11%

Equity And Shareholder Loan IRR – Nominal

349.29%

273.28%

Equity And Shareholder Loan IRR – Real

338.33%

231.07%

Debt to Equity Ratio – Max

33.33%

33.70%

Free Cashlow To Debt – Min

26.77%

2.72%

Debt To EBITDA – Max

49.49%

54.98%

Debt To Net Assets – Max

72.02%

72.02%

Interest Cover – Min

25.9

21.7

S ource:M odelling S olutions 18

Sect ion 1 B u ild in g th e forecast in g fin an cial mod el

A f ter inc orp orating the log ic outline above, ref er to Illustration 2 2 ( see Illustration2 2 . x ls) . In the S ensitivity M odule you c an see the targ et minimum lenders ratios link ed in. T he base c ase results are also link ed in. Eac h of the sensitivities is link ed to the sensitivity c alc s sheets w hic h are derived f rom the mac ro / VB A routine.

Sensitivity exercise

B ased up on the inp uts and log ic in your inanc ial model, build the log ic f or a sensitivity c ase w hic c alc ulates a 3 0 % inc rease in the g eneral inlation or R PI f rom the base c ase assump tions. Ensure that y c omp are the ef f ec t up on the lenders’ ratios and shareholder returns on a sing le w ork sheet. A f ter c omp le this sensitivity c omp ute another sc enario in a similar manner.

Checks

T his module c alc ulates the c hec k s f or the c orp orate inanc e f orec asting model. I w ill now tak e you the log ic of this module w ith ref erenc e to Illustration 2 3 ( see Illustration2 3 . x ls) . W here the results f rom the c hec k s eq ual z ero, the c hec k c onditions are ok . A number hig hlig dif f erenc e or the p otential inanc ial model error. W ith ref erenc e to the Chec k s sheet, you c an see a S ummary Chec k in c ell C1 that c alc ulates tha c hec k c alc ulations are eq ual to z ero and rec onc iling . Chec k s are p lac ed here to ensure that the balanc e balanc es, the net c ash rec onc iles and the retained p roit rec onc iles. T he w ork ing c ap ital is bac k c a to the assump tions in row s 9 to 1 2 . It is g ood p rac tic e and hig hly rec ommended to inc lude as many c ross c hec k s or c hec k sums in this that are c reated along the inanc ial model build p roc ess as this w ill g ive both you and the rec ip ients of the results muc h g reater c onidenc e.

Checks exercise

F or the inanc ial model that you have built to date add the f ollow ing log ic to the c hec k s module. A dd all t c hec k s outlined in Illustration 2 3 above p lus any additional c ross c hec k s that you have c reated during th model build ex erc ise that c an be link ed to this sheet.

Summary

A s identiied in the sc op ing stag e, the summary sheet should p resent the results in an unc luttered, c lear and c onc ise manner. Illustration 2 4 ( see Illustration2 4. x ls) show s the log ic behind the summary module. In order, to c omp lete the log ic f or the S ummary sheet w e have to simp ly link f rom other w ork she in the inanc ial model. T he ex isting business c orp orate inanc e model show s a summary sheet w hic h look at the inanc ial w ealth or risk p osition of three maj or interest g roup s or stak eholders ( that is, shareholders, lenders and the c omp any) . T he shareholders’ returns are show n in both real and nominal ( that is, money of the day) . T he shareholders’ returns are show n either as p ure eq uity ( that is, ordinary shares and dividends) and blended ( that is, eq uity p lus the shareholder loan) . T he c omp any minimum and max imum c ash p osition is show w hic h help s to show the streng th of its liq uidity and headroom f or reinvestment in other p roj ec ts or money mark et investments.

19

Corp orat e F in an ce Mod ellin g a n d A n alysis

Summary exercise

Link all p arts of your inanc ial model to the summary p ag e as ap p rop riate. R eview the reasonableness of the results as you do so. You w ill now c reate the answ ers p ag e f or your ex isting business c orp orate inanc e model.

Finalising the existing business corporate inancial model

D uring the c ourse of our c orp orate inanc ial model stag e build stag e w e have built a number of sp ec iic modules. How ever, there are a number of p roc esses and menu desig ns that w ill ideally mak e your inanc ial model easier to up date and more sec ure. T hese p oints are more usef ul if the model that you are building is a temp late or re- useable c orp orate inanc e model. T hese are the p rotec tion of the w ork sheets and w ork boo as ap p rop riate. F irstly, w e shall c onsider the automation of running the model. I rec ommend that the w ork book is ap p rop riately p rotec ted. In terms of ap p rop riate p rotec tion I rec mend that only the yellow inp ut c ells c an be up dated, the w ork sheets and the w ork book is p rotec ted. T w ill p revent any c orrup tion to the model. T he Ex c el/ VB A c ode show n in Illustration 2 5 c an be used to se this p urp ose.

Illustration 25 Unprotecting the yellow input cells in the corporate inance model Sub UnProtectEachYellowInputCell() '================================================== 'UNPROTECTS EACH YELLOW INPUT CELL IN THE MODEL 'USEFUL FOR USER PROTECTION OF CALCS 'AND UNPROTECTION OF INPUT CELLS 'www.modellingsolutions.co.uk '================================================== Application.ScreenUpdating = False Dim Sheet As Worksheet Dim Cell As Range On Error Resume Next UnProtectEachSheet For Each Sheet In ActiveWorkbook.Sheets Sheet.Select For Each Cell In ActiveSheet.UsedRange.Cells Application.ScreenUpdating = False Cell.Select continued 20

'If Cell is yellow then unprotect If Selection.Interior.ColorIndex = 6 Then Selection.Locked = False

Else End If Next Cell Application.StatusBar = "Now Working On Sheet : " & ActiveSheet.Name Next Sheet ProtectEachSheet Application.ScreenUpdating = True Application.StatusBar = Ready End Sub Source: Modelling Solutions

Illustration 26 Workbook and worksheet protection Sub ProtectEachSheet() Application.ScreenUpdating = False

Dim Sheet As Worksheet On Error Resume Next ActiveWorkbook.Protect ("xxxxxxx ") For Each Sheet In ActiveWorkbook.Sheets Sheet.Select Sheet.Protect ("xxxxxxx") Next Sheet Application.ScreenUpdating = True End Sub Sub UnProtectEachSheet() Application.ScreenUpdating = False Dim Sheet As Worksheet On Error Resume Next continued

Corp orat e F in an ce Mod ellin g a n d A n alysis

ActiveWorkbook.Protect ("xxxxxxx") For Each Sheet In ActiveWorkbook.Sheets Sheet.Select Sheet.Unprotect ("xxxxxxx ") Next Sheet Application.ScreenUpdating = True End Sub Source: Modelling Solutions

O nc e you have built a re- usable inanc ial model suc h as this it is g ood p rac tic e to p rotec t it ac c ording ly. T he starting p oint w ould be to ensure that all yellow inp ut c ells are unp rotec ted as ap p rop riate. T c ould be done by manual means but is of ten more error p rone. I rec ommend the use of similar VB A log ic as outlined in Illustration 2 5. T he imp ortant p art of the c ode f or doing this is w here the c ode starts for each w sheet ith ‘ in activew orkbook. sheets’ and ends w ithnex ‘ t sheet’. Here the c ode is g oing throug h eac h sheet in the w ork book and eac h c ell in the sheet, if the c ell’s c olour index is 6 ( that is, yellow ) the c ell is unloc k ed. A f ter unp rotec ting the sp ec iic c ells, I rec ommend p rotec ting the w ork book and sheets ac c ord A g ain this c an be done manually but if this task is undertak en a number of times its best automated throug h the use of a VB A mac ro. W e w ill turn our attention to Illustration 2 6 . In theP subroutine rotectEachS heet w e c an see the w ork book being p rotec ted byAthectivew use of orkbook. protect ( “Passw ord”) . Eac h sheet in the inanc ial model is p rotec ted by the use of the c ode embedded infor theeach ‘ sheet in activew orkbook. sheets’ and ending w ith nex‘ t sheet’. T he subroutine Unp rotec tEac hS heet uses similar log ic as the p rotec tion routine above w ith the ex c ep tion of the use of unp rotec t f or both the w ork sheet and w ork book s.

Exercise inalising the corporate inance model B ased up on the c orp orate inanc e model that you have built to date, add the inal touc hes. Unp rotec t the entire op erating model’s inp ut c ells and p rotec t all the w ork sheets.

Sources of error G iven our disc ussions outlined in this book and the nature of c orp orate inanc e models there are several p otential sourc es of errors. T hese c an be summarised as f ollow s. ● ● ● ●

22

Logic error: a log ic error arises due a c alc ulation error in the f ormula ( that is, summing the w rong rang e and so on) . Assumption / input error: if an inp ut assump tion is not as p er the inanc ial c ase then an error oc c urs ( f or ex amp le, disc ount rate should be 1 2 % not 1 0 % ! ) . Documentation error: the debt rep ayment p roile may not c omp ly w ith the basis outlined in the relevant leg al doc umentation. Data b ook error:the debt rep ayment p roile may not c omp ly w ith the basis outlined in the data book .

Sect ion 1 B u ild in g th e forecast in g fin an cial mod el

● ●

T ax ation compliance: if the tax treatment f or c ertain ex p enses is not tax deduc tible and is subtrac ted f rom the tax able p roit then w e have a tax c omp lianc e issue of one sort. Accounting compliance: if a c ertain item has been c ap italised but under the relevant ac c ounting treatment ( f or ex amp le, UK G A A P, IF R S ) immediate w rite of f is req uired then w e have an c omp lianc e issue of one sort.

Self testing the model

O nc e the model builder has c omp leted a draf t model they should stand of f and undertak e some self review . I rec ommend that the minimum amount of self - review or self - testing should inc lude the f ollow ing methods

Top level analytical review

T his tec hniq ue involves review ing the big p ic ture. It is g ood f or detec ting p otentially larg e errors f model run f or the base c ase or sp ec iic sensitivity c ases. T his is a similar tec hniq ue to the review of inanc statements in a inanc ial audit. T he ap p roac h may involve the c omp utation of k ey ratios over the f orec as p eriod. Look at revenue, c ost and inanc ing struc tures. W here p ossible you should c orrelate bac k to inp uts. S ome ex amp les of c orrelating the inp uts w ith the outp uts w ould be trade debtor assump tions, t c reditor assump tions, interest rate assump tions and any other assump tions in the model that you c ould relate to the models outp uts. K ey areas c an be g rap hed. T his help s to review the trends and hig hlig ht any blip s. You should look any obvious irreg ularities suc h as balanc e sheets not balanc ing , c ash low s f or the p eriod not eq ualling th movement in c ash balanc e f or the balanc e sheet, any neg ative debt balanc es and any other basic c hec k s. W e c an now turn our attention to a sp ec iic ex amp le of analytic al review tec hniq ues ap p lied c orp orate inanc e model in Illustration 2 7 ( see Illustration2 7 . x ls) .

Illustration 2 8 Analytical review Balance Sheet reconciles?

ok reconciles

Cash reconciles?

ok reconciles

Opening Cash Balance Cash generated during the year per the Cashlow Closing Cash Balance Cash Balance per the Balance Sheet Proit reconciles?

ok reconciles continued 23

Opening Proit per Balance Sheet Proit generated during the year Closing Proit Balance Sheet Reperformed Cash Balance per the Balance Sheet Sales Growth

ok reasonable as per assumptions

Gross Proit Margin

ok reasonable as per assumptions

EBITDA Margin

ok reasonable as per assumptions

EBIT Margin

ok reasonable as per assumptions

Tax To EBT

ok reasonable as per assumptions

Senior Debt Proile

ok reconciles

Opening Debt per Balance Sheet Debt Drawn Debt Repaid Closing Debt Balance Sheet Reperformed Debt Balance per the Balance Sheet Shareholder Loan Proile

ok reconciles, but why the negative drawn amount?

Opening Debt per Balance Sheet Debt Drawn Debt Repaid Closing Debt Balance Sheet Reperformed Debt Balance per the Balance Sheet continued

Sect ion 1 B u ild in g th e forecast in g fin an cial mod el

Interest – Senior Debt Interest per P&L Debt Closing Balance Reasonableness Check

ok reasonable per assumptions

Per Assumption Interest – Shareholder Loan Interest per P&L Debt Closing Balance Reasonableness Check

ok reasonable per assumptions

Per Assumption Working Capital Trade Debtor Days

ok as per the assumptions

Trade Creditor Days

ok as per the assumptions

Stock Holding Days

ok as per the assumptions

Other Current Asset Days

ok as per the assumptions

S ource:M odelling S olutions

You c an see that w e have c reated a sheet c alled A nalytic al R eview – W ork ing s. It c ontains a num k ey w ork ing s or c alc ulations ag ainst the inanc ial models timeline. F irst there are three c hec k s of inte c onsistenc y, that is, does the balanc e sheet rec onc ile over the f orec ast p eriod? D oes the movement in the balanc e sheet c ash and p roit f or eac h year eq ual the c ash g enerated or the p roit retained f or the year? T he sales g row th is c alc ulated on a year by year basis and is 1 % p er annum w hic h is c onsistent w it assump tion in the G eneral Inp uts sheet ( c ontained in row s 1 0 to 1 9 ) . T he g ross p roit marg in to sales ratio is c alc ulated on a year by year basis and is c onsistent w ith the assump tion in the G eneral Inp uts sheet ( c ontained in row s 2 3 to 3 1 ) . T he EB IT D A and EB IT marg in seems f airly c onsistent and reasonable and nothing immediately o ous is hig hlig hted and req uires no investig ation. T he tax in the P& L look s reasonable w hen you c omp are it w ith the tax rates p er annum, the tax dedu ibility of the ex p enses and any c ap ital allow anc es. T his seems f airly c onsistent and reasonable and nothing immediately obvious is hig hlig hted and req uires no investig ation.

25

Corp orat e F in an ce Mod ellin g a n d A n alysis

T he tw o debt balanc es ap p ear internally c onsistent w hen c onsidering the op ening balanc e and adj usting this f or the debt draw n and rep aid in the year. T he p rinc ip als also eq ual the rep ayment p roile in the G eneral Inp uts sheet of ive years. T he interest c harg ed to both the P& L and the c ash low look s reasonable. T he interest is c omp ared to the averag e of the op ening and c losing debt balanc es and ex p ressed as a p erc entag e w hic h is c omp ared w ith the orig inal interest rate f or reasonableness p urp oses. You c annot ex p this to be an ex ac t matc h to the orig inal interest rate assump tion but simp ly reasonably c lose to it. T he w ork ing c ap ital days have been bac k c alc ulated using the P& L and balanc e sheet and c omp are the orig inal assump tions in the G eneral Inp uts sheet c ontained in row 1 42 to 1 45. S o the only real p roblem that req uires investig ation and adj ustment ap p ears to be the shareholder loan amount that is a neg ative draw ing ! W e c an now turn our attention to a sp ec iic ex amp le of analytic al review tec hniq ues using g rap w hic h is ap p lied to our c orp orate inanc e model in Illustration 2 9 ( see Illustration2 9 . x ls) .

Illustration 3 0 Analytical review graphs

Dividend payout 30.0

£ millions

25.0 20.0

Dividends

15.0

Profit available for dividends at payout ratio

10.0

Cash available for dividends at payout ratio

5.0 0.0 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Year ending

S ource:M odelling S olutions

W hen look ing at the sheet in the ex amp le c alled A R – G rap hs w e c an see that w e are undertak review method that w ill ultimately end in a g rap hing . W e are look ing at the dividends dec lared in the P& L and p aid in the c ash low f or eac h year. T he ac tual p roits and c ash available f or dividend and the p ayout 26

Sect ion 1 B u ild in g th e forecast in g fin an cial mod el

ratio have been used to ensure that distributable reserves and the c ash in the c omp any have been maintained. F rom the g rap h the dividend does not ex c eed the c ash available thus ring ing no alarm bells.

Key output review

T he k ey outp uts ratios suc h as c redit ratios, IR R s and so on, are lik ely to p roduc e material errors w here error ex ists as they are at the hig hest level. It is rec ommended that the results and the log ic behind the k ey outp uts are review ed as ap p rop riately. W e c an now turn our attention to a sp ec iic ex amp le of k ey outp ut review tec hniq ues ap p li c orp orate inanc e model in Illustration 3 1 ( see Illustration3 1 . x ls) .

Illustration 3 2 Key output review Ref

Label

Calculation

Result

=NOW() B1

EQUITY RETURNS AND LENDERS RATIOS

=NOW()

26/03/2011 19:18

=NOW() =YEAR(C3) C1

EQUITY RETURNS AND LENDERS RATIOS

=YEAR(Period Ending)

2011

=YEAR(31/12/2011) =IF(Project_Name="","",Project_Name) A2

undeined

=IF(Project_Name="","",Project_Name)

COMPANY A

=IF(Project_Name="","",Project_Name) B3

Period Ending

=EOMONTH(C3,-12) =EOMONTH(Period Ending,-12) =EOMONTH(31/12/2011,-12)

31/12/2010

C3

Period Ending

=EOMONTH(Model_Start_Date,11) =EOMONTH(Model_Start_Date,11) =EOMONTH(Model_Start_Date,11)

31/12/2011

D3

Period Ending

=EOMONTH(C3,12) =EOMONTH(Period Ending,12) =EOMONTH(31/12/2011,12)

31/12/2012

A10

undeined

='Balance Sheet'!A22 =Senior Debt =Senior Debt

Senior Debt

M10

undeined

=SUM('Balance Sheet'!B22:L22)-SUM(B10:L10) =SUM(Senior Debt:Senior Debt)-SUM(undeined:undeined) =SUM(12.1:0.0)-SUM(12.1:0.0)

0 continued 27

B13

Senior Debt

='Balance Sheet'!B22 =Senior Debt =12.1

M13

Senior Debt

=SUM('Balance Sheet'!B22:L22)-SUM(B13:L13) =SUM(Senior Debt:Senior Debt)-SUM(Senior Debt :Senior Debt ) =SUM(12.1:0.0)-SUM(12.1:0.0)

B14

Equity

='Balance Sheet'!B28 =Equity =16.8

M14

Equity

=SUM('Balance Sheet'!B28:L28)-SUM(B14:L14) =SUM(Equity:Equity)-SUM(Equity:Equity) =SUM(16.8:21.8)-SUM(16.8:21.8)

B15

Shareholder Loan

='Balance Sheet'!B21 =Shareholder Loan =8.1

8.1

B16

Total Debt & Equity

=SUM(B13:B15) =SUM(Senior Debt :Shareholder Loan) =SUM(12.1:8.1)

37

B18

Debt to Equity Ratio

=IF(ROUND(B10,0)=0,"N/A",B10/B16) =IF(ROUND(undeined,0)=0,"N/A",undeined/Total Debt & Equity) =IF(ROUND(12.1,0)=0,"N/A",12.1/37.0)

0.327027027

B19

Debt to Equity Ratio Maximum

=MAX(B18:L18) =MAX(Debt to Equity Ratio:Debt to Equity Ratio) =MAX(32.7%:N/A)

0.327027027

B20

Debt To Equity Maximum Date

=INDEX($B$3:$L$3,MATCH(Debt_to_Equity_Ratio_Maximum,$B$18:$L $18,0)) =INDEX(Period Ending:Period Ending,MATCH(Debt to Equity Ratio Maximum, Debt to Equity Ratio:Debt to Equity Ratio,0)) =INDEX(31/12/2010:31/12/2020,MATCH(32.7%,32.7%:N/A,0))

B21

Debt To Equity Average

12.1

0

16.8

0

31/12/2010

=AVERAGE(B18:L18) =AVERAGE(Debt to Equity Ratio:Debt to Equity Ratio)

0.247994363

=AVERAGE(32.7%:N/A) C25

undeined

=Cashlow!C13 =undeined =8.9

M25

undeined

=SUM(Cashlow!C13:L13)-SUM(C25:L25) =SUM(undeined:undeined)-SUM(undeined:undeined) =SUM(8.9:23.5)-SUM(8.9:23.5)

8.918432555

0

=SUM(B24:B25) B26

Free Cash Flow

=SUM(undeined:undeined)

0

=SUM(undeined:undeined) C29

Senior Debt

='Balance Sheet'!C22 =Senior Debt =12.7

12.72138114 continued

M29

Senior Debt

=SUM('Balance Sheet'!C22:L22)-SUM(C29:L29) =SUM(Senior Debt:Senior Debt)-SUM(Senior Debt :Senior Debt ) =SUM(12.7:0.0)-SUM(12.7:0.0)

0

B30

Total Debt

=SUM(B29:B29) =SUM(Senior Debt ) =SUM(undeined)

0

B32

Free Cashlow to Debt Ratio

=IF(ROUND(B30,0)=0,"N/A",B26/B30) =IF(ROUND(Total Debt ,0)=0,"N/A",Free Cash Flow/Total Debt )

N/A

=IF(ROUND(0.0,0)=0,"N/A",0.0/0.0)

B33

B34

Free Cashlow to Debt Ratio Minimum

Free Cashlow to Debt Ratio Minimum Date

=MIN(B32:L32) =MIN(Free Cashlow to Debt Ratio:Free Cashlow to Debt Ratio)

0.701058514

=MIN(N/A:N/A) =INDEX($B$3:$L$3,MATCH(Free_Cashlow_to_Debt_Ratio_Minimum, $B$32:$L$32,0)) =INDEX(Period Ending:Period Ending,MATCH(Free Cashlow to Debt Ratio Minimum,Free Cashlow to Debt Ratio:Free Cashlow to Debt Ratio,0))

31/12/2011

=INDEX(31/12/2010:31/12/2020,MATCH(70.1%,N/A:N/A,0)) =AVERAGE(B32:L32) B35

Free Cashlow to Debt Ratio Average

=AVERAGE(Free Cashlow to Debt Ratio:Free Cashlow to Debt Ratio)

3.638155197

=AVERAGE(N/A:N/A) C40

Senior Debt

='Balance Sheet'!C22 =Senior Debt =12.7

M40

Senior Debt

=SUM('Balance Sheet'!C22:L22)-SUM(C40:L40) =SUM(Senior Debt:Senior Debt)-SUM(Senior Debt :Senior Debt ) =SUM(12.7:0.0)-SUM(12.7:0.0)

C41

Total Debt

=SUM(C39:C40) =SUM(undeined:Senior Debt ) =SUM(undeined:12.7)

C44

EBITDA

='Proit & Loss'!C10 =EBITDA =29.5

M44

EBITDA

=SUM('Proit & Loss'!C10:L10)-SUM(C44:L44) =SUM(EBITDA:EBITDA)-SUM(EBITDA:EBITDA) =SUM(29.5:29.1)-SUM(29.5:29.1)

C45

EBITDA

=SUM(C44:C44) =SUM(EBITDA) =SUM(29.5)

12.72138114

0

12.72138114

29.5

0

29.5 continued

=IF(ROUND(C41,0)=0,"N/A",C41/C45) C47

Debt to EBITDA Ratio

=IF(ROUND(Total Debt,0)=0,"N/A",Total Debt/EBITDA)

0.431233259

=IF(ROUND(12.7,0)=0,"N/A",12.7/29.5) =MAX(B47:L47) B48

Debt to EBITDA Ratio Maximum

=MAX(Debt to EBITDA Ratio:Debt to EBITDA Ratio)

0.431233259

=MAX(undeined:N/A) =INDEX($B$3:$L$3,MATCH(B48,$B$47:$L$47,0)) B49

Debt to EBITDA Ratio Minimum Date

=INDEX(Period Ending:Period Ending,MATCH(Debt to EBITDA Ratio Maximum,Debt to EBITDA Ratio:Debt to EBITDA Ratio,0))

31/12/2011

=INDEX(31/12/2010:31/12/2020,MATCH(43.1%,undeined:N/A,0)) =AVERAGE(B47:L47) B50

Debt to EBITDA Average

=AVERAGE(Debt to EBITDA Ratio:Debt to EBITDA Ratio)

0.269671124

=AVERAGE(undeined:N/A) B54

Senior Debt

='Balance Sheet'!B22 =Senior Debt =12.1

M54

Senior Debt

=SUM('Balance Sheet'!C22:L22)-SUM(C54:L54) =SUM(Senior Debt:Senior Debt)-SUM(Senior Debt :Senior Debt ) =SUM(12.7:0.0)-SUM(12.7:0.0)

B55

Total Debt

=SUM(B53:B54) =SUM(undeined:Senior Debt ) =SUM(undeined:12.1)

12.1

B58

Net Assets

='Balance Sheet'!B24 =Net Assets =16.8

16.8

M58

Net Assets

=SUM('Balance Sheet'!C24:L24)-SUM(C58:L58) =SUM(Net Assets:Net Assets)-SUM(Net Assets:Net Assets) =SUM(39.4:95.0)-SUM(39.4:95.0)

B59

Net Assets

=SUM(B58:B58) =SUM(Net Assets) =SUM(16.8)

B61

Debt to Net Assets Ratio

12.1

0

0

16.8

=IF(ROUND(B55,0)=0,"N/A",B55/B59) =IF(ROUND(Total Debt,0)=0,"N/A",Total Debt/Net Assets)

0.720238095

=IF(ROUND(12.1,0)=0,"N/A",12.1/16.8) =MAX(B61:L61) B62

Debt to Net Assets Ratio Maximum

=MAX(Debt to Net Assets Ratio:Debt to Net Assets Ratio)

0.720238095

=MAX(72.0%:N/A) continued

=INDEX($B$3:$L$3,MATCH(Debt_to_Net_Assets_Ratio_Maximum,$B$61: $L$61,0)) B63

Debt to Net Assets Ratio Maximum Date

=INDEX(Period Ending:Period Ending,MATCH(Debt to Net Assets Ratio Maximum,Debt to Net Assets Ratio:Debt to Net Assets Ratio,0))

31/12/2010

=INDEX(31/12/2010:31/12/2020,MATCH(72.0%,72.0%:N/A,0)) =AVERAGE(B61:L61) B64

Debt to Net Assets Average

=AVERAGE(Debt to Net Assets Ratio:Debt to Net Assets Ratio)

0.277054871

=AVERAGE(72.0%:N/A) C68

EBIT

='Proit & Loss'!C13 =EBIT =26.7

M68

EBIT

=SUM('Proit & Loss'!C13:L13)-SUM(C68:L68) =SUM(EBIT:EBIT)-SUM(EBIT:EBIT) =SUM(26.7:26.3)-SUM(26.7:26.3)

0

B70

EBIT

=SUM(B68:B69) =SUM(EBIT:Cash Interest / (Expense)) =SUM(undeined:undeined)

0

C73

Interest - Senior Debt

='Proit & Loss'!C16 =Interest - Senior Debt =0.9

M73

Interest - Senior Debt

=SUM('Proit & Loss'!C16:L16)-SUM(C73:L73) =SUM(Interest - Senior Debt:Interest - Senior Debt)-SUM(Interest - Senior Debt:Interest - Senior Debt) =SUM(0.9:0.0)-SUM(0.9:0.0)

0

B74

undeined

=SUM(B73:B73) =SUM(Interest - Senior Debt) =SUM(undeined)

0

B76

Interest Cover Ratio

26.68562364

0.945058267

=IF(ROUND(B73,1)=0,"N/A",B70/B74) =IF(ROUND(Interest - Senior Debt,1)=0,"N/A",EBIT/undeined)

N/A

=IF(ROUND(undeined,1)=0,"N/A",0.0/0.0) =MIN(B76:L76) B77

Interest Cover Ratio Minimum

=MIN(Interest Cover Ratio:Interest Cover Ratio)

28.56024364

=MIN(N/A:N/A)

B78

Interest Cover Ratio Minimum Date

=INDEX($B$3:$L$3,MATCH(Interest_Cover_Ratio_Minimum,$B$76:$L $76,0)) =INDEX(Period Ending:Period Ending,MATCH(Interest Cover Ratio Minimum, Interest Cover Ratio:Interest Cover Ratio,0))

31/12/2011

=INDEX(31/12/2010:31/12/2020,MATCH(28.6,N/A:N/A,0)) continued

=AVERAGE(B76:L76) B79

Interest Cover Ratio Average

=AVERAGE(Interest Cover Ratio:Interest Cover Ratio)

59.12358685

=AVERAGE(N/A:N/A) =B86*(1+Inlation_Per_Annum) C86

General Inlation Index

=General Inlation Index*(1+Inlation_Per_Annum)

1.025

=1.000*(1+Inlation_Per_Annum) C88

Equity Drawn

=-Cashlow!C19 =-Equity Drawn =-5.0

M88

Equity Drawn

=SUM(Cashlow!C19:L19)+SUM(C88:L88) =SUM(Equity Drawn:Equity Drawn)+SUM(Equity Drawn :Equity Drawn ) =SUM(5.0:0.0)+SUM(-5.0:0.0)

0

C90

Dividends Paid

=-Cashlow!C27 =-Dividends Paid =-0.0

0

M90

Dividends Paid

=SUM(Cashlow!C27:L27)+SUM(C90:L90) =SUM(Dividends Paid:Dividends Paid)+SUM(Dividends Paid :Dividends Paid ) =SUM(0.0:-18.3)+SUM(0.0:18.3)

0

C92

Subordinated Debt Total Drawn

-5

=-Cashlow!C17 =-Shareholders Loan Drawn

1.198273573

=--1.2 =SUM(C92:L92)+SUM(Cashlow!C17:L17) M92

Subordinated Debt Total Drawn

=SUM(Subordinated Debt Total - Drawn:Subordinated Debt Total Drawn)+SUM(Shareholders Loan Drawn:Shareholders Loan Drawn)

0

=SUM(1.2:0.0)+SUM(-1.2:0.0) =-Cashlow!C20 C93

Subordinated Debt Total Repayment

=-Shareholders Loan Principal

1.380345285

=--1.4 =SUM(Cashlow!C20:L20)+SUM(C93:L93) M93

Subordinated Debt Total Repayment

=SUM(Shareholders Loan Principal:Shareholders Loan Principal)+SUM(Subordinated Debt Total - Repayment:Subordinated Debt Total - Repayment)

0

=SUM(-1.4:0.0)+SUM(1.4:0.0) =-Cashlow!C22 C94

Subordinated Debt Total Interest

=-Shareholders Loan - Interest

1.125129482

=--1.1 continued

=SUM(C94:L94)+SUM(Cashlow!C22:L22) M94

Subordinated Debt Total Interest

=SUM(Subordinated Debt Total - Interest:Subordinated Debt Total Interest)+SUM(Shareholders Loan - Interest:Shareholders Loan - Interest)

0

=SUM(1.1:0.0)+SUM(-1.1:0.0) =-Cashlow!C24 C95

Subordinated Debt Total - Fees Paid

=-Shareholders Loan - Fees

-0.017974104

=-0.0 =SUM(C95:L95)+SUM(Cashlow!C24:L24) M95

Subordinated Debt Total - Fees Paid

=SUM(Subordinated Debt Total - Fees Paid:Subordinated Debt Total - Fees Paid)+SUM(Shareholders Loan - Fees:Shareholders Loan - Fees)

0

=SUM(0.0:0.0)+SUM(0.0:0.0) =SUM(C92:C95) C96

Net Shareholders Loan Cashlow

=SUM(Subordinated Debt Total - Drawn:Subordinated Debt Total - Fees Paid)

3.685774237

=SUM(1.2:0.0)

B100

Equity IRR Nominal

C100

Equity IRR Nominal

=IF(ISERROR(IRR(C100:L100,0.1)),0,IRR(C100:L100,0.1)) =IF(ISERROR(IRR(Equity IRR - Nominal:Equity IRR - Nominal,0.1)),0,IRR (Equity IRR - Nominal:Equity IRR - Nominal,0.1)) =IF(ISERROR(IRR(-5.0:18.3,0.1)),0,IRR(-5.0:18.3,0.1))

1.688836976

=C88+C90 =Equity Drawn +Dividends Paid

-5

=-5.0+0.0

B102

Equity IRR - Real

=IF(ISERROR(IRR(C102:L102,0.1)),0,IRR(C102:L102,0.1)) =IF(ISERROR(IRR(Equity IRR - Real:Equity IRR - Real,0.1)),0,IRR(Equity IRR Real:Equity IRR - Real,0.1)) =IF(ISERROR(IRR(-4.9:14.3,0.1)),0,IRR(-4.9:14.3,0.1))

1.623255587

=C100/C86 C102

Equity IRR - Real

=Equity IRR - Nominal/General Inlation Index

-4.87804878

=-5.0/1.025

B104

Equity & Sub Debt IRR - Nominal

C104

Equity & Sub Debt IRR - Nominal

=IF(ISERROR(IRR(C104:L104,0.1)),0,IRR(C104:L104,0.1)) =IF(ISERROR(IRR(Equity & Sub Debt IRR - Nominal:Equity & Sub Debt IRR - Nominal,0.1)),0,IRR(Equity & Sub Debt IRR - Nominal:Equity & Sub Debt IRR - Nominal,0.1)) =IF(ISERROR(IRR(-1.3:18.3,0.1)),0,IRR(-1.3:18.3,0.1))

7.348401049

=C88+C90+C96 =Equity Drawn +Dividends Paid +Net Shareholders Loan Cashlow

-1.314225763

=-5.0+0.0+3.7 continued

Corp orat e F in an ce Mod ellin g a n d A n alysis

=IF(ISERROR(IRR(C106:L106,0.1)),0,IRR(C106:L106,0.1)) B106

=IF(ISERROR(IRR(Equity & Sub Debt IRR - Real:Equity & Sub Debt IRR Equity & Sub Debt - Real,0.1)),0,IRR(Equity & Sub Debt IRR - Real:Equity & Sub Debt IRR IRR - Real Real,0.1))

7.144781512

=IF(ISERROR(IRR(-1.3:14.3,0.1)),0,IRR(-1.3:14.3,0.1)) =C104/C86 C106

Equity & Sub Debt =Equity & Sub Debt IRR - Nominal/General Inlation Index IRR - Real

-1.282171477

=-1.3/1.025

S ource:M odelling S olutions

Illustration 3 2 is a run f rom the S p readsheet Prof essional A udit tool that has p rinted out all the uniq ue f ormula w hic h derive or c alc ulate the k ey outp ut ratios f or the lender or the shareholder. A s these k ey outp uts are a typ ic al k ey risk it is advisable to use the outp ut to c hec k the log ic al integ rity of eac h c ell rep or to the Eq uity R eturns and Lenders’ R atio sheet inc luded in the ex amp le.

Flex and sensitivity review

F lex testing is a valuable tec hniq ue f or inding p otentially larg e errors in a model. It involves the variation of inp uts and the observation of the ef f ec t on the outp uts. It is imp ortant to c onc entrate on k ey risk areas. A sensitivity c an be review ed by c hang ing inp uts req uired f or the desig nated sensitivity c ase and review ing the results. How ever, it is better to use a sensitivity c omp arison to the base c ase ( that is, trac k ing c hang es) betw een the outp uts and assessing w hether the model c hang es in areas as ex p ec ted. B oth lex te ing and sensitivity review should use this ap p roac h and should c ollaborate eac h sensitivity w ith a hig h level analytic al review . T he inal p art w ould be to rank eac h result in order and assess the relative rank ing g iven your k now ledg e of the c ase.

Exercise self testing the inancial model

B ased up on the c orp orate inanc e model that you have built to date, undertak e a self testing and review ap p roac h. M ore sp ec iic ally, undertak e an analytic al review of the statement f orec asts, review the k outp uts f or the c redit ratios and eq uity returns and lex the k ey inp ut assump tions using the lex testing ap p roac h. A f ter you have undertak en your self - testing or review of the inanc ial model that you have built, mak e any nec essary c orrec tions.

Using the model

F rom the inanc ial model that you have built you have the c ap ability to p rep are inanc ially viable p roj ec tions f rom all stak eholder view p oints. T he c omp any w ill p rovide adeq uate returns to its shareholders, suf ic ient debt servic e to its lenders and any other material outp ut areas w ill be c onsidered.

34

Sect ion 1 B u ild in g th e forecast in g fin an cial mod el

Disclaimers It is hig hly rec ommended that g iven the multip le sourc es that c an g ive rise to errors in inanc ial models of this nature that liability needs to be w aived as ap p rop riate. T he disc laimer below outlines a typ ic disc laimer that should alw ays be p lac ed in inanc ial model bef ore it is distributed.

Disclaimer T his model has been p rep ared by M odelling S olutions Limited ( M S ) f rom data p rovided by var p arties. It has not been audited and rec ip ients should use their ow n due dilig enc e. No rep resentation, w arranty or undertak ing ( ex p ressed or imp lied) is made in relation to it. No resp onsibility is tak en o ac c ep ted by M S f or the ac c urac y of the model or the assump tions on w hic h it is based and all liab theref ore is ex p ressly ex c luded.

35

Section 2

Corporate inance decisions Acquisitions

I w ill now tak e readers throug h a inanc ial modelling and analysis p roc ess f or the p otential ac q uisition an unq uoted c omp any. A lthoug h it is rec og nised that there are other strateg ic and non q uantiiable asp ec ts to a p otential ac q sition op p ortunity the sc op e of this book w ill p urely c onsider the inanc ial asp ec ts both historic ally p roj ec ted w hic h af f ec t the inanc ial results in terms inanc ial analysis and inanc ial modelling .

Step 1 Undertake due diligence regarding the actual inancial position of the target company

T he irst step is to obtain at least the last three years’ annual ac c ounts if available. If these are audited then all the better, as this w ill help reduc e the amount of due dilig enc e req uired to be p erf ormed on the ac tuals. A t the time of w riting the audit ex emp tion g uidelines f or small c omp anies that at least tw o out of the f ollow ing three c riteria must be satisied: ● ● ●

annual turnover must be £5. 6 million or less; the balanc e sheet total must be £2 . 8 million or less; and the averag e number of emp loyees must be 50 or f ew er.

T his ef f ec tively means that those that f all outside this sc op e are subj ec t to an audit. R educ ed disc losure req uirements are needed f or medium siz ed c omp anies. T hese must satisf y f urthe sp ec iic c riteria. It is advisable to review the deg ree of non- disc losure in the medium- siz ed c omp any audited ac c ounts if your ac q uisition targ et f alls into this c ateg ory. If the non- disc losed items ap p ear to be areas that are materia to your p otential ac q uisition targ et then it is obviously advisable to undertak e f urther due dilig enc e. In the ex amp le w here w e have audited c omp any ac c ounts w ith no ex emp tions as at 3 1 M arc there is a need to bridg e the g ap betw een these tw o dates in terms of the ac tuals and undertak e the nec essary due dilig enc e. G iven that the ac q uisition date is 1 J anuary 2 0 1 1 , w e w ould be req uired to derive a b sheet p osition of 3 1 D ec ember 2 0 1 0 f or inc lusion of the targ ets inanc ial p roj ec tion model.

Step 2 Place an acquisition value on the target

Valuing a business is an art and not a sc ienc e and there are a number of p otential valuation tec hniq ues or methods at our disp osal f or us to attemp t to p lac e a valuation on the targ et c omp any. G iven that the targ et is an unq uoted c omp any w e w ill demonstrate the f ollow ing ap p roac hes. ●

Asset b ased avluations: this ex amp le show s an asset based valuation ap p roac h. In Illustration 3 3 w e c an see the targ et c omp any’s balanc e sheet at historic c ost. How ever, up review of the c omp any’s balanc e sheet w e have f ound that the c urrent value of the c ertain balanc e sheets assets is as f ollow s: 37

Corp orat e F in an ce Mod ellin g a n d A n alysis

# # #

ix ed assets NB V £1 1 . 0 m; ac c ounts rec eivable £3 . 0 m bad debt are ex p ec ted; and stoc k £3 . 2 million mark et value now hig her.

B ased up on the req uired c urrent values w e c an rec alc ulate the net assets at c urrent value and thus c omp lete the double entry j ournal adj ustments. Essentially, w e have inc luded revaluation j ournal entries. Illustration 3 4 ( see Illustration3 4. x ls) . Essentially w e have inc luded revaluation j ournal entries in c olumns C and D in order to c alc ulate the imp ac t on the assets and the revaluation reserve. T his results in a c omp any valuation of £6 . 9 million. A rule of thumb is that the net asset valuation should alw ays set the sc ene f or the low est valuation.

Illustration 3 3 Pre current value Project Name

NET ASSETS VALUATION

Model Start Date – Forecasts Start

01 January 2011

ACTUAL OPENING BALANCE SHEET

HISTORIC COST 31 December 2010 £ million

CURRENT VALUE 31 December 2010 £ million

Increase / (Decrease) 31 December 2010 £ million

Fixed Assets – Net Book Value

8.2

11.0

2.8

Capitalised Arrangement Fees

0.3

Current Assets Cash

15.3

Accounts Receivable

4.5

3.0

–1.5

Stock

2.5

3.2

0.7

Other Current Assets

3.0 25.3

Current Liabilities Accounts Payable

3.4

Vat Payable / (Receivable)

0.6

Tax Payable

4.6 8.6

Long Term Liabilities Shareholder Loan

8.1

Senior Debt

12.1 20.2

Net Assets

5.0

1.9 continued

38

Financed By

Equity

5.0

Retained Earnings

0.0

Shareholders Funds

5.0

Checks

0.0

S ource:M odelling S olutions

Illustration 3 5 Net assets valuation Period Ending

31 December 2010

Revaluation

Revaluation

31 December 2010

HISTORIC COST

Journal

Journal

CURRENT VALUE

£ million

£ million DR

CR

Fixed Assets – Net Book Value

8.2

2.8

11.0

Capitalised Arrangement Fees

0.3

0.3

Cash

15.3

15.3

Accounts Receivable

4.5

Stock

2.5

Other Current Assets

3.0

3.0

25.3

24.4

Accounts Payable

3.4

3.4

Vat Payable / (Receivable)

0.6

0.6

Tax Payable

4.6

4.6

8.6

8.6

Shareholder Loan

8.1

8.1

Senior Debt

12.1

12.1

20.2

20.2

5.0

6.9

Current Assets

−1.5 0.7

3.0 3.2

Current Liabilities

Long Term Liabilities

Net Assets

continued

Corp orat e F in an ce Mod ellin g a n d A n alysis

Financed by Equity

5.0

5.0

Retained Earnings

0.0

0.0

Revaluation Reserve

0.0

Shareholders Funds

5.0

–1.5

3.5

1.9 6.9

S ource:M odelling S olutions

●

Free cash low the : f ree c ash low ap p roac h f or valuation p urp oses rep resents the c ash low available f or distribution to all investors in the c orp oration i. e. debt and eq uity sourc es. F ree c ash low c an be deined as f ollow s: EB IT D A Plus D ep rec iation/ A mortisation Plus Chang e In W ork ing Cap ital Less Cap ital Ex p enditure Less T ax ation

●

40

M ultiples b ased approaches: the ex it multip le ap p roac h assumes that a business w ill be sold at the end of a c ertain year in the f orec ast. T he ex it multip le used is usually derived by using inanc ial analysis assoc iated w ith c omp arable c omp anies. T he analysis of c omp arable c omp anies w ill help identif y rang e of multip les that c an be ap p lied. T he most c ommon basis used is an EB IT D A multip le w hic based up on Enterp rise Value/ EB IT D A . T he EB IT D A multip le is then ap p lied to the EB IT D year of ex it or sale of the business. A terminal value is usually c alc ulated at the year of ex it. Illustration 3 6 show s an ex amp le of an EB IT D A multip le c alc ulation that w ould typ ic ally be f or eac h c omp arable c omp any usually f rom their latest ac c ounts w ith the view ap p lying a mean o indeed averag e of these statistic s. In Illustration 3 6 , w e are req uired to ind the enterp rise value of the p artic ular c omp any f or the valuation date of 3 1 D ec ember 2 0 1 0 . T he mark et p ric e p er ordinary share is £6 . 7 8 and there a rently 1 6 . 8 million in issue. W e c an derive the mark et p ric e of the ordinary shares by simp ly multip ly these tw o numbers. T he debt and the c ash are tak en f rom the balanc e sheet. Using this c alc ulation basis w e derive an enterp rise value f or the c omp any of £1 0 8 . 6 million. T he EB IT D A f or the year ending 3 1 D ec ember 2 0 1 0 is £1 0 . 0 million theref ore our multip le is 1 0 . 9 .

Illustration 3 6 EBITDA multiple valuation EBITDA Multiple Valuation

Project Name

31 December 2010

Date of Valuation Market Price Ordinary Share

£6.78

Number Of Ordinary Shares In Issue (million)

16.8

PROFIT & LOSS ACCOUNT EBITDA Multiple Valuation Period Ending

2010 Year Ending: 31 December 2010 Forecast £ million

Sales

99.0

Cost Of Sales

45.0

Gross Proit

54.0

Operating Expenses

44.0

EBITDA

10.0

Depreciation

3.2

Amortisation - Arrangement Fees

0.1

EBIT

6.7

Cash Interest / (Expense)

0.3

Interest - Shareholder Loan

1.3

Interest - Senior Debt

1.0

EBT

4.7

Tax

7.1

Earnings After Tax

−2.4

Dividends

0.0

Earning Retained For The Period

−2.4

BALANCE SHEET EBITDA Multiple Valuation Period Ending

31 December 2010 Actual £ million

Fixed Assets – Net Book Value

31.8

Capitalised Arrangement Fees

0.3 continued

Current Assets Cash

15.3

Accounts Receivable

4.5

Stock

2.5

Other Current Assets

3.0 25.3

Current Liabilities Accounts Payable

3.4

Vat Payable / (Receivable)

0.6

Tax Payable

4.6 8.6

Long Term Liabilities Senior Debt

10.0 10.0

Net Assets

38.8

Financed By

Equity

16.8

Retained Earnings

22.0

Shareholders Funds

38.8

SUMMARY EBITDA Multiple Valuation Date of Valuation

31 December 2010

Ordinary Shares At Market Value

£113.9

Add Debt

£10.0

Less Cash

−£15.3

Enterprise Value

£108.6

EBITDA

10.0

EBITDA Multiple

10.9

S ource:M odelling S olutions

Sect ion 2 C orp orat e f in an ce d ecision s

●

T he above ex amp les c an be seen in f urther detail the Ex c el ex amp le Illustration 3 7 ( see Illustr tion3 7 . x ls) . T erminal value:a terminal value ap p roac h is the p resent value based up on a p oint in time of all f uture c ash low s at a g row th rate into the f uture. T here are tw o main methods of mak ing the terminal valu c alc ulations ( that is, EB IT D A multip le ap p roac h and the p erp etuity g row th ap p roac h) . T he c alc ulation f or a p erp etuity based terminal value is as f ollow s: F CF F inal Year / ( D isc ount R ate – G row th R ate)

In Illustration 3 8 , w e have a f ree c ash low of £2 5. 4 million in the inal year of our 1 0 year inanc p roj ec tions, a disc ount rate based up on the c omp any’s w eig hted averag e c ost of c ap ital of 1 2 % annual g row th rate of 3 % p er annum. T his derives a terminal value of £2 8 2 . 1 million.

Illustration 3 8 Terminal value perpetuity growth TERMINAL VALUE PERPETUITY GROWTH Free Cash Flow in the inal year of the projections £ million

25.4

WACC Discount Rate

12.0%

Perpetuity Growth

3.0%

Terminal Value

282.1

S ource:M odelling S olutions

T he c alc ulation f or a EB IT D A multip le based terminal value is as f ollow s: EB IT D A F inal Year @

EB IT D A M ultip le

In Illustration 3 9 w e have an EB IT D A of £2 9 . 1 million in the inal year of our 1 0 year i p roj ec tions and an EB IT D A multip le of 1 0 . T his derives a terminal value of £2 9 0 . 8 mil

43

Corp orat e F in an ce Mod ellin g a n d A n alysis

Illustration 3 9 Terminal value EBITDA multiple EBITDA MULTIPLE EBITDA

29.1

EBITDA Multiple

10

Terminal Value

290.8

S ource:M odelling S olutions

T he above ex amp les c an be seen in f urther detail the Ex c el ex amp le Illustration 40 ( see Illustration40 . x ls) . S o the nex t q uestion w hic h w ould sp ring to mind is w hat are the resp ec tive limitations of the tw alternative ap p roac hes? Put simp ly both bases have a limitation assoc iated w ith c onstant g row th. In terms of p op ularity in the real w orld the EB IT D A multip le is f ar more w idely adop ted by p rac tition E nterprise value:enterp rise value is a measure that relec ts the value of the w hole business w hic h is normally valued at mark et values. Enterp rise value c an be deined as:

●

O rdinary shares ( eq uity) at mark et value A dd D ebt at mark et value A dd Pref erenc es shares at mark et value Less c ash

In Illustration 41 w e are req uired to ind the enterp rise value of the p artic ular c omp any f or the valuation date of 3 1 D ec ember 2 0 1 0 . T he mark et p ric e p er ordinary share is £4. 6 7 and there are c urrent million in issue. W e c an derive the mark et p ric e of the ordinary shares by simp ly multip lying these tw o numbers. T he debt and the c ash are tak en f rom the balanc e sheet. Using this c alc ulation basis w e derive an enterp rise value f or the c omp any of £8 3 . 4 million.

Illustration 41 Enterprise value Project Name

ENTERPRISE VALUE

Date of Valuation

31 December 2010

Market Price Ordinary Share

£4.67

Number Of Ordinary Shares in issue (million)

16.8 continued

44

Sect ion 2 C orp orat e f in an ce d ecision s

Date of Valuation

31 December 2010

Ordinary Shares at Market Value

£78.5

Add Debt

£20.2

Less Cash

−£15.3

Enterprise Value

£83.4

S ource:M odelling S olutions

T he above ex amp les c an be seen in f urther detail the Ex c el ex amp le Illustration 42 Illustration42 . x ls) .

( see

Step 3 Prepare the acquirer actuals and projections T he ac q uiring c omp any is req uired to p rovide oj ec its tions p rannually over the 1 0 year p eriod. Tll his be the w i ac q uirer’s inanc ial p osition assuming that theany c omp c ontinues as it is w ithout ac q uiring thectarg ompet any.

Step 4 Prepare the combined co-actuals and projections

T he c ombined c omp any p osition w ill be p roj ec ted ac c ording ly over the 1 0 year p eriod. T he c omb w ill inc lude the q uantiiable synerg ies, the g oodw ill ac c ounting treatment, and the ac q uisition f unding . T he valuation tec hniq ues f or a q uoted c omp any w ill dif f er bec ause shares are being p urc hased sold in the targ et c omp any. Conseq uently, in addition to the valuation methods outlined in the sec tion above relating to the valuation of a p rivate c omp any targ et, w e c an also outline the f ollow ing tec hniq ues. ●

P rice earnings ratio approaches:the PE ratio ap p roac h uses the relationship betw een earning s and the mark et p ric e p er share to value the c omp any. T his is a stoc k mark et ratio w hic h is used as a meas of g row th p rosp ec ts f or a c omp any’s shares. T he PE R atio is deined as f ollow s: M ark et Pric e Per S hare/ Earning s Per S hare

●

Dividend models: the dividend model is a inanc ial model that values shares in a c omp any w hic h c onsiders the p resent value of the c omp any’s dividend c ash low stream. Conseq uently disc ounted c ash low tec hniq ues are used ac c ording ly. T he dividend streams are lik ely to be based up on inanc ial f orec asts p roduc ed by a inanc ial model. T here w ould be a terminal value c alc ulated f rom the last date of the f orec ast p eriod ac c ording ly. Illustration 43 , w e are using a w eig hted averag e c ost of c ap ital ( W A CC) disc ount rate of 1 2 c ount the 1 0 year dividend c ash low stream inc luded in the c ash low f orec ast of our inanc ial mod G iven the NPV that is derived w e c an then add our terminal value c alc ulation to derive our inal dividend model valuation £3 50 million. T he terminal value selec ted f or this p urp ose is based up on an EB IT D A multip le basis. Conseq uently based up on an EB IT D A of £2 9 . 1 million and a mu w e derive a terminal value of £2 9 0 . 8 million. T he net p resent value ( NPV) of the dividend streams £59 . 2 million. T he dividend stream p lus terminal value results in a valuation of £3 50 million.

45

Corp orat e F in an ce Mod ellin g a n d A n alysis

Illustration 43 Dividend Model Valuation DIVIDEND MODEL VALUATION PERPETUITY GROWTH Free Cash Flow in the inal year of the projections £ million

25.4

WACC Discount Rate

12.0%

Perpetuity Growth

3.0%

Terminal Value £ million

282.1

EBITDA MULTIPLE EBITDA £ million

29.1

EBITDA Multiple

10

Terminal Value £ million

290.8

NPV Of Dividend Stream £ million

59.2

Dividend Model Valuation £ million

350.0

S ource:M odelling S olutions

T he above ex amp les c an be seen in f urther in detail in the Ex c el Illustration 44 ( see Illustration44. x ls) . In the ex amp le, inanc ial modelling ex trac t show s the ability to sw itc h betw een the EB IT D A tip le basis and the Perp etuity G row th basis as p er the G eneral Inp uts sheet.

Acquisitions exercise

B ased up on the inanc ial model built to date add the various valuation methods assuming that you are dealing w ith a p ublic ly q uoted targ et. F inanc e the ac q uisition 50 % debt and 50 % eq uity. Ensure th c omp ute the c redit ratios and stoc k mark et ratios as ap p rop riate. 46

Sect ion 2 C orp orat e f in an ce d ecision s

Mergers

A t a hig h level, a merg er hap p ens w hen tw o irms ag ree to c ombine and op erate as a sing le new c om rather than remain sep arately ow ned entities and op erations. S uc h a business c ombination is of ten ref erred to as a ‘merg er of eq uals’ and the c omp anies c an of ten be of similar siz e. A business c ombination of eq c omp anies w ill be c alled a merg er w hen the c hairman or board of the tw o c omp anies ag ree that the mer w ill be of mutual beneit. M erg ers c an be f ew and f ar betw een as of ten one p arty is lik ely to have a stro p osition than the other. How ever, let us c onsider the strateg ic and inanc ial beneits of a p ossible merg er. T he tw o c omp anies may beneit f rom a reduc tion in surp lus c ap ac ity in their p artic ular industry th leading to a low er c ombined c ost base. T he resulting merg er may inc rease mark et p ow er, f or ex amp le, more distribution outlets. T here may be synerg istic beneit w hereby the sum of the c ombined entities may w ell be g reater than the sum of the sep arate entities, that is, 2 + 2 = 5. Ec onomies of sc ale may be ex p erienc ed throug h the ability to neg otiate better sup p lier c ontrac ts due t hig her business volumes and so on. Let us now turn to our illustration. Illustration 45 ( see Illustration45. x ls) show s the c urrent inanc ial p osition and p roj ec tions of Comp any A p re- merg er. T he assump tions c an be identiied in the G eneral Inp uts sheet and the c omp any’s inanc ial p osition is show n in the S ummary sheet. T he model layout and desig n is similar to our early c onvention f or inanc ial model builds outlined in S ec tion 1 , under ‘Layout’ and ‘D esig ning the inanc ial model’. Illustration 46 show s the p osition of Comp any A p rior to the merg er w ith Comp any B . W e c an see f rom the results that the c ombined c omp any has a suf ic iently stable p osition in terms of its c ash p osition and its c redit ratios f or its lenders are w ithin ac c ep table targ et levels. Certain stoc k mark statistic s are c alc ulated w hic h w ill later be benc hmark ed ag ainst the c ombined c omp any p osition. T inc lude earning s p er share ( EPS ) , mark et p ric e p er share and dividend p er share.

Illustration 46 Company A prior to merger COMPANY CASH POSITION £ million Minimum Balance

0.0

Year of Minimum Balance

31 December 2011

Maximum Balance

51.2

Year of Maximum Balance

31 December 2020

continued 47

LENDERS CREDIT RATIOS Debt to Equity Ratio – Max Free Cash low to Debt – Min Debt to EBITDA – Max Debt to Net Assets – Max Interest Cover – Min

Minimum

Target

OK

Target Maximum

20.3%

80.0%

OK

Target Maximum

263.7%

60.0%

OK

Target Maximum

20.3%

60.00%

OK

Target Maximum

23.1%

90.00%

OK

Target Minimum

102.3

2.0

Year of Min / Max

Average

31 December 2011

11.8%

31 December 2011

1540.3%

31 December 2011

8.4%

31 December 2012

13.2%

31 December 2012

211.3

STOCK MARKET RATIOS Earnings Per Share

PE Ratio

Market Price Per Share £15.78

31 December 2010 31 December 2011

£3.01

6.5

£19.55

31 December 2012

£3.05

6.5

£19.83

31 December 2013

£3.12

6.5

£20.28

31 December 2014

£3.20

6.5

£20.80

31 December 2015

£3.25

6.5

£21.10

31 December 2016

£3.28

6.5

£21.33

31 December 2017

£3.32

6.5

£21.56

31 December 2018

£3.35

6.5

£21.79

31 December 2019

£3.39

6.5

£22.03

31 December 2020

£3.42

6.5

£22.26

STOCK MARKET RATIOS Free Cash Flow Per Share

Dividend Per Share

31 December 2011

£1.93

£3.13

31 December 2012

£3.83

£3.69

31 December 2013

£3.89

£3.13

31 December 2014

£3.97

£3.20 continued

Sect ion 2 C orp orat e f in an ce d ecision s

31 December 2015

£4.05

£3.25

31 December 2016

£4.09

£3.28

31 December 2017

£4.12

£3.32

31 December 2018

£4.15

£3.35

31 December 2019

£4.19

£3.39

31 December 2020

£4.22

£3.42

S ource:M odelling S olutions

Illustration 47 ( see Illustration47 . x ls) show s the c urrent inanc ial p osition and p roj ec tions of Comp B p re- merg er. T he assump tions c an be identiied in the G eneral Inp uts sheet and the c omp any’s inanc p osition is show n in the S ummary sheet. T he model layout and desig n is similar to our early c onvention f or inanc ial model builds outlined in S ec tion 1 , under ‘Layout’ and ‘D esig ning the inanc ial model’. Illustration 48 show s the p osition of Comp any B p rior to the merg er w ith Comp any A . W e c an see f rom the results that the c ombined c omp any has a suf ic iently stable p osition in terms of its c ash p osition and its c redit ratios f or its lenders are w ithin ac c ep table targ et levels. Certain stoc k mark statistic s are c alc ulated w hic h w ill later be benc hmark ed ag ainst the c ombined c omp any p osition. T inc lude EPS , mark et p ric e p er share and dividend p er share.

Illustration 48 Company B prior to merger COMPANY CASH POSITION £ million Minimum Balance

1.9

Year of Minimum Balance

31 December 2011

Maximum Balance

88.1

Year of Maximum Balance

31 December 2020

LENDERS CREDIT RATIOS Debt to Equity Ratio – Max Free Cash low to Debt – Min

Minimum

Target

OK

Target Maximum

21.9%

80.0%

OK

Target Maximum

714.9%

60.0%

Year of Min / Max

Average

31 December 2011

15.1%

31 December 2011

1941.7% continued 49

Debt to EBITDA – Max Debt to Net Assets – Max Interest Cover – Min

OK

Target Maximum

21.9%

60.00%

OK

Target Maximum

32.8%

90.00%

OK

Target Minimum

191.3

2.0

31 December 2011

5.4%

31 December 2011

20.5%

31 December 2012

386.7

STOCK MARKET RATIOS Earnings Per Share

PE Ratio

Market Price Per Share £22.00

31 December 2010 31 December 2011

£5.00

5

£25.00

31 December 2012

£5.08

5

£25.42

31 December 2013

£5.22

5

£26.11

31 December 2014

£5.36

5

£26.82

31 December 2015

£5.45

5

£27.27

31 December 2016

£5.56

5

£27.82

31 December 2017

£5.63

5

£28.13

31 December 2018

£5.69

5

£28.44

31 December 2019

£5.75

5

£28.75

31 December 2020

£5.81

5

£29.07

STOCK MARKET RATIOS Free Cash Flow Per Share

Dividend Per Share

31 December 2011

£4.56

£5.86

31 December 2012

£5.98

£5.08

31 December 2013

£6.11

£5.22

31 December 2014

£6.23

£5.36

31 December 2015

£6.36

£5.45

31 December 2016

£6.43

£5.56

31 December 2017

£6.48

£5.63

31 December 2018

£6.55

£5.69

31 December 2019

£6.61

£5.75

31 December 2020

£6.68

£5.81

S ource: M odelling S olutions

Sect ion 2 C orp orat e f in an ce d ecision s

W e shall now turn our attention to the p roj ec tions of the merg ed c omp any. ● ● ● ●

T he p rop osed inanc ial terms f or the shareholders of the merg er are a one f or one share ex c hang e. T he c omp anies are in the p osition to tak e advantag e of c ross selling op p ortunities of their resp ec p roduc t rang es, thus inc reasing revenues. T he c omp anies are able to reduc e their dup lic ated c entralised f unc tions throug h ec onomies of sc a enj oyed by the larg er c ombined c omp any. T he c omp any’s g ross marg ins w ill also inc rease due to the imp rovement in p urc hasing terms that c be obtained f rom bulk p urc hase disc ounts f or stoc k .

Illustration 49 ( see Illustration49 . x ls) rep resents the p ost merg er p roj ec tions f or Comp any A . T his r the inc rease sales g row th, inc reases marg ins or reduc ed c ost of sales and the reduc ed c entral overheads as show n in the G eneral Inp uts sheet of the ex amp le. Illustration 50 ( see Illustration50 . x ls) rep resents the p ost merg er p roj ec tions f or Comp any B . relec ts the inc reased sales g row th, inc reased marg ins, or reduc ed c ost of sales, and the reduc ed c entra overheads as show n in the G eneral Inp uts sheet of the ex amp le. T he merg ed c omp any’s inanc ial p roj ec tions are show n in Illustration 51 ( see Illustration51 . x ls) . Here, the inanc ial results of the tw o c omp anies are c onsolidated w ith the ex c ep tion to the dividends that are now made at the c onsolidated p lc level as op p osed to the subsidiary level. W e have assumed a 50 % dividend p ayout ratio in eac h year. A s there are no c orp oration tax losses arising , tax is c omp uted at th subsidiary level. It is imp ortant to note that there are of ten inanc ial beneits that rise if one c omp any has a tax loss p osition and the other has larg e tax able p roits in terms of g roup relief f or c orp oration tax p urp T he base results arising f rom our merg er c an be seen in Illustration 52 .

Illustration 52 Post merger results COMPANY CASH POSITION £ million Minimum Balance

3.3

Year of Minimum Balance

31 December 2010

Maximum Balance

405.0

Year of Maximum Balance

31 December 2020

LENDERS CREDIT RATIOS Debt to Equity Ratio – Max Free Cash low to Debt – Min

Minimum

Target

OK

Target Maximum

21.2%

80.0%

OK

Target Maximum

838.7%

60.0%

Year Of Min / Max

Average

31 December 2011

9.1%

31 December 2011

7111.4% continued 51

Debt to EBITDA – Max Debt to Net Assets – Max

OK

Target Maximum

21.2%

60.00%

OK

Target Maximum

11.9%

90.00%

OK

Target Minimum

31 December 2011

3.0%

31 December 2011

3.7%

STOCK MARKET RATIOS Earnings Per Share

PE Ratio

Market Price Per Share

31 December 2011

£5.95

6

£35.70

31 December 2012

£6.30

6

£37.81

31 December 2013

£6.70

6

£40.23

31 December 2014

£7.13

6

£42.79

31 December 2015

£7.50

6

£45.02

31 December 2016

£7.89

6

£47.33

31 December 2017

£8.26

6

£49.54

31 December 2018

£8.64

6

£51.83

31 December 2019

£9.03

6

£54.20

31 December 2020

£9.44

6

£56.66

31 December 2010

STOCK MARKET RATIOS Free Cash Flow Per Share

Dividend Per Share

31 December 2011

£5.68

£3.39

31 December 2012

£7.34

£4.84

31 December 2013

£7.74

£5.77

31 December 2014

£8.17

£6.45

31 December 2015

£8.62

£6.98

31 December 2016

£9.01

£7.43

31 December 2017

£9.39

£7.85

31 December 2018

£9.79

£8.24

31 December 2019

£10.21

£8.64

31 December 2020

£10.64

£9.04

S ource:M odelling S olutions

Sect ion 2 C orp orat e f in an ce d ecision s

W e c an see f rom the results above that the c ombined c omp any has a suf ic iently stable p osition in terms of its c ash p osition. Its c redit ratios f or its lenders are w ithin ac c ep table targ et levels. In summary, based up on the assump tions the earning s p er share p er annum is g reater than eac h of the sep arate c omp anies; the mark et p ric e p er share is also g reater than eac h of the sep arate c omp anies. mark et p ric e p er share is based up on a PE ratio that is betw een the c urrent values of eac h c omp any sep arate It is hig hly rec ommended that sensitivity analysis and sc enario p lanning is undertak en around the k ey variables that af f ec t the k ey outp ut metric s f or a merg er ac c ording ly. T he real ac id test is w hether the c ombined c omp any c an deliver up on suc h c ombined p roj ec tions a my rec ommendation is that the irst year of the p lan is g iven as budg etary targ et f or the irst year of integ ration and p erf ormanc e measured ag ainst this.

Company merger exercise

B ased up on the inanc ial model built to date, rep lic ate this as an additional w ork book f or another c omp an and c onsolidate results using a one f or one share ex c hang e f or c onsideration p urp oses.

Initial public offering

T his rep resents the irst stag e of a p rivate c omp any selling its shares to the g eneral p ublic . O f c ou sourc e of long term inanc e f or ex p ansion p urp oses. F or the irst time in its history the c omp any is subj ec t to stoc k mark et disc ip line, so it needs to ensure that its shares are attrac tively p ric ed and dividend inc ome c an be p aid to its shareholders. T he advantag e of g oing p ublic by of f ering shares to members of the p ublic w ill help the c om senior manag ement and direc tors retain a larg e deg ree of c ontrol w hic h may not be the c ase w ith other f unding sourc es. A w ell manag ed p rivate limited c omp any w ith a strong balanc e sheet, c ash p ositio p roits is indeed in a g ood p osition to g o p ublic and raise c ap ital throug h the use of the initial p ublic of f ing ( IPO ) route. A nother advantag e of the IPO route w ill inc lude the ac c ess to c ap ital initially and g reater ac c ess to stoc k mark ets f unds in the f uture. It is p ossible f or the c omp any’s direc tors and its ex isting shareholders retain shares and use these f or suc h p urp oses as p roviding share op tion beneits to k ey members of staf f and the p otential of using shares f or inanc ing p otential merg ers or ac q uisitions. O ne w ould usually ex p ec t that g enerally the c omp any’s debt to eq uity ratio and valuation may imp rov w hic h c ould lead to it being able to attrac t muc h better interest rates f rom lenders. T here is also a g reater p ublic relations imag e assoc iated w ith a p ublic limited c omp any to that of p rivate limited c omp any. T he disadvantag e of g oing p ublic or an IPO inc ludes the hig h p rof essional f ees involving ac c ou and law yers. S o in 2 0 1 1 terms, a small c omp any may be ex p ec ted to p ay as muc h as £3 0 0 ,0 0 0 In addition to these p rof essional f ees, the underw riter req uires a p ayment w hic h c an also be q uite larg and is based up on a p erc entag e of the inanc ing raised throug h the IPO route. T he underw riter’s f ee is u ally around the 6 % to 1 5% rang e. T he j ob of the underw riter in an IPO transac tion is to help the c om to dec ide w hether it should raise shares by the ordinary share c ap ital route or by the p ref erenc e share route. T he underw riter w ill help to dec ide on the best p ric e and w hen to tak e the IPO to mark et. A p rosp ec tus is req uired in order to inf orm the p rosp ec tive investors about the op p ortunity. A p sp ec tus is a leg al doc ument w hic h has to be leg ally p roduc ed and iled w ith the S ec urities and Ex c h Commission. T he p rosp ec tus w ill inc lude bac k g round inf ormation of the c omp any, the c omp any’s p rosp ec ts and the number of share c ertiic ates to issue and the of f er p ric e p er share. 53

Corp orat e F in an ce Mod ellin g a n d A n alysis

T he ex amp le outlined in Illustration 53 ( see Illustration53 . x ls) show s an ex amp le of a p re- IPO c p any w ith a healthy inanc ial p osition reg arding p roits, c ash and a strong balanc e sheet, j ust rig ht f or IPO you w ould think ( subj ec t to mark et c onditions) . T he IPO w ill tak e p lac e at the start of 2 0 1 1 . T he er’s f ee is 6 % of the ordinary share c ap ital to be raised. T he amount of ordinary share c ap ital to be of f ered to the p ublic is £2 0 million; 51 % is to be retained by manag ement f or strateg ic p urp oses and 49 % is to of f ered to the p ublic . T he underw riter has f ound the f ollow ing data f rom researc hing the ex isting sto mark et statistic s; the underw riter has look ed at c omp arable p ublic c omp anies in the same industry sec tor. I w ould lik e to ref er you to Illustration 54.

Illustration 54 Comparable companies stock market analysis Comparable Company Stock Market Analysis Company

P/E Ratio

EPS

Market Price

Dividend

Per Share

%

A

4

3.000

£12.00

12.00%

B

3

3.200

£9.60

11.00%

C

3

3.200

£9.60

7.80%

D

5

3.100

£15.50

11.00%

E

6

3.540

£21.24

10.00%

F

7

4.000

£28.00

9.00%

G

8

3.450

£27.60

7.99%

Average

5

£17.65

S ource: M odelling S olutions

T he p ric e earning s ratio is deined as the mark et p ric e p er share divided by the earning s p er share. T he earning s p er share is deined as the p roit af ter tax divided by the number of ordinary shares in issue. T he dividend yield is deined as the dividend p er share divided by the mark et p ric e p er share. T his c an be seen in f urther detail in the Ex c el ex amp le Illustration 55 ( see Illustration55. x ls) . T he dividend c over is deined as the earning s p er share divided by the dividend p er share. G iven that the mean p ric e p er share of all the c omp arable c omp anies in the industry sec tor is £1 7 . 6 5 p er share, the c om p any has dec ided to issue 1 ,1 7 6 ,47 1 ordinary shares at £1 7 . 0 0 p er share; 51 % w ill be issued to manag and 41 % w ill be of f ered to the p ublic . T his means that the c omp any w ill p ay £1 0 . 2 million f rom its in c ash resourc es. T he p ublic w ill p ay the c omp any £9 . 8 million g iven that this lotation is very attrac tive an w ill be f ully subsc ribed. 54

Sect ion 2 C orp orat e f in an ce d ecision s

W e w ill now turn our attention to our IPO ex amp le. R ef er to the c omp any’s inanc ial p osition af IPO in Illustration 56 . T his c an be seen in f urther detail in the Ex c el ex amp le Illustration 57 ( see Illustr tion57 . x ls) .

Illustration 56 Post IPO STOCK MARKET RATIOS Earnings per Share

PE Ratio

Market Price Per Share £17.00

31 December 2010 31 December 2011

£3.29

6.5

£21.36

31 December 2012

£3.47

6.5

£22.54

31 December 2013

£3.99

6.5

£25.95

31 December 2014

£4.51

6.5

£29.32

31 December 2015

£4.77

6.5

£31.04

31 December 2016

£4.97

6.5

£32.32

31 December 2017

£4.71

6.5

£30.62

31 December 2018

£4.41

6.5

£28.70

31 December 2019

£4.09

6.5

£26.58

31 December 2020

£3.73

6.5

£24.27

S ource:M odelling S olutions

IPO exercise

B ased up on the inanc ial model built to date, issue shares at 2 0 % disc ount to the max imum c omp arabl c omp any, value it at a PE ratio of 7 and c omp ute the share p ric e over the 1 0 year f orec ast p eriod.

Rights issues

A rig hts issue is a c ap ital raising ex erc ise that involves selling new shares to its ex isting shareholders. T shares are usually of f ered in p rop ortion to its ex isting shareholding p erc entag e. T he rig hts issue p ric share is usually at a disc ount to the ex isting mark et p ric e p er share. S o, w hen the ex isting shareholde ex erc ise their rig hts they w ill obviously maintain their p erc entag e c ontrol. O ther advantag es of a rig hts issue are that the lotation or issue c osts are low er than that of a sale to new shareholders by the lotation route. O f c ourse the ex isting shareholders are also lik ely to be more rec ep tive to the deal than mark eting to new shareholders.

55

Corp orat e F in an ce Mod ellin g a n d A n alysis

T he inanc e direc tor of Comp any A has rec og nised the beneits of a rig hts issue in order to raise long term inanc e. T he c omp any’s Proit and Loss A c c ount and B alanc e sheet p rior to the rig hts issue c an be seen by ref erenc ing Illustration 58 .

Illustration 58 Pre rights issue BALANCE SHEET COMPANY A Period Ending

31 December 2010 Actual £ million

Fixed Assets – Net Book Value

23.0

Capitalised Arrangement Fees

0.3

Current Assets Cash

15.3

Accounts Receivable

4.5

Stock

2.5

Other Current Assets

3.0 25.3

Current Liabilities Accounts Payable

3.4

Vat Payable / (Receivable)

0.6

Tax Payable

4.6 8.6

Long Term Liabilities Shareholder Loan

8.1

Senior Debt

12.1 20.2

Net Assets

19.8

Financed by Ordinary Shares (16.8 million @ £1 each) Retained Earnings Shareholders Funds

56

16.8 3.0 19.8

continued

Sect ion 2 C orp orat e f in an ce d ecision s

PROFIT & LOSS ACCOUNT COMPANY A Period Ending

Year Ending: 31 December 2010 Forecast £ Million

Sales

100.0

Cost Of Sales

50.0

Gross Proit

50.0

Operating Expenses

20.5

EBITDA

29.5

Depreciation

2.8

Amortisation – Arrangement Fees

0.1

EBIT

26.7

Cash Interest / (Expense)

0.3

Interest – Shareholder Loan

1.1

Interest – Senior Debt

0.9

EBT

24.9

Tax

7.3

Earnings after Tax

17.6

S ource:M odelling S olutions

S o w e c an see f rom Illustration 58 that Comp any A earns £1 7 . 6 million af ter tax ation and c urrently 1 6 . 8 million ordinary shares in issue. Conseq uently this g ives a c urrent earning s p er share of £1 . 0 5. T c omp any’s c urrent mark et p ric e p er share is £3 . 2 6 . T he inanc e direc tor w ants to raise an addition million throug h the rig hts issue. S o the burning q uestion is how many shares should be issued and at w hat p ric e p er share? F irstly mos rig hts issues are made at a p ric e w hic h is low er than the c urrent mark et p ric e p er share. W e have dec i issue the shares at £3 . 0 0 eac h w hic h means that w e w ill issue 1 1 . 6 6 million new shares to ex istin holders, that is, 0 . 6 9 shares p er ex isting share held by eac h shareholder. A s soon as the rig hts issue has been ac tioned, w e have 2 8 . 46 million ordinary shares in issue valued at £8 9 . 7 5 million g iving a share p r of £3 . 1 5 p er share. How ever, the stoc k mark et w ill value the new shares at a hig her p ric e than £3 share if it has the c onidenc e that Comp any A c an invest the ex trac t c ap ital raised at rate of return g reat than the shareholders req uired rate of return and low er if it c annot have suc h c onidenc e. O f c ourse, stoc mark et behaviour is not a sc ienc e! How ever, it rec ommended that the c omp any c ontinues to ref orec ast the p erf ormanc e ag ainst the stoc k mark et p ost rig hts issue. W e w ill now turn our attention to our ex am Illustration 59 ( see Illustration59 . x ls) . 57

Corp orat e F in an ce Mod ellin g a n d A n alysis

T he G eneral Inp uts sheet show s the assump tions w hic h are behind the ref orec ast p roj ec tion p ost rig issue. T he p ost rig hts issue balanc e sheet is inc luded in rang e B 1 50 to B 1 7 2 of the G eneral Inp uts Essentially, the eq uity and the c ash have both inc reased by the £3 5 million raised by the rig hts issue. T he number of shares in issue p ost rig hts issue is show n in rang e B 1 7 7 to B 1 8 7 . T he c urrent share p ric e, the theoretic al ex rig hts share p ric e is show n B 1 8 9 . T he rig hts issue has been valued at the c urrent PE rati T he f unds raised f rom the rig hts issue w ill be sp ent on £3 5 million of additional c ap ital ex p enditure p roj ec as p er row 1 1 0 . T he other p roj ec tions assump tions are laid out in the G eneral Inp uts sheet. T he S ummary sheet show s a p ositive c ash balanc e over the lif e of the 1 0 year ref orec ast. A ll the lender c redit ratios meet the targ ets. T he Earning s Per S hare show s a rising g row th over the 1 0 years valued at the c urrent PE ratio and ap p ears to show share p ric e g row th. T he other area that the c omp any needs to be in tune w ith is its dividend p olic y w hic h obviously af f ec ts the c omp any’s share p ric e g row th. T his w ill be addr in S ec tion 2 , under ‘D ividend p olic y’.

Rights issues exercise B ased up on the inanc ial model built to date, assuming that the c omp any w ants to raise an additional £50 million, issue shares to the c omp any’s additional shareholders at a 1 0 % mark et disc ount, value the shares at a PE ratio of 8 and c omp ute the share p ric e over the 1 0 year f orec ast p eriod.

Disposals

T he ing redient f or a suc c essf ul sale of a c omp any inc ludes the p ric e ac hieved, struc turing the c onsideratio p ac k ag e, c omp any valuations, due dilig enc e and a w ell p rep ared inf ormation memorandum. T he role of th inanc ial adviser w ill be to ensure that all bidders f or the c omp any eng ag e in a c omp etitive p roc ess. W hen undertak ing a disp osal the ac c ounting treatment to be f ollow ed should be IF R S f or most larg org anisations. T he material areas of IF R S 5 R elating to D isc ontinued O p erations, w hic h should be addre w hen ac c ounting and p lanning f or disp osals are as f ollow s. C lassiication as discontinuing . A disc ontinued op eration is a c omp onent of an entity that either has been disp osed of or is c lassiied as held f or sale, and: ● ● ●

rep resents either a sep arate maj or line of business or a g eog rap hic al area of op erations; is p art of a sing le c o- ordinated p lan to disp ose of a sep arate maj or line of business or g eog rap hic al area of op erations; or is a subsidiary ac q uired ex c lusively w ith a view to resale and the disp osal involves loss of c ontrol.

Income statement. T he sum of the p ost- tax p roit or loss of the disc ontinued op eration and the p ost- tax g ain or loss rec og nised on the measurement to f air value less c ost to sell or f air value adj ustments on the disp osal of the assets ( or disp osal g roup ) should be p resented as a sing le amount on the f ac e of the statement of c omp rehensive inc ome. If the entity p resents p roit or loss in a sep arate inc ome statement, a sec tion identiied as relating to disc ontinued op erations is p resented in that sep arate statement. T his ef f ec tively means that the disc ontinued p roit and loss items should be show n up to the disp osal date and the g ain or loss or disp osal show n. D etailed disc losure of revenue, ex p enses, p re- tax p roit or loss and related inc ome tax es is req uired either in the notes or in the statement of c omp rehensive inc ome in a sec tion distinc t f rom c ontinuing op erations. S uc h detailed disc losures must c over both the c urrent and all p rior p eriods p resented in the inanc ial statements. T his ef f ec tively means that the disc ontinued c ash low items should be show n up to the disp osal date.

58

Sect ion 2 C orp orat e f in an ce d ecision s

D etailed notes and disc losures should not bother us at the inanc ial p lanning and analysis stag e. C ash low statement. T he net c ash low s attributable to the op erating , investing , and inanc ing ac tivities of a disc ontinued op eration shall be sep arately p resented on the f ac e of the c ash low statement or disc losed in the notes. D etailed notes and disc losures should not bother us at the inanc ial p lanning and analysis stag e. B alance sheet.T he net assets at f air value should be ex c luded f rom the balanc e sheet f rom the date of disp osal. W e w ill now turn our attention to our D isp osal ex amp le, ref er to Illustration 6 0 ( see Illustration6 0 T he ex amp le show s a g roup struc ture c omp rising three f ully ow ned subsidiaries. T he g roup w c onsider mak ing one or tw o disp osals in order to streng then its c ash p osition to p otentially ac q uire a targ c omp any that w ill better it into its c orp orate strateg ic obj ec tives. S o f or this strateg ic need the c om req uires c ash f or ac q uisition p urp oses. T he board ac tually are c ertain that the disp osal and ac q uisi ac tivity w ill hap p en w ithin a 1 0 month timef rame. Conseq uently to this end the subsidiaries have p rovide monthly inanc ial p roj ec tions f rom the c urrent ac tual p osition and p rovided p roj ec tions on a monthly basis f or the p roit and loss, c ash low and balanc e sheet in an identic al f ormat as req uired by the g roup f or ease of c onsolidation and analysis. W e c an see the subsidiary inanc ial submissions in the yellow p roit and loss, c ash low and balanc e sheet tabs of our ex amp le. In the G eneral Inp uts tab you c an see the k ey assump ti reg arding the disp osal of any of the three subsidiaries, that is, the date of disp osal ( this is enabled by a drop dow n box w hic h enables the selec tion of the disp osal date) and the selling p ric e of the business. O f c the c omp any has also undertak en sep arate valuation ex erc ises that are similar to those outlined in S ec tion 2 , under ‘A c q uisitions’. How ever, the c urrent sc enario assumes that the c omp any w ould lik e to ex p l the disp osal of both subsidiaries 1 and 2 at M arc h 2 0 1 2 and A p ril 2 0 1 2 at £1 0 0 million and £ resp ec tively. In the g reen c alc ulation sheets the p roit and loss ac c ount and c ash low f orec asts are inc lu up to the p oint of disp osal. T he balanc e sheets inc lude the removal of the net assets at the date of disp osal f or subsidiary. T he D isp osal - J ournal Entries sheet show s the disp osal date, the c ash p roc eeds and the net asset value of the subsidiary tog ether w ith the p roit or loss on disp osal of the subsidiary. T he blue outp ut sheets show the c onsolidated p roj ec ted p osition of the g roup p ost disp osal. T he solidated p roit and loss ac c ount inc ludes the p roit or loss on disp osal of the subsidiaries. T he c onsolidated c ash low inc ludes the c ash rec eip t arising on the disp osal other subsidiaries. T he Consolidated B alanc sheet inc ludes all the subsidiaries up until the p oint of disp osal and any adj ustments f or the p roit or losses arising on the sale of the subsidiaries – see row 2 9 of the B alanc e sheet – Consolidated w ork sheet tab inc luded in Illustration6 0 . x ls. T he Consolidated B alanc e sheet also inc ludes the c ash f rom the sale of th subsidiaries – see row 1 0 of the B alanc e sheet – Consolidated w ork sheet tab inc luded in Illustration6 0 . x T he c omp any w ould now be in a p osition to use its c ash resourc es w ith or w ithout other f orms of l term f unding to p ursue its ac q uisition targ et. O f c ourse the model g ives the lex ibility to ex p lore dif f disp osal sc enarios and amounts as nec essary.

Disposal exercise

B uild a inanc ial model f or disp osal analysis p urp oses. Use the p lanning outp uts f rom f our w holly ow subsidiaries in the same f ormat over a monthly timeline f or 1 2 months. S et up the inp ut assump tions as a lex ible disp osal date and amount f or eac h subsidiary. T he end obj ec tive is to p rep are the c onsolidated p roj ec tions p ost disp osal.

59

Corp orat e F in an ce Mod ellin g a n d A n alysis

Reinancing

R einanc ing is w hen the terms of the ex isting debt f or the c omp any is rep lac ed w ith better debt terms w hi c an of ten be available due to c hang es in mark et c onditions. T he terms of the reinanc ed log ic w ould have to be inc orp orated in the p artic ular c omp anies c orp orate inanc e model and a review or evaluation undertak en reg arding the overall ef f ec t on the c omp any’s inanc ial p osition in terms of shareholder returns, g eneral liq uidity and the lenders’ c redit ratios. R ef er to the c omp any’s inanc ial p osition bef ore reinanc ing in Illustration 6 1 ( see Illustration6 1 . x ls A t p resent the c omp any has £1 2 . 1 million of senior debt w hic h bears an interest rate of 1 2 % as p er of the G eneral Inp uts sheet. T he mark et interest rates have f allen and w e have dec ided to reinanc e the £1 2 . 1 million debt at more f avourable interest rates. O f c ourse, there is a f ee p ayable f or undertak ing this reinanc ing transac tion w hic is rep ayable to the bank . W e have been of f ered a revised interest rate of 8 % w ith an arrang ement f ee of 0 . 9 R ef er to the c omp any’s inanc ial p osition af ter reinanc ing in Illustration 6 2 ( see Illustration6 2 . x ls) Note that c ells B 7 4 and B 8 1 have been adj usted in order to review the ef f ec t of the reinanc ed terms. W have saved over £2 million of net interest over the ive year f ac ility. W e c an see this by ref erenc ing the c ash low sheet in eac h ex amp le. T he senior debt interest and f ee have been hig hlig hted in yellow and summed ac c ording ly. In terms of the overall inanc ial p osition of the c omp any w e have, as ex p ec ted, imp roved th shareholder returns, the c ash p osition and the interest c over slig htly. T his c an be seen by ref erenc ing the S ummary sheet f or both the bef ore and af ter c ases.

Reinancing exercise

B ased up on the inanc ial model built in S ec tion 1 , add reinanc ing log ic to rep ay the debt tw o years earlier, reduc e the interest rate by 3 0 % and inc ur a 2 . 5% arrang ement f ee of the op ening debt.

Capital structures

A n op timal c ap ital struc ture ref ers to the mix of debt and eq uity c ap ital. T he W A CC w ill have an ef f the valuation of the irm. T his is bec ause the W A CC should be the disc ount rate that inc remental business dec isions and p roj ec ts are evaluated in D isc ounted Cash F low p urp oses. S o if a c omp any has £7 0 millio debt and £3 0 million of eq uity it is said to have a 7 0 % debt eq uity ratio. Indeed many of us may have heard of the M iller and M odig liani theorem w here it is rec og nised that there is an op timum debt ratio w hic h rec og nises the imp ac t of g earing and its tax deduc tibility ef f ec t up on the c ost of debt, that is, usually interest, and the ef f ec t up on the shareholders’ req uired rate of return due to the p erc eived risk of not g etting a dividend p ayout due, having to p ay the interest and p rinc ip al f or the debt bef ore the shareholder g ets any dividend inc ome. W e c an now turn our attention to the ex amp le in Illustration 6 3 ( see Illustration6 3 . x ls) . Look ing at the G eneral Inp uts sheet of the ex trac t of our ex amp le inanc ial model w e c an see that our debt to eq uity ratio is c urrent set at 8 9 % , that is, 8 9 % debt and 1 1 % eq uity. T he debt is rep aid over 1 0 in row B 2 8 4 at an interest rate of 1 3 % and the dividend p ayout ratio is 1 5% p er annum in the row below T he risk p remium c urves at c ertain levels of g earing or debt % is g iven f or lenders in row s 7 7 to 1 that is, as the debt % inc reases the lender w ill req uire a hig her rate of return to c omp ensate f or the risk . T he risk p remium c urves at c ertain levels of g earing or debt % is g iven f or shareholders in row s 1 8 0 2 8 0 , that is, as the debt % inc reases the shareholder w ill req uire a hig her rate of return to c omp ensate f or the risk . A t an 8 9 % debt ratio the shareholders w ill req uire an additional 0 . 2 5% risk p remium. Look i the eq uity c ash low analysis in the Eq uity R eturns & Lenders R atios sheet w e c an see that the eq uity draw n 60

Sect ion 2 C orp orat e f in an ce d ecision s

c ash low and the dividends p aid c ash low s is inc luded to ind the net c ash low used f or disc ounting p p oses to the c alc ulate the internal rate of return ( IR R ) adding to it the risk p remium to ind the c ost of eq u T he F inanc ing & W . Cap ital sheet show s in row s 2 8 to 3 8 show s the interest and p rinc ip c alc ulated f or the debt. T he debt eq uity ratio tog ether w ith the inc remental marg in is being ac c essed 0 . 3 0 % . T he interest rate tog ether w ith the risk p remium f or the debt ratio is show n in row 3 3 . sc hedule is c alc ulated below w hic h inc ludes the debt amortisation and the interest c ash low s. T urning bac k to the Eq uity R eturns & Lenders R atios the c ost of debt is c alc ulated in row s 9 7 T he debt is inc luded as an investment. T he p rinc ip als and interest c ash low ( net of tax saving s) are sh as p ositives in order to c alc ulate the IR R or the c ost of debt. B ased up on the IR R derived f or the c ost of debt and the c ost of eq uity w e c an c alc ulate the w e averag e c ost of c ap ital as p er c ell C1 5 of the Cap ital S truc ture – Calc s sheet. Conseq uently, based up o assump tions the W A CC is c urrently 1 1 . 8 4% . W e c an ex tend our analysis of our inanc ial modelling by trying to ind the op timum debt eq uity ratio, that is, debt % w here W A CC is minimal and w here w e rec ommend that the c omp any op erates inanc in order to max imise its value and the NPV of its inc remental investments. T he op timum is f ound by c onsidering the relative rates of return f rom the investors and their risk p roiles tog ether w ith the tax deduc tible saving s ef f ec t of the interest c osts on the debt f or c orp oration tax p urp oses. A rec ommended ap p roac h f or inding the op timum p oint is to set up a tw o variable data table w h c onsiders dif f erent mix es of debt and eq uity as in the Cap ital S truc ture – Calc s in rang e A 1 7 to CY1 1 O f c ourse, it is imp ortant to note that w e c an only have a c ombination of debt and eq uity that eq uals 1 0 0 % . W e address this issue by iltering out the irrelevant results by, rep lic ating the sheets log ic and p la a f ormula w hic h tests: IF ( Eq uity %

+ Debt % = 1 , + R esult, 0 )

W e c an then ind the debt %

based up on realistic assump tions that g ive the low est W A CC.

Capital structures exercise

B ased up on the inanc ial model built in S ec tion 1 of this book , c omp ute the w eig hted averag e c ost of c based up on the c urrent debt eq uity ratio.

Dividend policy

D ividend p olic y involves a inanc ial dec ision as to w hether to distribute the p roits to the shareholders in the f orm of dividends or to retain the p roits and reinvest the c ash in the c omp any’s f uture p roj ec ts. T here is a belief that the best dividend p olic y is w here the balanc e is met w hic h max imises the f uture dividend stream and the mark et share p ric e. In terms of w hether a irm should p ay a dividend there are several f ac tors that w ill enter the dec ision. T he c onstraints around the dividend p olic y w ill inc lude the irm’s c ash p osition, its leg al p osition reg ardin its maintenanc e of c ap ital throug h distributable reserves. It is usual f or the dividend not to ex c eed the low er of its c ash p osition or distributable reserves p osition. T here are a number of c onsiderations that a inanc ial manag er and the board of p lc direc tors should tak e into ac c ount w hen c onsidering distribution to shareholders. ●

T he liq uidity p osition of the org anisation may w ell be an imp ortant f ac tor. It may be the c ase tha althoug h a irm has hig h p roitability, its c ash p osition p revents it f rom p aying a dividend. In suc h c ir c umstanc es the board c an of ten dec ide not to p ay a dividend. 61

Corp orat e F in an ce Mod ellin g a n d A n alysis

● ●

● ●

●

●

●

T he internal investment op p ortunities that f ac e the c omp any’s board of direc tors and the IR R of these relative to p aying a dividend to the shareholders c an be a f ac tor in a dividend dec ision. T he stability of the c omp any’s earning s w ill dic tate the dividend p olic y to a deg ree. F or ex amp le a c omp any w ith stable and more p redic table earning s is more lik ely to be able to p ay out a hig her p rop ortion of its earning s than a c omp any that has volatile and luc tuating earning s. T he c omp any’s debt p osition w ill be f ac tor. A c omp any may dec ide to redeem debt instead of p ayin its shareholders a dividend. A c ontrol f ac tor w ill of ten be an imp ortant dec ision in a c omp any’s dividend distribution dec ision. F or ex amp le a c ertain g roup may w ish to k eep c ontrol of the c omp any and the board may dec ide to rely more on internal f unding . T he tax p osition of the c omp any’s shareholders c an be an additional f ac tor w hen dec iding to p ay a dividend. A larg e c omp any w ith a vast number of shareholders may be in a hig h dividend p ayout ratio. How ever, if the c omp any is small w ith a small number of shareholders p aying inc ome tax at hig her rates, the c omp any may p ay relatively low p ayouts of dividends. In suc h c irc umstanc es the retention of the f unds by the c omp any is lik ely to lead to hig her c ap ital g ains in the f orm of share p ric e g row t w here the c omp any c an invest in p roitable op p ortunities. T he rate of ex p ansion or g row th of a irm may also be an imp ortant f ac tor, that is, w hether the c omp any needs to invest in c ap ital ex p enditure f or f uture g row th. If the irm needs to mak e substantial c ap ital investments it is less lik ely that it w ill mak e a hig h dividend distribution. T he need to send p ositive messag es to the stoc k mark et is an imp ortant c onsideration. T he maj ority of c omp anies seek to maintain a stable dividend p er share. F rom a p urely log ic al view p oint it is a saf e assump tion that stable dividends are lik ely to lead to hig her share p ric es. F rom a shareholder p oint of view , a shareholder is more lik ely to value its investment more p ositively f rom a stable dividend c ash low stream as it attac hes a low er disc ount rate and low er risk p ersp ec tive allow ing a p otentially hig h share p ric e. Conversely, a c omp any w ith an unstable dividend stream is lik ely to have a low er share p ric e due to a hig her disc ount rate being ap p lied due the risk assoc iated w ith suc h c ash low s.

W e c an now turn our attention to the ex amp le in Illustration 6 4 ( see Illustration6 4. x ls) . W e c an see the assump tions reg arding our dividend p olic y dec ision in the G eneral Inp uts sheet. A p resent the c omp any’s share p ric e is q uoted at £1 3 8 . 1 3 p er share and a PE ratio of 1 0 . 5. T he c omp rently has 9 . 4 million shares in issue and does not intend to raise any f urther f unds throug h ordinary share issues g iven this c urrent set of p roj ec tions and p lans. T he board has dec ided to undertak e a stable dividend p er share p olic y by benc hmark ing c omp arable c omp anies in its industry sec tor and p itc hing suc h a dividen p ayment at an attrac tive level at the up p er q uartile. It has c omp uted the averag e dividend p er share and the standard deviation ( a measure sp read around the mean or averag e) in order to set the targ et dividend p er share at £6 . 59 in today’s money. In terms of the inanc ial modelling log ic the main area that you should f oc us up on is the D ividends sheet. You w ill see here the c alc ulation irm’s c ash p osition, its leg al p osition reg arding its maintenanc e of c ap ital throug h distributable reserves. It is usual f or the dividend not to ex c eed the low er of its c ash p osition or distributable reserves p osition. In row s 2 1 to 2 7 the targ et dividend p er share is c alc ulated. In order to c omp ute the dividend p ayout it is nec essary to multip ly the number of ordinary shares by the dividend p er share and multip ly this by the inlation index as ap p rop riate. T he stable dividend p er share c alc ulation is then link ed to the dividend dec lared line in row 2 9 . W e should now tak e a look at Illustration 6 5.

62

Illustration 6 5 Dividend policy results SUMMARY DIVIDEND POLICY COMPANY CASH POSITION £ million Minimum Balance

3.3

Year of Minimum Balance

31 December 2010

Maximum Balance

1,221.3

Year of Maximum Balance

31 December 2020

LENDERS CREDIT RATIOS

Minimum

Target

OK

Target Maximum

21.2%

80.0%

OK

Target Maximum

838.7%

60.0%

OK

Target Maximum

21.2%

60.00%

OK

Target Maximum

11.9%

90.00%

OK

Target Minimum

222.8

2.0

Debt to Equity Ratio – Max

Free Cash low to Debt – Min

Debt to EBITDA – Max

Debt to Net Assets – Max

Interest Cover – Min

Year of Min / Max

Average

31 December 2011

9.1%

31 December 2011

7111.4%

31 December 2011

3.0%

31 December 2011

3.7%

31 December 2012

1023.4 continued

STOCK MARKET RATIOS Earnings Per Share

PE Ratio

Market Price Per Share

31 December 2011

£14.07

10.5

£147.70

31 December 2012

£14.90

10.5

£156.41

31 December 2013

£15.85

10.5

£166.43

31 December 2014

£16.86

10.5

£177.03

31 December 2015

£17.74

10.5

£186.28

31 December 2016

£18.65

10.5

£195.81

31 December 2017

£19.52

10.5

£204.96

31 December 2018

£20.42

10.5

£214.44

31 December 2019

£21.36

10.5

£224.26

31 December 2020

£22.33

10.5

£234.42

Free Cash Flow Per Share

Dividend Per Share

Dividend Per Share

31 December 2011

£13.42

£6.75

31 December 2012

£17.36

£6.92

2.5%

31 December 2013

£18.31

£7.10

2.5%

31 December 2014

£19.31

£7.27

2.5%

31 December 2015

£20.37

£7.46

2.5%

31 December 2016

£21.30

£7.64

2.5%

31 December 2017

£22.20

£7.83

2.5%

31 December 2018

£23.14

£8.03

2.5%

31 December 2019

£24.13

£8.23

2.5%

31 December 2020

£25.15

£8.44

2.5%

31 December 2010

STOCK MARKET RATIOS

COMPARABLE COMPANY ANALYSIS Dividend Per Share Average

£5.73

Standard Deviation

£0.86

% SD

15.1%

S ource:M odelling S olutions

Sect ion 2 C orp orat e f in an ce d ecision s

B ased up on the assump tions w e c an see a stable dividend p er share being p aid out at the levels p lanned but inc luded the 2 . 5% inlation p er annum. B ased up on the PE ratio of 1 0 . 5 w e c an see a p lanned share g row th. T he c omp any also look s very attrac tive in terms of its c ash p osition.

Dividend policy exercise

F or the inanc ial model that you have built to date, add the f ollow ing log ic to the D ividends module. Inc orp orate log ic that p ays a stable dividend p er share w hic h is c omp arable to an up p er q uartile of industry levels. Ensure that you p roduc e a viable set of p roj ec tions overall.

Working capital management

W ork ing c ap ital manag ement is a sourc e of short term inanc ing involving manag ing the ef f ec t ultimate c ash p osition and the ef f ec t on the c omp any’s balanc e sheets and c urrent assets suc h as trade debtors, and stoc k and balanc e sheet c urrent liabilities suc h as trade c reditors. D uring the c ourse of this sec tion, w e w ill tak e a detailed look at inanc ial strateg ies and initiatives and the w ay that w ill help c ontrol these imp ortant areas thus max imising the c ash p osition f or the org anisation. T he f ollow ing methods f or easing any short term w ork ing c ap ital p roblems that a business may enc ounter. ● ● ● ● ●

T T T T T

he c he c he c he c he c

omp omp omp omp omp

any c any c any c any c any c

ould p ostp one any c ap ital ex p enditure p lans until a later date. ould try to p ress its debtors f or an earlier p ayment. ould try to sell of f any assets that the c omp any may ow n. ould try to ex tend any c redit timing w ith sup p liers. ould reduc e its dividend p ayments.

How ever the c onverse p osition of holding c ash has the f ollow ing beneits. ● ● ●

T here is a transac tion motive of holding day to day c ash ( that is, the ability to p ay c reditors) . T here is a p rec autionary motive of holding c ash, that is, the ability to p ay f or any unf oreseen req uirements. T here is the sp ec ulative motive w hic h attac hes to the need to undertak e business op p ortunities suc h as p otential ac q uisitions.

S trateg ic initiatives involving trade debtors inc lude manag ing trade c redit terms and invoic e disc ounting . Let us irstly look at a dec ision reg arding exthetension of trade credit termsto all the c ustomers of a c omp any in q uestion. T he c omp any ex p ec ts sales of £3 million p er month. Variable c osts of sales a million p er month all p ayable in the month of sale. If the c omp any ex tended the c redit p eriod allow ed to its trade debtors f rom 3 0 days to 6 0 days it estimates that sales w ould inc rease by 2 0 % . S o, if this c omp a a c ost of c ap ital of 1 2 % w ould the ex tension of the trade debtor’s c redit be inanc ially j ustiiable? I ref er you to the ex amp le in Illustration 6 6 .

65

Corp orat e F in an ce Mod ellin g a n d A n alysis

Illustration 6 6 Trade debtor credit extension Sales Per Month

£3,000,000

Variable Cost of Sales

£2,000,000

Current Credit Period – Days

30

Proposed Credit Period – Days

60

Forecasted Sales Increase

20.0%

Cost of Capital

12.0%

Current Trade Debtors

£2,958,904

Revised Trade Debtors

£7,101,370

Increase In Trade Debtors

£4,142,466

Cost of Finance

-£497,096

Contribution from Additional Sales

£2,400,000

Net Beneit / (Cost) Per Annum

£1,902,904

S ource: M odelling S olutions

T he c urrent trade debtor’s balanc e at the end of the year is £2 ,9 58 ,9 0 4. T he revised trade debtor p osition under the ex tended c redit terms of 6 0 days is £7 ,1 0 1 ,3 7 0 . T his g ives an overall inc rease in the tr debtors of £4,1 42 ,46 6 w hic h w ould need to be inanc ed at 1 2 % , arising in an inc remental c ost to the c p any of £49 7 ,0 9 6 . T he inc remental c ontribution to ix ed c osts and p roit is £2 ,40 0 ,0 0 0 based u inc reased sales and c ontribution ratio to sales. T his ap p ears to be a w orthw hile p olic y w hen look ing at th net beneit £1 ,9 0 2 ,9 0 4. T his ex amp le c an be seen in f urther detail in the Ex c el ex amp le, Illustration 6 7 ( see Illustration6 7 . x l W e c an now look at a dec ision involving invoice discounting or factoring. Invoic e disc ounting usually p rovides up to 8 0 % of the outstanding trade debtors by the inanc ial institution or f ac tor. T he invoic es are sent to the f ac tor or inanc ial institution as the g oods or servic es are ap p lied. O n rec eip t of the invoic es up to 8 0 % of the invoic e value is made available to the c omp a T he remaining amount invoic ed is p aid to the c omp any by the f ac tor onc e p ayment has been rec eived f rom the c ustomer. 66

Sect ion 2 C orp orat e f in an ce d ecision s

Let us now look at a sp ec iic ex amp le w here a c omp any w ants to disc ount £1 0 million of invoic at 7 5% advanc e and a 1 7 % f ee rate to the f ac toring c omp any or inanc ial institution up on settlement invoic es in 6 0 days.

Illustration 6 8 Invoice discounting scenario Current Date

1 April 2011

Invoiced

£10,000,000

Advanced

75.00%

Factors Fee

17.00%

Trade Debtors Credit period Month Ending :

60 1 April 2011

Advanced

31 May 2011

−£7,500,000

Cash Receipts

£10,000,000

Factors Fee

−£1,700,000

Net Cash low IRR

30 June 2011

−£7,500,000

£8,300,000

£0

85.25%

S ource: M odelling S olutions

S o, based up on the terms of the f ac toring or invoic e disc ounting deal, w e c an see in Illustration 6 8 t 7 5% of the £1 0 million is advanc ed immediately to the c omp any by the f ac toring c omp any on p resenta of the invoic es. In 6 0 days’ time the c ash is c ollec ted f rom the c ustomer and the f ac tor tak es their 1 7 % f or doing the transac tion. W hen look ing at the c ost of inanc e f or this transac tion or the return to the f ac it is obviously ex p ensive as a sourc e of short term f unding f or the c omp any. T he above ex amp le c an be seen in f urther detail the Ex in c el ex amp le, Illustration 6 9 ( see Illustratio n6 9 . x ls) . In summary, the advantag es to a c orp orate of using invoic e disc ounting as a short term f orm of inanc ing are as f ollow s. 67

Corp orat e F in an ce Mod ellin g a n d A n alysis

● ● ●

T his c an help to reduc e administration and or c ash c ollec tion c osts. It obviously help s short term liq uidity. It doesn’t reduc e the c orp orate debt c ap ac ity in any w ay.

In summary, the disadvantag e to a c orp orate of using invoic e disc ounting as a short term f orm of inanc ing f rom the ex amp le show n is that the c ost of this short term inanc ing is hig h w hen c omp ared to other sourc es. S trategic initiatives involving stockinc lude manag ing stoc k throug h the c lassic al re order system and j ust in time inventory manag ement ap p roac hes. T here are several tec hniq ues available f or stoc k and inventory c ontrol p urp oses, all of w hic h have the overall p urp ose of establishing w hat, w hen and how muc h stoc k to order to maintain a balanc e betw een ordering and holding stoc k s or inventory. B ef ore p rog ressing to c onsider the mec hanic s and p roc esse behind a stoc k c ontrol system w e need to understand the c osts assoc iated w ith stoc k s and inventory. T hese c an be summarised as f ollow s. ● ● ●

O rdering c osts – if the ordering c osts rep resent ix ed c ost p er order p lac ed then this w ill af f ec t c omp any’s stoc k c ontrol p olic y. Purc hase c osts – the c omp any’s stoc k c ontrol p olic y w ill only be af f ec ted by p urc hase c osts if q ua disc ounts are of f ered by sup p liers. Holding c osts – if you have a w arehouse and eq uip ment these c osts w ill be assumed as ix ed and theref ore w ill not af f ec t the c omp any’s stoc k c ontrol p olic y. Holding c osts that vary w ith the number items of inventory held in stoc k are to be tak en into ac c ount and w ill af f ec t the c omp any’s stoc k c ontro p olic y. It is imp ortant to p oint out that a very imp ortant stoc k holding c ost is the c ost of c ap ital that w be tied up to inanc e the stoc k holding .

T he c lassic al system of stoc k c ontrol is w hat is used f or most stoc k c ontrol systems. T here are c ertain k ey f ac tors that w ill need to be tak en into c onsideration as f ollow s. ● ● ●

F irstly, a reorder lead time – allow s f or the time betw een p lac ing an order and rec eiving it into stoc k . S ec ondly, an ec onomic order q uantity ( EO Q ) – is the standard f ormula used to arrive at a op timum p oint betw een holding too muc h or too little stoc k . T his f ormula is typ ic ally used in stoc k c ontrol, sof tw ar T hirdly, demand f orec asting – this is a c ritic al variable f or any stoc k c ontrol system. How ever, dep endent up on the nature of the p roduc ts suc h demand levels may vary ac c ording to the p redic tability. A demand f orec asting tec hniq ue may vary f rom a simp le estimated stable number p er month to the need to use reg ression analysis or multip le reg ression analysis tec hniq ues. T hese statistic al methods are larg ely outside the sc op e of this book .

W e w ill now turn our attention to Illustration 7 0 ( see Illustration7 0 . x ls) . S o, f or eac h p roduc t req uired f or resale and to be held in stoc k an EO Q and reorder lead time should be c omp uted. T his w ill tell the buyer how muc h to order and w hen. S o, f or p roduc t A B C1 2 3 that has a p urc hase p ric e of £1 0 0 , annual demand of 2 0 0 0 units, an of £2 0 , the c ost of inanc ing w ork ing c ap ital is 1 2 % p er annum, and the delivery lead time is three w that is, it tak es three w eek s f rom p oint of p lac ing the order to rec eiving the p roduc t into stoc k . T he EO Q is c alc ulated as p er the f ormula in c ell C1 0 , that is, the p oint at w hic h the c ost of order and holding the stoc k is minimised. T he R eorder Level is c alc ulated as p er the f ormula in c ell C1 1 , that is, the w eek ly demand w ithin the lead time.

68

Sect ion 2 C orp orat e f in an ce d ecision s

Just in time ( JIT) stock control system– this aims to reduc e c osts by k eep ing stoc k levels to a minimum. S toc k items are delivered w hen they are needed and used immediately. T here is a risk of running out of stoc k , so you need to be very sure that your sup p liers c an deliver on demand and that you have c lose relationship s w ith them. In very p rac tic al terms if your c omp any has multip le p roduc ts then you w ill need to c onsider c om merc ial sof tw are based up on suc h c onc ep ts that have been desc ribed. T here is a need to c onsider th f ollow ing p oints. ● ● ●

W hat is the basis of data c ap ture, f or ex amp le, elec tronic p oint of sale ( EPO S ) and bar c oding D oes the system c omp ly w ith the c orrec t ec onomic c alc ulation basis, that is, EO Q s and reorder lev W hat additional inf ormation or req uirements do you req uire f rom a stoc k c ontrol system? F or ex amp integ ration w ith p urc hase order systems, g ood rec eived notes, integ ration w ith ac c ounting ledg and systems.

Stock control exercise

B uild a stoc k c ontrol system in Ex c el f or a c omp any that has only 1 0 p roduc t lines. Use simp le l reg ression to f orec ast the annual demand based up on ive years’ monthly trading history. Your outp uts should inc lude the EO Q and the reorder level f or eac h p roduc t. S trategic initiatives involving cashinc lude manag ing c ash throug h the c ash low f orec asting and short term c ash dep osits. W e c an f urther look at the c osts and beneits of holding c ash. T he c ost of holding c an be the lost interest on invested c ash. W e rec og nise that the beneits of holding c ash allow a c orp orate p ay f or its day to day transac tions, it allow s them to have a buf f er f or any unf oreseen req uirements. It also allow s c omp anies to tak e advantag e of any p ossible f uture ac q uisitions and so on. S o w hen a c omp an ex c ess c ash w hic h it may w ant to think about investing it w ill have to c onsider the f ollow ing areas w are c ritic al to its f uture c ash low s. ● ● ●

T he rate of return that c an be obtained f rom the investment. T he risk assoc iated w ith the investment. T he liq uidity assoc iated w ith the investment, that is, how and returns?

easy it w ould be to realise the c ash

S o there are c ertain investments that c ould be c onsidered as f ollow s. ●

● ● ● ●

T he org anisation c ould reduc e an overdraf t of one of its bank ac c ounts. T his w ill g enerate a h return due to the interest saved. T he risk assoc iated w ith this c ourse of ac tion is lik ely to be low . It w of c ourse be limited to the amount of the overdraf t. T his is lik ely to be a liq uid c ourse of ac tion and almost instantaneous. T he org anisation c ould mak e a bank dep osit. T his w ould g ive a f airly low return. T he risk of this of ac tion is low . How ever, some notic e is g enerally req uired to mak e a w ithdraw al. T he org anisation c ould mak e a money mark et dep osit. T he return w ould dep end up on the time maturity. T his w ould not be too liq uid. T he org anisation c ould invest in g overnment stoc k s or treasury bills. T hese have a low return, low ris and are of medium liq uidity. T heorg anisation c ould invest in ordinary shares on the stoc k ex c hang e, w hic h c an g ive hig h returns hig h risk and liq uidity is simp le throug h sale of the stoc k s.

69

Corp orat e F in an ce Mod ellin g a n d A n alysis

S trategic initiatives involving trade creditorsinc lude manag ing trade c redit terms w ill now be look ed at. Let us now look at a sp ec iic ex amp le of w here a c omp any has been of f ered a disc ount of 2 % of f an in amount if settled w ithin 1 0 days rather than the standard 3 0 days p ayment terms g iven by the sup p lier f or the £8 million p urc hase.

Illustration 7 1 Supplier early settlement terms Current Date

1 April 2011

Invoiced

£8,000,000

Supplier Discount Trade Debtors Credit period

2.00% 30

Month Ending :

11 April 2011

Discounted Payment

-£7,840,000

Non Discounted Payment Forgone

£8,000,000

Net Cash low

IRR

30 April 2011

– -£7,840,000

£8,000,000

47.42%

S ource: M odelling S olutions

S o based up on the terms of the early disc ounting deal w e c an see in Illustration 7 1 that by p aying 9 8 % of the £8 million in 1 0 days to the sup p lier and avoiding the £8 million p ayment in 3 0 days, that is, 3 0 A p 2 0 1 1 , yields an IR R of 47 . 42 % . T his c ourse of ac tion is lik ely to add value to the org anisation buyi servic es as their w eig hted averag e c ost of c ap ital is lik ely too muc h low er than the IR R f or this dec ision T he above ex amp le c an be seen in f urther detail in the Ex c el ex amp le, Illustration 7 2 ( see Illustration7 2 . x ls) .

70

Section 3

Other areas for inancial modelling and analysis

Project inance as a source of funding

W hilst it is rec og nised that this book is dedic ated to c orp orate inanc e modelling and analysis tec hniq u and not sp ec iic ally to p roj ec t inanc e modelling analysis tec hniq ues, there w ill be instanc es w hen the op of p roj ec t inanc e may be usef ul. How ever, the c ontents during this sec tion are simp ly an introduc tion an readers w ho w ish to ex p lore this subj ec t in more detailed are rec ommended to read a p roj ec t inanc ia modelling and analysis dedic ated book . T he f ollow ing outline deinition of p roj ec t inanc e is tak en f rom the deinition p rovided by the Interna tional Proj ec t F inanc e A ssoc iation ( IPF A ) .

T he inanc ing of long - term inf rastruc ture, industrial p roj ec ts and p ublic servic es based up on a n rec ourse or limited rec ourse inanc ial struc ture w here p roj ec t debt and eq uity are used to inanc e the p roj ec t are p aid bac k f rom the c ash low g enerated by the p roj ec t.

Proj ec t F inanc e is a sourc e of non rec ourse or limited rec ourse inanc e w hereby the p roj ec t debt is sec u by the p roj ec t assets and sec ured by the p roj ec t c ash low s. T he beneits of this to the c orp orate lender or the p roj ec t sp onsor are as f ollow s. ● ● ● ● ● ●

It help s to k eep the debt of f the balanc e sheet and does not inc rease the c orp orate g earing ratio. It low ers p otential c ost of inanc ing . It p rotec ts the c orp orate debt c ap ac ity. It p rotec ts the c orp orate assets f rom p roj ec t risk . It is used f or p roj ec ts that may be too big f or one sp onsor. It allow s overseas business ventures.

T here are c ertain risk s that are inherent in a p roj ec t inanc e transac tion w hic h need to be mitig ated throug the alloc ation of risk throug h various mec hanisms and c ontrac tual arrang ements. T he f ollow ing typ risk s c an be mitig ated or reduc ed in the f ollow ing w ays. R isk Construc tion p hase risk . O p erational p hase risk . T ec hnolog ic al risk . Currenc y risk . Politic al risk . F orc e maj eure.

P ossib le mitigation techniq ue S p onsor c omp letion g uarantees. G overnment g uarantees minimum volumes. Proven tec hnolog y. Hedg ing or bac k to bac k c ontrac ts. Insuranc e or stable c ountry. Insuranc e.

A typ ic al c ontrac t struc ture c an be seen in Illustration 7 3 .

71

Corp orat e F in an ce Mod ellin g a n d A n alysis

Illustration 7 3 A typical project inance contractual structure – design build inance and operate Sub debt and equity

Consortium

Blended returns

Debt

Project agreement

Special purpose company (SPC)

Senior lenders syndicate

Public sector body

Debt servicing

Tariff

Design and build contractors

Facilities management contractors

Construction

Services

S ource: M odelling S olutions

A s the p urp ose of this book is not dedic ated to p roj ec t inanc e modelling , w e w ill simp ly use a dem onstration model that show s the p roit and loss, c ash low balanc e sheet and summary outp uts and desc ribe this at a hig h level. Illustration 7 4 ( see Illustration7 4. x ls) rep resents our p roj ec t inanc e demonstration model. T he demonstration model is not a f ully w ork ing model in the sense that the inp uts c an be c hang ed and the results

72

Sect ion 3 O t h er a reas for f in an cial mod ellin g a n d a n alysis

w ill be relec ted ac c ording ly; note the c alc ulations in the g reen sheets are simp ly c ut and p asted value How ever, w hat is imp ortant is the hig h level over view of a typ ic al p roj ec t inanc e model in the resp ec the k ey outp ut areas in blue. T he c oding log ic has been maintained f or these areas and c an be interp reted and ref erenc ed ac c ording ly. T he w ork sheet P& L – S emi A nnual S ummary show s the p roit and loss ac c ount on a six monthly basis T he w ork sheet Cashlow – S emi A nnual S ummary show s the c ash low on a six monthly basis. T he w ork sheet B alanc e S heet – S emi A nnual S ummary show s the c ash low on a six monthly b

Illustration 7 5 A typical project inance summary PROJECT ECONOMICS

Nominal

Real

TARIFF

Project IRR before Tax

18.85%

16.52%

Real Tariff Per Month

£000

Project IRR after Tax

16.00%

13.73%

1 June 2007

£14,862

Equity IRR

49.50%

46.57%

Equity and Sub Debt IRR

34.00%

31.37%

SENIOR LENDERS RATIOS

Minimum

Target Minimum

Year Of Min

Average

Forward

1.15

1.15

30 June 2012

1.19

Historic

1.15

1.15

31 December 2012

1.16

LLCR

1.34

1.25

31 December 2012

1.73

PLCR

2.30

1.20

30 June 2012

6.97

Annual Debt Service Cover Ratios

S ource: M odelling S olutions

T yp ic al k ey outp uts are used to mak e a dec ision reg arding an inf rastruc ture p roj ec t inanc ing . W disc uss the log ic behind eac h of the outp ut metric s inc luded in Illustration 7 5. 73

Corp orat e F in an ce Mod ellin g a n d A n alysis

Key project inance areas ● ● ●

●

● ●

●

●

●

●

●

74

P roj ect I R R b ef the oreptax roj:ec t IR R rep resents the IR R w here the net p( resent NPV) value of the p re inanc ing c ash low s bef ore tax eq uals z ero. P roj ect I R R af ter thetax p roj : ec t IR R rep resents the IR R w here the NPV of the p re inanc ing c a low s af ter tax eq uals z ero. E q uity I RtheReq :uity IR R rep resents the IR R w here the NPV of the eq uity c ash low s af ter tax eq u z ero. Essentially the eq uity net c ash low rep resents the dividend rec eived in relation to the eq uity investment made. E q uity and sub deb t Ithe R eq R uity : IR R rep resents the IR R w here the NPV of the eq uity and shareholder loan c ash low s af ter tax eq uals z ero. Essentially the eq uity net c ash low rep resents the dividend rec eived in relation to the eq uity investment made p lus the interest and p rinc ip al rec eived in relation to the debt advanc ed. R eal tarif f per month: the amount of the tarif f p aid by the g overnment is rep resented in real terms, that is, at today’s p ric e levels. ADSC R – f orw the ard: f orw ard annual debt servic e c over ratio ( A D S CR ) is eq ual to the c urrent six monthly p eriod p lus the nex t six monthly p eriod at eac h six monthly interval. M ore detailed c alc ulations c an be seen in the Lenders’ R atios sheet of the ex amp le used. ADSC R – historic: the historic A D S CR is eq ual to the c urrent six monthly p eriod p lus the nex t six monthly p eriod at eac h six monthly interval. M ore detailed c alc ulations c an be seen in the Lenders’ R atios sheet of the ex amp le used. LLC Rloan : lif e c over ratio ( LLCR ) , the ratio of the NPV of c ash available f or debt servic e during the term of the senior debt to the outstanding balanc e of the senior debt. T his is c alc ulated at eac h six monthly interval and is rep resented as both a minimum and an averag e. T he targ et minimum is c omp ared to this outp ut result ac c ording ly. M ore detailed c alc ulations c an be seen in the Lenders’ R atios sheet of the ex amp le p rovided. P LC pR roj : ec t lif e c over ratio ( PLCR ) , the ratio of the NPV of c ash available f or debt servic e during the lif e of the p roj ec t to the outstanding balanc e of the senior debt. T his is c alc ulated at eac h six monthly interval and is rep resented as both a minimum and an averag e. T he targ et minimum is c omp ared to this outp ut result ac c ording ly. M ore detailed c alc ulations c an be seen in the Lenders’ R atios sheet of the ex amp le used. R eserve accounts:the p roj ec t inanc e lenders’ ag reements usually ask f or c ash reserve ac c ounts to be maintained to ensure that c ritic al items suc h as debt servic e c ap ac ity and maintaining of the asset is p rovided f or in c ash terms. T here c an be other c ash ac c ounts, suc h as c hang e in law s’ reserve ac c ount Illustration 7 6 ( see Illustration7 6 . x ls) show s ex amp les of suc h log ic . T he debt servic e reserve ac c ount ( D S R A ) c alc ulates the req uired ac c ount balanc e at the en eac h of the six months as in row 1 3 6 7 . T his typ ic ally rep resents six months w orth of the nex t p e senior debt servic ing req uirements. T he dif f erenc e betw een the op ening and c losing balanc e is trans f erred f rom or to the c ash ac c ount to meet the req uirements. T he maintenanc e reserve ac c ount ( M R A ) c alc ulates the req uired ac c ount balanc e at the end eac h of the six months as in row 1 3 8 3 . T his typ ic ally rep resents six months w orth of the nex t p e lif ec yc le req uirements. A g ain, the dif f erenc e betw een the op ening and c losing balanc e is transf er f rom or to the c ash ac c ount to meet the req uirement. Dividends: w e w ill disc uss the log ic f or the building of the dividends module as ap p rop riate. Illustration 7 7 ( see Illustration7 7 . x ls) show s the log ic behind the dividends module.

Sect ion 3 O t h er a reas for f in an cial mod ellin g a n d a n alysis

Prior to distribution of any dividend, there are the restric tions that are p lac ed on the sp ec ial p urp ose c omp any in terms of the dividend loc k up s that may be trig g ered by virtue of the restric tive c ovenants that may be f ound in the lenders’ ag reement and the f ac ility ag reement. T here are of ten minimum A D S CR and LLCR levels that must be met in the six monthly p eriod, and p erhap s the need to meet th maintenanc e reserve req uirements. In row s 1 1 to 1 3 the minimum A D S CR and LLCR ratios bef ore dividend loc k up are ref tog ether w ith the indic ator stating w hether the maintenanc e reserve ac c ount req uirements are met. T he f orec ast p osition f or the six monthly A D S CR , LLCR and maintenanc e reserve ac c oun link ed into row s 1 8 to 2 0 . F rom row s 2 4 to 2 7 the distribution test is ap p lied. T he trig g er w ill c ount the number of O using Ex c el’s C ‘ount If ’ f unc tion. T he distribute log ic w ill p ay out all the available c ash at the end of the c onc ession date. B ef ore th end of the c onc ession if the number c alc ulated by the trig g er is eq ual to the number of distribution tests the overall c ondition w ill be ok . In row s 3 1 to 3 3 the amount of c ash available f or dividend is c alc ulated. T he c ash available dividends is c alc ulated as f ollow s. O p ening c ash balanc e ( p er the balanc e sheet) Plus Cash low g enerated in the p eriod p rior to dividends ( p er the c ash low )

In row s 3 7 to 3 9 the amount of retained earning s available f or dividend is c alc ulated. T he earning available f or dividends is c alc ulated as f ollow s: O p ening retained earning s ( p er the balanc e sheet) Plus Proit bef ore dividends ( p er the p roit and loss ac c ount)

T he dividend dec lared in the p roit and loss ac c ount ensures that the c ash available is p aid out to the ex tent that there are suf ic ient distributable reserves, that is, retained earning s available. F or simp lic ity terms, g iven that w e are w ork ing at a six monthly level the p roit and loss ac c ount and c ash l entries are amended to be the same.

Dividends exercise F or the inanc ial model that you have built to date add the f ollow ing log ic to the dividends module. e LLCR Us and A D S CR minimum targ ets f or loc k up p. 1urp 0 .oses A dd of c1 ash and p roit p osition log ic ibution. bef ore distr Calc ulate the c ash low , p roit and loss and any balanc e sheet results that w ill be link ed to the summary inanc ial statements.

IFRS (IFRIC 12 concession accounting) Financial asset accounting

A n imp ortant starting p oint is to determine w hether the p rivate sec tor op erator has an asset of the p rop er used to p rovide the c ontrac ted servic es or alternatively a inanc ial asset being a debt due f rom the p ublic sec tor body f or the f air value of the p rop erty. T his asset should be rec orded at the outset and reduc ed in subseq uent years as p ayments are rec eived f rom the p urc haser. F inanc e inc ome on this inanc ial asset should be rec orded in subseq uent years using a p rop erty sp ec iic rate. T he remainder of the tarif f p ayme 75

Corp orat e F in an ce Mod ellin g a n d A n alysis

( that is, the f ull p ayments, less the c ap ital rep ayment and the imp uted inanc ial c harg e) should be rec orded as op erating p roit. J ust how this is translated into numbers and c ode w ill be demonstrated in Illustration 7 8 ( see Illustration7 8 . x ls) . Under IF R S ( IF R IC 1 2 ) , there is an initial assessment of w ho has the beneits and risk s of the p rop e tak ing into ac c ount the p otential variations in p rop erty p roits. T he typ e of areas that w ill help to lead to the c onc lusion that the p rop erty is the asset of the p rivate sec tor op erator is as f ollow s. How ever, it should be noted that the g eneral ac c ounting treatment adop ted f or the sp ec ial p urp ose c omp any is that of ‘inanc ial asset ac c ounting ’. T he f ollow ing c harac teristic s are usually evident w here the p rivate sec tor op erator rec og nises the p ro erty as a ix ed asset in their book s. T his w ill help demonstrate w hy the vast maj ority of p ublic p rivate p artnership ( sPPPs) or p roj ec t inanc ing s are being ac c ounted f or as a inanc ial asset. F irstly, there are of ten p otential p enalties f or underp erf ormanc e of the p rop erty w hic h c an be sig niic ant and have a reasonable p ossibility of oc c urring . S ec ondly, relevant c osts are both sig niic ant and hig hly unc ertain, and all p otential material c ost variations w ill be borne by the p rivate sec tor op erator. T hirdly, obsolesc enc e or c hang es in tec hnolog y are sig niic ant and the p ublic sec tor c ontrac tor w ill bear the c osts and any assoc iated risk s. F ourthly, w here the residual risk is sig niic ant and borne by the p rivate sec tor op erator. A lso w here the years of the p rivate inanc e initiative ( PF I) c ontrac t are materially less than the usef ul ec onomic lif e of the p rop erty. In most UK desig n build inanc e and op erate ( D B F O ) typ e arrang ements they do not g enerally ho true, theref ore inanc ial asset ac c ounting is adop ted. How ever, w e k now f rom our inanc ial c lose p osition that w e need to ac c ount f or a inanc ial asset. W e w ill now outline the log ic and numbers behind inanc ial asset w ith ref erenc e to Illustration 7 8 ( see Illustration7 8 . x ls) . In row 1 3 an ‘F D EndO f Contrac t’ lag is used to identif y the p eriod f or inanc ial asset balanc e to eq to z ero. T he log ic p lac es this lag if both the c urrent p eriod’s c ommenc ing date is less than the c onc essi end date and the c urrent p eriod’s month ending date is g reater than or eq ual to the c onc ession end date otherw ise a blank is entered. T he inanc ial asset c losing balanc e is show n in row 1 8 . T his c omp rises the op ening balanc e p lu enue at f air value p lus the inanc e inc ome less the tarif f rec eip ts. T he inanc e inc ome is c alc ulated in row 2 1 and is eq ual to the inanc ial asset op ening balanc e at the six monthly interest rate. T he revenue to be rec og nised in the p roit and loss ac c ount is show n in row s 2 5 to 3 1 . Here all the c ost are show n that add a mark up to derive the revenue at f air value. T he ‘F inanc ialA ssetA mortisation’ mac ro is f or g oal seek ing the f air value marg in. T he c ounter varia is deined and then sets the c ounter to z ero. T arg et A deines the variable w hic h sets the inanc ial asset balanc e to z ero. T arg et B deines the variable that inds the mark up . T he log ic f or inding the inanc ial asset nested in the ‘D o Loop ’ c ondition. T he c ounter inc rease by 1 w ith eac h iteration until either 1 0 0 iteration are made. T he standard g oal seek log ic that you c ould rec ord throug h Ex c el has been substituted w ith the rang e names f or the inanc ial asset and the mark up . T he sub routineF‘ INA NC IA L ’Ais StheS main ET routine w hic h you w ould have to run to ind the marg in that amortises the inanc ial asset balanc e to z ero at the end of the c onc ession. It c alls the three sub routines that are req uired to run the f ull p roc ess, that is, deleting the old rang e name, inserting the end of c onc ession mark er and running the inanc ial asset amortisation g oal seek log ic . T he routine ‘Prep areR ang eName’ simp ly deletes the p revious ‘F D EndO f Contrac t’ so that a c urren op en c an be added. 76

Sect ion 3 O t h er a reas for f in an cial mod ellin g a n d a n alysis

T he routine ‘InsertR ang eNameEndO f Conc ession’ inserts the ‘F D EndO f Contrac t’ rang e name in c olumn w here the end of the c ontrac t date is. Essentially, a f or nex t loop is used to g o throug h eac h date i the time line w hic h is deined as the rang e name ‘Conc essionPeriodEnd’ and inserts the ‘F D EndO f Contrac t’ name w here the date is eq ual of f setting ive row s dow n f rom the date timeline.

Illustration 79 Financial asset amortisation macro/VBA code Sub FinancialAssetAmortisation() '==================================================================== ==================================== 'FinancialAssetAmortisation Macro 'Written by David Whittaker 'www.modellingsolutions.co.uk '==================================================================== ==================================== ' Application.ScreenUpdating = False Dim Counter Counter = 0 On Error Resume Next 'Result = Financial Asset Balance Equals Zero A = Sheets("Accounting").Range("FDEndOfContract").Value 'Target = Operating Cost Margin B = Sheets("Accounting Inputs").Range("Mark_Up___Fair_Value").Value Sheets("Accounting").Select Do '(Start Loop) Counter = Counter + 1 Application.StatusBar = "Please Wait Finding The Turnover Asset Mark Up - Iteration " & Counter Range("FDEndOfContract").GoalSeek Goal:=0, ChangingCell:=Range("Mark_Up___Fair_Value") 'set fd balance at end of contract 'to zero balance by changing the fd interest rate Loop Until A = B Or Counter = 200 Application.ScreenUpdating = True Application.StatusBar = Ready End Sub Sub PrepareRangeName() '==================================================================== ==================================== continued 77

'resets last inancial asset balance 'Written by David Whittaker 'www.modellingsolutions.co.uk '==================================================================== ==================================== '==================================================================== ==================================== ActiveWorkbook.Names("FDEndOfContract").Delete

End Sub Sub FINANCIALASSET() PrepareRangeName InsertRangeNameEndOfConcession FinancialAssetAmortisation Sheets("Cover").Select End Sub Sub InsertRangeNameEndOfConcession() 'Finds Date for Final amortisation Application.ScreenUpdating = False Dim Cell As Range Calculate Sheets("Accounting").Select For Each Cell In Range("ConcessionPeriodEnd").Cells Cell.Select If Cell.Value = "FDEndOfContract" Then Cell.Offset(5, 0).Select 'Inserts Range Name A = ActiveCell.Row B = ActiveCell.Column ActiveWorkbook.Names.Add Name:="FDEndOfContract", RefersToR1C1:= _ "='Accounting'!R" & A & "C" & B Else End If Next Cell

End Sub

Source: Modelling Solutions

Sect ion 3 O t h er a reas for f in an cial mod ellin g a n d a n alysis

Fixed asset accounting

A g ain under IF R IC 1 2 ( IF R S ) , there is an initial assessment of w ho has the beneits and risk s of the p tak ing into ac c ount the p otential variations in p rop erty p roits. T he p oints that are c onsidered above w ag ain be relevant. W here it is c onc luded that the op erator has an asset of the p rop erty, this asset should be rec orded in its balanc e sheet. T his asset should be rec orded at its c ost and then dep rec iated to its ex p ec ted residual value over its ec onomic usef ul lif e.

Revenue recognition

R evenue is rec og nised in line w ith the op erating c osts c harg e to the p roit and loss ac c ount, that is, simp ly ap p ly the mark up to the c osts as our assump tions. T he inanc e or inanc e asset interest is also a sourc e of revenue and the log ic f or this has been outlined above in the sec tion above.

Debt sculpting

I am sure that many readers w ould have heard of the c onc ep t of senior debt sc ulp ting . T his relates to the need to p roile the senior debt p rinc ip al to meet the lenders’ debt c over ratios. It is due to the f ac t that the lif ec yc le c osts of ten assoc iated w ith p roj ec t inanc ing s are c yc lic al in nature w ith p eak s and trou suc h a p roc ess is req uired, that is, sc ulp ting the p rinc ip al to the c ash available f or debt servic ing . A most thing s there are several w ays to ac hieve an end g oal, in terms of debt sc ulp ting there is the Ex c el w ork sheet alg ebraic method and the Ex c el VB A or mac ro ap p roac h. How ever, as w ith most thin alw ays best to use the easiest and simp lest method, w hic h is a rule that I alw ays adop t f or all inanc ial modelling task s. S o, in terms of debt sc ulp ting the rule w hic h needs to be made is alw ays try to solve th numbers using w ork sheet based or the alg ebraic method irst. W e c an see the alg ebraic method ap p lied an ex amp le in Illustration 8 0 ( see Illustration8 0 . x ls) . F or this ex amp le our sp ec ial p urp ose c omptered any the hasdebt en servic e p eriod in terms of our f orec asting . In row s 5 to 9 w e have link ed in c ertain assump tions and results f rom other p arts of the inanc ial model. T hese are the semi annual eq uivalents f or the interest rate, the c ash low s available f or debt servic e and the targ et minimum A D S CR req uired f rom our lender ag reements. In row s 1 1 to 1 5, w e c an see our semi annual debt sc hedule. T his c omp rises the op ening balanc e, dow ns, p rinc ip al and the c losing balanc e. B ased up on the c ash low s available f or debt servic e, interes targ et debt c over ratios w e have derived a p rinc ip al p roile in row 1 4 that amortises the senior debt by 3 M arc h 2 0 1 9 . In row s 1 7 to 2 3 , w e c an see the c alc ulation of the A D S CR . W e have simp ly started w ith th able f or debt servic e ( CA F D S ) , divided this by the targ et A D S CR to arrive at the debt servic e sup f or the six monthly p eriods. T he interest is a simp le c alc ulation based up on the op ening balanc e. T he p c ip al is the balanc e of the debt servic e req uirement that is restric ted to the minimum of this and the op ening debt balanc e. W e c alc ulate the ratio that meets the 1 . 2 0 targ et in row 2 3 . A n imp ortant q uestion w hic h arises here is w hen the simp le alg ebraic method is not suitable f or deb sc ulp ting and w hen a inanc ial modeller should adop t a mac ro or VB A ap p roac h. Essentially, the adop of the alg ebraic ap p roac h is suitable w hen the deinition of the ratio c alc ulations is simp le and c an irst be solved by this method. How ever, there are oc c asions w here c irc ularities c an be introduc ed as p art of the ratio deinition f or either the CA F D S or the debt servic ing as p art of the ratio deinition. S o, if the simp ap p roac h c annot ac hieve our debt sc ulp ting g oal w e have to ind a basis that ac hieves our obj ec tive a indeed the VB A or mac ro ap p roac h has to be the nex t f avoured alternative. 79

Corp orat e F in an ce Mod ellin g a n d A n alysis

How ever, the VB A c oding ap p roac h w ill be dif ic ult f or beg inners to p ic k up . T he art of de ing throug h VB A is p robably one of the most sk illed inanc ial modelling task s that I have p ersonally c ome ac ross. In Illustration 8 1 ( see Illustration8 1 . x ls) you w ill see the detailed w ork sheet c alc ulations that are behind the debt sc ulp ting c alc ulation log ic . In the ‘F inanc ing Inp uts’ w ork sheet you w ill notic e that the senior rep ayment p roile has been set to ‘S c ulp ted Historic A D S CR ’ and the targ et historic minimum has been set to 1 . 1 0 . T he c ore c alc ulations are made in the ‘inanc ing ’ w ork sheet in row s 1 2 9 1 to 1 2 9 7 . Here you w that the debt is rep aid w ith a 1 . 1 ratio ac hieved f or eac h six monthly p eriod. T he p rinc ip al p roile is sho in row 1 2 9 3 , w ith a 1 . 1 0 targ et ratio and the c losing balanc e f ully amortised by 3 1 D ec ember 2 0 In the ‘B alanc e S heet – S emi A nnual’ w ork sheet you w ill see that the senior debt is also f ully amortised. In the ‘Lenders R atios’ w ork sheet you c an see the detailed c alc ulation f or the historic A D S CR an that it is met f or eac h of the targ et six monthly p eriods. T he targ et is also met in the ‘S ummary’ w ork sheet. Let us move into the tec hnic al area of the Ex c el VB A c ode log ic w hic h help s op timise and sc ulp senior debt rep ayment p roile, see Illustration 8 2 .

Illustration 82 Sculpts the senior debt principal repayments to equal the minimum historic ASDCR Sub SculptHistoricADSCR() ' 'Sculpts the Senior Principal Repayments to Equal the Minimum Historic ADSCR 'Written By Modelling Solutions Limited ' 1 Application.ScreenUpdating = False (Switches screen updating off) '==================================================================== =========== 'Resets All Principals to Zero Prior To Sculpting '==================================================================== =========== 2 Sheets("Financing").Select (Selects the sheet) 3 If Range("SeniorDebtRepaymentProile").Value = "Sculpted Historic ADSCR" Then (if Sculpted Historic ADSCR is run then) 4 For Each Cell In Range("SculptedPrincipal").Cells (go through each cell in LLCR sculpted principal range) 5 Cell.Select (select cell) 6 Cell.Value = 0 (set cell to zero) 7 Next Cell (go to next cell) 8 Calculate (calculate) 9 Else (if not) 10 End If (end condition)

continued 80

11 For Each Cell In Range("SculptedPrincipalADSCR").Cells 12 Cell.Select 13 Cell.Value = 0 (Resets each principal to zero) 14 Next Cell 15 Calculate '==================================================================== ========== 16 Dim Counter (deines the variable counter) 17 On Error Resume Next (on error process next)

18 Counter = -1 (deines the counter start point) 19 Do (starts the loop)

'goal seek sculpted principal 20 Application.StatusBar = "Please Wait Sculpting The Principal For The Historic ADSCR - Iteration " & Counter (shows the iteration number on the status bar) 21 Counter = Counter + 1 (step up counter by 1 iteration) 22 B = Sheets("Financing Inputs").Range("ADSCRTargetHistoricMin").Value (Deines the target) 23 If Range("HistoricADSCRatio").Offset(0, Counter).Value Sale of Asset

x

Capital Allowances Foregone

x

Lease Rental

x

Corporation Tax Saved

x

Net Cash low

y

NPV

−£9.0

S ource: M odelling S olutions

It is rec ommended p rac tic e to evaluate the sale or lease bac k dec ision using disc ounted c ash low tec hniq ues and mak e a inal inanc ial dec ision reg arding the transac tion and the ef f ec t up on the c omp an T his w ill derive a result that c onsiders the time value of money and the inc remental ef f ec t on the c omp any’s c ash p osition by undertak ing the sale and lease bac k transac tion. Illustration 9 2 ( see Illustration9 2 . x ls) show s the log ic behind the sale and lease bac k ex amp le. In the ex amp le the c omp any uses 1 2 . 5% W A CC as the disc ount rate f or D CF ap p raisal p ur c omp any mak ing the ap p raisal is in a tax p aying p osition and c an theref ore of f set any op erating ex p and c ap ital allow anc es f or c orp oration tax p urp oses. T he c omp any’s marg inal rate of c orp oration ta and it c an c laim 2 0 % reduc ing balanc e c ap ital allow anc e f or this typ e of c ap ital p urc hase if i p urc hase the eq uip ment. T he lease terms that have been of f ered f or this eq uip ment is a ive year lease w ith an annual lease rent of £5 million. B ased up on the assump tions abov e w e c an c alc ulate the inc remental NPV as f ollow s. F irstly, c ash is rec eived f or the sale of the asset to the inanc ial institution of £1 0 million. B y selling thi asset you f org o the c ap ital allow anc es over the ive year p eriod. T he inc remental lease rentals are p aid and the c orp oration tax is saved on the lease rentals.

95

Corp orat e F in an ce Mod ellin g a n d A n alysis

T his results in neg ative NPV of £9 . 0 million. How ever w hen neg otiating w ith a inanc ial institution on a sale and lease bac k transac tion it is advisable to evaluate the term of f ered by attemp ting to g et as c lose to a z ero or p ositive NPV as p ossible. T he result derived in the analysis above is not as c lear c ut as that the c omp any should reneg otiate the transac tion and or try to review c omp arable deals.

Negotiating by using sensitivity analysis

T he inanc ial modelling and analysis ap p roac h outlined above c an be used in order to neg otiate w ith the inanc ial institution reg arding the asset resale value and the lease terms. T here are tw o methods or main tec hniq ues that are at our disp osal. F irstly, w e c an use Ex c el’s data table to vary both the c ap ital resale value and the lease rental and measure the ef f ec t on the NPV. S ec ondly, w e c ould use Ex c el’s g oal seek f unc tionality to ind targ et NPVs f or either the lease rentals or the c ap ital resale value. F irstly, let us tak e a look at the data table method f or c alc ulating the ef f ec t on the NPV of both the c ap ital resale value and the lease rep ayment. Illustration 9 3 ( see Illustration9 3 . x ls) show s the f ollow ing assump tions and results f or a lease versus p urc hase evaluation. Illustration 9 3 b ( see Illustration9 3 b. x ls) show s the f ollow ing assump tions and results f or a lease versus p urc hase evaluation assuming no tax ation.

Illustration 9 4 Sale and lease back data table EFFECT ON NPV

Resale Value −£9.0

£10,000,000

Lease Rental

£1,000,000

£1.7

Lease Rental

£2,000,000

–£0.9

Lease Rental

£3,000,000

–£3.6

Lease Rental

£4,000,000

–£6.3

Lease Rental

£5,000,000

–£9.0

The data table shows us that in order to break even in NPV terms we require a £6 million to £10 million resale value and a £1million rental. S ource: M odelling S olutions

Lease versus buy decisions

Leasing is of ten an alternative method to buying or buying and inanc ing an asset. T here is the beneit of using the asset w ithout the need to ow n it. Lease rentals c an be inanc ed throug h the c omp any’s c ash low g eneration. How ever, w hen look ing at the dec ision of w hether to lease or buy an asset or eq uip ment w e need 96

Sect ion 3 O t h er a reas for f in an cial mod ellin g a n d a n alysis

to c onsider both the q ualitative advantag es and disadvantag es of the lease versus p urc hase dec ision and the inanc ial outc ome throug h inanc ial modelling and evaluation. ●

●

●

T he advantag es of leased eq uip ment. # T he leasing c omp any usually has a lot of tec hnic al k now ledg e reg arding the eq uip ment t leases and c an p rovide sup p ort and advic e. # T he leased eq uip ment c an of ten allow the c orp oration to up date the eq uip ment more easily tha ow nership and thus beneit f rom the latest tec hnolog y. # Leasing w ill c ome w ith the beneit that the lease rental p ayments are tax - deduc tible f or c orp oratio tax p urp oses. # Leasing w ill also not req uire a big c ap ital outlay, dep osit, or inanc ing that is assoc iated w ith p urc hase and or inanc ing dec ision. T he disadvantag es of leased eq uip ment # T he main inanc ial disadvantag e is that you w ill lose the c ap ital allow anc es or tax dep rec iati beneits that are assoc iated w ith buying and ow ing an asset or eq uip ment. # A nother disadvantag e is that you w ill not beneit f rom the resale value of the asset or eq uip ment at the time of up g rade. Lease versus p urc hase dec isions # Illustration 9 5 show s the f ollow ing assump tions and results f or a lease versus p urc hase evaluation.

Illustration 9 5 Lease versus purchase Project Name Model Start Date – Forecasts Start

Discount Rate

LEASE VERSUS PURCHASE DECISION 01 January 2011

12.5%

Taxation Taxable Proits Main Rate of Corporation Tax

Yes 28.0%

Capital Allowance Rates Plant & Machinery – Reducing Balance

20.0% continued 97

Lease Terms Lease Rental Excluding VAT

£3,500

Lease Years

7

Capital Purchase Capital Cost

£55,000

Salvage Value

£1,000

Period Ending

LEASE EQUIPMENT Lease Rental Corporation Tax Saved Net Cash low NPV

£11,810

BUY EQUIPMENT Buy Equipment Salvage Value Capital allowances Net Cash low NPV S ource: M odelling S olutions

£17,026

Sect ion 3 O t h er a reas for f in an cial mod ellin g a n d a n alysis

It is rec ommended p rac tic e to evaluate the lease or buy dec ision using disc ounted c ash low tec hniq ue and mak e a inal inanc ial dec ision or op tion ap p raisal of the tw o sourc es of inanc ing the eq uip ment b up on the op tion that derives the low NPV est of the net c ash low . T his w ill rep resent the op tion that c onsidering the time value of money has the low est c ost result. In the ex amp le in Illustration 9 5 the c omp any uses 1 2 . 5% W A CC as the disc ount rate f or D CF a p urp oses. T he c omp any mak ing the ap p raisal is in a tax p aying p osition and c an theref ore of f set any ing ex p enditure and c ap ital allow anc es f or c orp oration tax p urp oses. T he c omp any’s marg inal rate ration tax is 2 8 % and it c an c laim 2 0 % reduc ing balanc e c ap ital allow anc e f or this typ e of c ap if it dec ides to p urc hase the eq uip ment. T he lease terms that have been of f ered f or this eq uip ment is a seven year lease w ith an annual lease rent of £3 ,50 0 . T he c ost of buying this eq uip ment is £55,0 0 0 and the resale or residual value at the end of seven years is £1 0 0 0 . B ased up on the assump tions above w e c an c alc ulate the c ost of both the op tions as f ollow s. In terms of the leasing c ourse of ac tion w e c an see the lease rental being p aid in eac h of the seven years w ith an of f set of the tax deduc tibility element f or c orp oration tax p urp oses w ith a time lag bec ause c o tion tax is normally p aid 1 0 months af ter the ac c ounting year end. T he net c ash low is then summed f eac h year and the NPV is c alc ulated f or this op tion. In terms of the p urc hase c ourse of ac tion w e c an see the p urc hase of the eq uip ment being mad the irst year w ith an of f set of the tax deduc tibility element f or the c ap ital allow anc es f or c orp oration p urp oses w ith a time lag bec ause c orp oration tax is normally p aid 1 0 months af ter the ac c ounting yea T he salvag e value is assumed in year seven. T he net c ash low is then summed f or eac h year and the NPV is c alc ulated f or this op tion. T he inanc ial modelling and analysis outlined above has been undertak en on an eq ually c omp arative ap p roac h ( that is, the same disc ount rate over the same term of seven years) . O n the basis of our analysis the leasing op tion should be undertak en as this g ives a low er NPV than the p urc hase op tion. Illustration 9 6 show s the f ollow ing assump tions and results f or a lease versus p urc hase evaluation w here a c omp any is in a non- tax p aying p osition f or the f oreseeable f uture.

Illustration 9 6 Lease versus purchase no tax Project Name Model Start Date – Forecasts Start

Discount Rate

LEASE VERSUS PURCHASE DECISION 01 January 2011

12.5%

continued

99

Taxation Taxable Proits

No

Main Rate of Corporation Tax

28.0%

Capital Allowance Rates Plant & Machinery – Reducing Balance

20.0%

Lease Terms Lease Rental Excluding VAT Lease Years

£3,500 7

Capital Purchase Capital Cost

£55,000

Salvage Value

£1,000

LEASE EQUIPMENT Lease Rental Corporation Tax Saved Net Cash low NPV

£15,723

BUY EQUIPMENT Buy Equipment Salvage Value Capital allowances Net Cash low NPV S ource: M odelling S olutions

£48,450

Sect ion 3 O t h er a reas for f in an cial mod ellin g a n d a n alysis

T his show s that the tax beneits have a larg e bearing up on our analysis and under the assump tion above the leased op tion w ould be materially inanc ially more advantag eous. C onsider the lease terms before you take the decision . It is ex tremely imp ortant that you review the lease ag reement and c onsider any imp ortant c lauses that c ould have a bearing up on you dec ision and inc lude them in your inanc ial evaluation ap p rop riately. F or ex amp le, any dep osits and notic e p eriods req uired ma be c ritic al to your analysis.

101

Section 4

Additional useful Excel functions

A lthoug h most of the k ey Ex c el f ormula have been demonstrated throug h the ex amp les in this book , ther are some other usef ul f ormula that are lik ely to f urther inc rease your c orp orate inanc e modelling sk ills.

FV

T his f unc tion c alc ulates the f uture value of an investment based up on a c onstant p eriodic p ayment an c onstant interest rate. In essenc e, it is a c alc ulation that w ill tell you w hat value your investment w ill g row to. In the ex amp le as outlined in Illustration 9 7 , the annual interest rate is 1 0 % , the monthly p ayment is £1 0 0 ,0 0 0 , w ith a initial investment of £1 ,0 0 0 ,0 0 0 and there are 3 6 eq ual monthly p ayments m these assump tions w hat w ill be the f uture value of the investment? Essentially, the syntax f or the f ormula c omp utes the results as f ollow s: = - F V ( D3 / 1 2 ,D6 ,D4 ,D5 ) T his g ives a result of a f uture value of £5,52 6 ,3 6 4.

Illustration 9 7 FV Annual Interest Rate Amount of Payment Monthly

10.0% £100,000

Initial Investment now

£1,000,000

No of Monthly periods

36

Future Value

£5,526,364

S ource: M odelling S olutions

Illustration 9 8 ( see Illustration9 8 . x ls) show s the detail behind the Ex c el ex amp le.

MIRR

T his f unc tion c alc ulates the modiied internal rate of return f or a series of c ash low s. In addition to the IR R f unc tion it w ill also inc lude the interest rec eived on the reinvestment of c ash. 103

Corp orat e F in an ce Mod ellin g a n d A n alysis

In the ex amp le as outlined in Illustration 9 9 an ex amp le of the modiied internal rate of return is demonstrated. In the ex amp le the loan interest rate is 1 2 % and the reinvestment interest rate is 1 4% . T here is a neg ative c ash low in year z ero and p ositive c ash low s arising thereaf ter. In Illustration 9 9 the M IR R is 1 5. 5% and the IR R 1 6 . 6 % . T he dif f erenc e in the result f or th lations is due to the reinvestment of any surp lus c ash af ter rep aying the loan of £1 0 0 million w hen c onsidering the disc ount rate w here the NPV eq uals z ero.

Illustration 9 9 MIRR Loan Interest

12.00%

Reinvestment Interest

14.00%

Year

Cash lows

0

−£100,000,000

1

£20,000,000

2

£40,000,000

3

£22,000,000

4

£30,000,000

5

£50,000,000

MIRR

15.5%

IRR

16.6%

S ource: M odelling S olutions

Illustration 1 0 0 ( see Illustration1 0 0 . x ls) show s the detail behind the Ex c el ex amp le.

NPER

In the ex amp le as outlined in Illustration 1 0 1 , the annual interest rate is 1 0 % , the monthly p ayment is £1 0 0 ,0 0 0 , w ith a initial investment of £1 ,0 0 0 ,0 0 0 . G iven these assump tions w hat w ill the n monthly p ayments have to be to meet the f uture value of £1 0 million? Essentially, the syntax f or the f ormula c omp utes the results as f ollow s:

= - NP ER ( A nnual Interest R ate/ 1 2 ,A mount O f P ayment Monthly,Initial payment Now ,F uture V alu T his g ives a result of 2 2 6 eq ual monthly p ayments. 104

Sect ion 4 A d d it ion al u sefu l E x cel fu n ct ion s

Illustration 1 0 1 NPER Annual Interest Rate Amount of Payment Monthly

10.0% £100,000

Initial Investment now

£1,000,000

Future Value

£10,000,000

Number of Equal Monthly Payments

226

S ource:M odelling S olutions

Illustration 1 0 2 ( see Illustration1 0 2 . x ls) show s the detail behind the Ex c el ex amp le.

RATE

In the ex amp le as outlined in Illustration 1 0 3 , the monthly rep ayment is £7 5,0 0 0 , w ith an amount borrow of £5,0 0 0 ,0 0 0 over 1 0 years. G iven these assump tions w hat w ill the annual interest rate have t Essentially, the syntax f or the f ormula c omp utes the results as f ollow s:

= R A TE( Y ears O f R epayment* 1 2 ,- amount of monthly repayment, A mount O f L oan B orrow ed T his g ives a result of a 1 3 . 1 2 %

interest rate p er annum.

Illustration 1 0 3 RATE Years of Repayment Amount of Payment Monthly

10 £75,000

Amount of Loan Borrowed

£5,000,000

Interest Rate Per Annum

13.12%

S ource: M odelling S olutions

Illustration 1 0 4 ( see Illustration1 0 4. x ls) show s the detail behind the Ex c el ex amp le.

105

Corp orat e F in an ce Mod ellin g a n d A n alysis

XIRR

T he XIR R f unc tion c alc ulates an IR R f or a series of c ash low s that do not oc c ur unif ormly or indee annual intervals. T he ex amp le as outlined in Illustration 1 0 5 show s the ‘x internal rate of return’. T he ex amp le has an initial investment and a number of net rec eip ts arising over ive years. W e c an see that the IR R is 1 7 . 57 % based up on the £1 0 ,0 0 0 investment and the rec eip ts at the sp ec iied dates. Essentially, the syntax f or the f ormula c omp utes the results as f ollow s: = X IR R ( C ashlow ,Dates,Discount R ate G uess)

Illustration 1 0 5 XIRR

IRR

Cash low

Dates

−£10,000,000

31 March 2011

£3,000,000

30 September 2011

£2,000,000

30 November 2011

£3,000,000

31 July 2012

£1,600,000

30 April 2013

£3,100,000

30 April 2014

17.57%

S ource: M odelling S olutions

Illustration 1 0 6 ( see Illustration1 0 6 . x ls) show s the detail behind the Ex c el ex amp le.

XNPV T heXNPV f unc tion c alc ulates NPV f or a series of c ash low s that do not oc c ur unif ormly or indeed at annual intervals. In the ex amp le as outlined in Illustration 1 0 7 the ‘x net p resent value’ is demonstrated. In the ex amp le w e have an initial investment and a number of net rec eip ts arising over ive years. In our ex amp le w e c an see that the NPV is £9 9 9 ,58 2 based up on the £1 0 million investment and the rec eip at the sp ec iied dates. Essentially, the syntax f or the f ormula c omp utes the results as f ollow s: = NP V ( Discount R ate, C ash low s, Dates)

106

Sect ion 4 A d d it ion al u sefu l E x cel fu n ct ion s

Illustration 1 0 7 XNPV Discount Rate

10.0% Cash low

Dates

−£10,000,000

31 March 2011

£3,000,000

30 September 2011

£2,000,000

30 November 2011

£3,000,000

31 July 2012

£1,600,000

30 April 2013

£3,100,000

30 April 2014

NPV

£999,582

S ource: M odelling S olutions

Illustration 1 0 8 ( see Illustration1 0 8 . x ls) show s the detail behind the Ex c el ex amp le.

107

Section 5

Using VBA

An introduction to Excel VBA

T his book is not intended as a substitute f or a book w hic h is dedic ated to Ex c el Visual B asic f or A p p li ( VB A ) p rog ramming but here w e are simp ly outlining some value- added Ex c el VB A tec hniq ues f f urther value to your c orp orate inanc e models. In summary, Ex c el VB A ex p ands and allow s c ustomisation of the Ex c el environment and allow s u undertak e task s that Ex c el c annot do, that is, you are p rog ramming Ex c el. B ef ore w e p rog ress to d strating some value added routines, an overview of the Ex c el VB A struc ture w ill be p rovided. Essentially the c ode is rec orded and edited in the visual basic editor or in Ex c el 2 0 0 7 in the D evelop e ribbon under the Visual B asic op tion. T he Ex c el 2 0 0 7 Visual B asic Editor is show n in Illustration 1 0

109

Illustration 1 0 9 The Visual Basic editor

S ource: Ex c el 2 0 0 7

Sect ion 5 U sin g V BA

T he c ode is struc tured in an obj ec t hierarc hy, that is, obj ec t, p rop erty and method. Ex amp les of Ex c el’s obj ec ts inc lude its w ork book , sheets, rang Prop es and erties c ells. are something that the obj ec t has, w hereas methods are ac tions that do something . Prop erties and methods are assoc iated w ith an obj ec t throug h dot log ic . T his is an ex amp le of a sim obj ec t, p rop erty and method relationship : W ork sheet( ′A′) . R ang′Exe( amp ′)le. delete

T he above simp ly means that the w ork sheet obj ec t c alled ‘A ’ has a p rop erty c alled rang e name ‘Ex am that w ill be deleted. T his w ill bec ome c learer onc e you have f ollow ed the ex amp les throug h this sec tion. Ex c el VB A ’s obj ec t model c an be seen by ref erenc ing Illustration 1 1 0 . Essentially you c an selec t the obj ec t brow ser by selec ting F 2 on your PC k eyboard. T he obj ec t brow is a very usef ul w ay of understanding Ex c el VB A ’s obj ec t model in terms of obj ec t, p rop erties and met In the ex amp le below you w ill be able to understand the relationship f or the sheet’s obj ec t and its p rop erties and methods by entering the searc h f ac ility.

111

Illustration 1 1 0 The object browser

S ource:Ex c el 2 0 0 7

Sect ion 5 U sin g V BA

T urning to the ex amp les of how w e c an use VB A to enhanc e your c orp orate inanc e models ref er tration 1 1 1 ( see Illustration1 1 1 . x ls) . T his is the Ex c el ex amp le that inc ludes the VB A c ode f or th

Protect functionality

Using the p rotec t f unc tionality f or eac h sheet is very usef ul f or p rotec ting the inanc ial model so that i c ases w here other p arties w ill p op ulate your inanc ial model they are unable to alter the c alc ulations, either intentionally or unintentionally. Illustration 1 1 2 outlines the VB A c ode to do this. Line 1 sets Ex c el sc reen up dating of f . Line 2 deines the w ork sheet obj ec t as a variable c alled S Line 3 ig nores any errors and avoids run time messag ing . Line 4 unp rotec ts the w ork book by using th p assw ord. Line 5 starts the loop by ac tivating eac h sheet in the w ork book . Line 6 ac tually selec ts eac h Line 7 p assw ord p rotec ts the sheet. Line 8 ac tivates the nex t sheet in the w ork book . Line 9 sets the sc up dating bac k on.

Illustration 112 Protect Sub ProtectEachSheet() 1 Application.ScreenUpdating = False

2 Dim Sheet As Worksheet 3 On Error Resume Next 4 ActiveWorkbook.Protect ("CorporateFinance") 5 For Each Sheet In ActiveWorkbook.Sheets 6 Sheet.Select 7 Sheet.Protect ("CorporateFinance") 8 Next Sheet 9 Application.ScreenUpdating = True End Sub Source: Modelling Solutions

Unprotect functionality

Using the unp rotec t f unc tionality f or eac h sheet is very usef ul f or unp rotec ting all the sheets in the inanc i model in c ases w here you need to q uic k ly and easily unp rotec t the sheets. Illustration 1 1 3 outlines the VB c ode to do this. Line 1 sets Ex c el sc reen up dating of f . Line 2 deines the w ork sheet obj ec t as a variable c alled S Line 3 ig nores any errors and avoids run time messag ing . Line 4 unp rotec ts the w ork book by using th p assw ord. Line 5 starts the loop by ac tivating eac h sheet in the w ork book . Line 6 ac tually selec ts eac h 113

Corp orat e F in an ce Mod ellin g a n d A n alysis

Line 7 p assw ord unp rotec ts the sheet. Line 8 ac tivates the nex t sheet in the w ork book . Line 9 sets the sc re up dating bac k on.

Illustration 113 Unprotect Sub UnProtectEachSheet() 1 Application.ScreenUpdating = False 2 Dim Sheet As Worksheet 3 On Error Resume Next 4 ActiveWorkbook.Protect ("CorporateFinance") 5 For Each Sheet In ActiveWorkbook.Sheets 6 Sheet.Select 7 Sheet.Unprotect ("CorporateFinance") 8 Next Sheet 9 Application.ScreenUpdating = True End Sub Source: Modelling Solutions

Menu functionality

M enu f unc tionality is very usef ul f or a inanc ial model as you c an p lac e c ustom menu bars in the Ex c el menu or the ribbons menu bars ( Ex c el 2 0 0 7 ) . T he advantag e of using menu bars is that you or a user c an easily ind and run a desired op eration ( see Illustration 1 1 4) . T he LoadM enus c ode ensures that in lines 1 and 2 the c alc ulation is set to manual and the sc reen up dating is sw itc hed of f . Lines 3 to 7 deine the variables f or the menu bars ac c ording ly. T he p aths f or thes variables are f urther deined in lines 8 to 1 2 . T he rest of the lines relates to a list of c ap tions or names of the menu bar w hic h w hen selec ted trig g ers a p roc edure w hic h is ref erred to in the c ode as an ac tion. Eac h of routines is nested betw een end and w ith statements ac c ording ly.

Illustration 114 Load menus Sub LoadMenus() '==================================================================== =============== 'THIS PROCEDURE LOADS UP THE MENU BARS '==================================================================== =============== continued 114

1 Application.ScreenUpdating = False 2 Application.Calculation = xlCalculationManual 3 Dim cbWSMenubar As CommandBar 4 Dim muCustom As CommandBarControl 5 Dim iHelpIndex As Integer 6 Dim muCustom1 As CommandBarControl 7 Dim iWindowIndex As Integer 8 Set cbWSMenubar = CommandBars("Worksheet Menu Bar") 9 iHelpIndex = cbWSMenubar.Controls("Help").Index 10 iWindowIndex = cbWSMenubar.Controls("Window").Index 11 Set muCustom = cbWSMenubar.Controls.Add(Type:=msoControlPopup, Before:=iHelpIndex) 12 Set muCustom1 = cbWSMenubar.Controls.Add(Type:=msoControlPopup, Before:=iHelpIndex) '==================================================================== ============== ' '==================================================================== ==============

'==================================================================== ============== 'MODEL INPUTS '==================================================================== ============== 13 With muCustom1 .Caption = "&Model Inputs" .TooltipText = "Locates Model Input Sheets" 14 With .Controls.Add(Type:=msoControlButton) .Caption = "&Sensitivity Inputs" .OnAction = "SENSITIVITYINPUTS" End With 15 With .Controls.Add(Type:=msoControlButton) .Caption = "&General Inputs" .OnAction = "GENERALINPUTS" End With 16 With .Controls.Add(Type:=msoControlButton) .Caption = "&Financing Inputs" .OnAction = "FINANCINGINPUTS" End With

continued

17 With .Controls.Add(Type:=msoControlButton) .Caption = "&Taxation Inputs" .OnAction = “TAXATIONINPUTS” End With 18 With .Controls.Add(Type:=msoControlButton) .Caption = "&Accounting Inputs" .OnAction = "ACCOUNTINGINPUTS" End With '================================================ 'MODEL OUTPUTS '================================================ 19 With muCustom .Caption = "&Model Outputs" .TooltipText = "Locates Model’s Output Sheets"

20 With .Controls.Add(Type:=msoControlButton) .Caption = "&P and L Semi Annual Summary" .OnAction = "PANDLSEMIANNUALSUMMARY" End With 21 With .Controls.Add(Type:=msoControlButton) .Caption = "&Cashlow Semi Annual" .OnAction = "CASHFLOWSEMIANNUAL" End With 22 With .Controls.Add(Type:=msoControlButton) .Caption = "&Balance Sheet Semi Annual" .OnAction = "BALANCESHEETSEMIANNUAL" End With 23 With .Controls.Add(Type:=msoControlButton) .Caption = "&Summary" .OnAction = "SUMMARY" End With 24 With .Controls.Add(Type:=msoControlButton) .Caption = "&Sensitivities" .OnAction = "SENSITIVITIES" End With

continued

Sect ion 5 U sin g V BA

25 With .Controls.Add(Type:=msoControlButton) .Caption = "&Checks" .OnAction = "CHECKS" End With 26 End With 27 End With '==================================================================== ==================== ' '==================================================================== ==================== 28 Application.ScreenUpdating = True 29 Application.Calculation = xlCalculationAutomatic End Sub Source: Modelling Solutions

Auto open functionality

T he auto op en f unc tionality w ill trig g er c ertain p roc edures to be run onc e the Ex c el w ork book in q is op ened. Illustration 1 1 5 show s the VB A c ode to imp lement this. T he c ode that trig g ers the event is the ‘S ub A uto_ O p en( ) ’ line. T he lines of VB A c ode have b bered f or ref erenc e p urp oses ac c ording ly. O bviously, the S ub and End S ub lines start and end the routine log ic . Line 1 trig g ers the load menu routine. Line 2 selec ts the c over sheet. Line 3 trig g ers the timeout c h

Illustration 115 Auto open Sub Auto_Open() 1 LoadMenus 2 Sheets(«COVER”).Select 3 XANADOO End Sub Source: Modelling Solutions

117

Corp orat e F in an ce Mod ellin g a n d A n alysis

Auto close functionality

T he auto c lose f unc tionality w ill trig g er c ertain p roc edures to be run onc e the Ex c el w ork book in q ue is c losed. Illustration 1 1 6 show s the VB A c ode to imp lement this. T he c ode that trig g ers the event is the ‘S ub A uto_ Close( ) ’ line. T he lines of VB A c ode have been nu bered f or ref erenc e p urp oses. T his p artic ular A uto_ Close routine removes the menu bars up on c losing the Ex c el w ork book . Line 1 deines the variable as a menu bar. Line 2 ig nores any errors and avoids run time messag ing . Line 3 sets the variable to a w ork sheet menu bar. Line 4 sets the c ounter to z ero. Line 5 c ontrols the c ounter loop to a max imum of 1 0 iterations. T his w ill ensure that all op en model versions c an be removed. Line 6 sets the c ounter to step up by one f or iteration. Lines 7 and 8 delete the c ontrols f rom the menu bar. Line 9 loop s bac k to line 5.

Illustration 116 Auto close Sub Auto_Close() '=============================================================== 'THIS ROUTINE REMOVES THE MENUS BARS WHEN THE WORKBOOK IS CLOSED '=============================================================== 1 Dim cbWSMenubar As CommandBar 2 On Error Resume Next 3 Set cbWSMenubar = CommandBars("Worksheet Menu Bar") 4I=0 5 For I = I To 10 6I=I+1 7 cbWSMenubar.Controls("MODEL Inputs").Delete 8 cbWSMenubar.Controls("MODEL Outputs").Delete 9 Next I End Sub Source: Modelling Solutions

Using a timeout facility for demo inancial models A dding a timeout f ac ility to your inanc ial model may be usef ul w here you only w ant to show a inanc ial model f or a limited amount of time, say f or demonstration or sales p urp oses. How ever, alw ays ensure you have set up the time out f ac ility to w ork on the version being used f or demonstration p urp oses and not the orig inal! Illustration 1 1 7 show s the VB A c ode to imp lement this. In order to ac tivate the time out ref er to Illustration 1 1 7 b ( see Illustration1 1 7 b. x ls) . S elec t the S ummary sheet’s c ell B 6 552 2 , c hang ing the issue date to today’s date, and c op y and p aste a hard c oded number instead of a f ormula. T he demo lic ense days should be set to the number of days you 118

Sect ion 5 U sin g V BA

w ish to p rovide the lic ense. Ensure that you p rotec t the c ells and the w hole model. It is also imp ortant to p rotec t any unp rotec ted f unc tionality bef ore p roviding your demo inanc ial model. T he XA NA D O O c ode ensures that in lines 1 and 2 the c alc ulation is set to manual and the sc up dating is sw itc hed of f . Line 3 ig nores any errors and avoids run time messag ing . Line 4 deines the obj e w ork sheet as a variable c alled sheet. Lines 5 and 6 deine variables A and B . Line 7 deines variable A as th S ummary sheet and the rang e name C ‘ U R R ENTDA ’. LikTEew ise, line 8 deines variable B as the S ummary sheet and the rang e name EX ‘ P IR Y DA ’. Line TE 9 tests w hether the c urrent date ex c eeds the ex p iry date. If it does, it ac tions line 1 0 and unp rotec ts the w ork book by using the p assw ord. In line 1 1 , a loop beg w ill ensure that p roc edures are ac tioned f or eac h sheet, w hic h in lines 1 2 to 1 5 unp rotec ts all sheets c lears all their c ontents, disp laying a messag e ac c ording ly. Line 1 6 c loses the loop f or eac h sheet. Lin and 1 9 ef f ec tively c omp lete the test f or the ex p iry date ensuring that the inanc ial model does not destruc Lines 2 0 and 2 1 set the automatic c alc ulations and sc reen up dating bac k on.

Illustration 117 Timeout Sub XANADOO()

'================================================ 'TIMEOUT FACILITY FOR DEMO VERSIONS '================================================= 1 Application.Calculation = xlCalculationManual 2 Application.ScreenUpdating = False 3 On Error Resume Next 4 Dim Sheet As Worksheet 5 Dim A 6 Dim B 7 A = Sheets("SUMMARY").Range("CURRENTDATE").Value 8 B = Sheets("SUMMARY").Range("EXPIRYDATE").Value

9 If A >= B Then '================================================= 'Delete the logic in each sheet '================================================= 10 ActiveWorkbook.Unprotect ("CorporateFinance")

continued 119

Corp orat e F in an ce Mod ellin g a n d A n alysis

11 For Each Sheet In ActiveWorkbook.Sheets 12 Sheet.Select 13 Sheet.Unprotect ("CorporateFinance") 14 Cells.Select 15 Selection.Clear 16 Next Sheet 17 MsgBox "Please Contact Modelling Solutions Your Demo Licence Has Expired" 18 Else 19 End If 20 Application.Calculation = xlCalculationAutomatic 21 Application.ScreenUpdating = True End Sub Source: Modelling Solutions

Unhide sheets

Using the unhide f unc tionality f or eac h sheet is very usef ul f or unhiding the hidden sheets in the inanc ial model w ithout the need to unhide multip le sheets sing ularly. Illustration 1 1 8 show s the VB A c ode. T h c ould be a usef ul p roc edure f or the need to unhide sheets of a third p arty model f or review or audit p urp oses. Line 1 of the c ode below sets the obj ec t w ork sheet as a variable name W ork sheet. Line 2 ensures that eac h sheet in the w ork book is look ed at. Line 3 ig nores any errors and avoids run time messag ing . Line 4 selec ts the nex t sheet. Line 5 ensures that the sheet is visible. Line 6 selec ts the nex t sheet in the loop .

Illustration 118 Unhide Sub UnhideSheets() 'Unhides each sheet in the workbook 1 Dim Sheet As Worksheet 2 For Each Sheet In ActiveWorkbook.Sheets 3 On Error Resume Next 4 ActiveSheet.Select 5 Sheet.Visible = xlSheetVisible 6 Next Sheet End Sub Source: Modelling Solutions continued 120

Sect ion 5 U sin g V BA

Hide sheets

Using the hide f unc tionality f or eac h sheet is very usef ul f or hiding the inanc ial model so that you as a inanc ial modeller c an f oc us on p artic ular sheets in the inanc ial model w ithout the need to hide multip le sheets sing ularly. T his has the beneit of either allow ing the develop er to f oc us or indeed restric ting sheets f or p resentation p urp oses. Illustration 1 1 9 show s the VB A c ode. Line 1 of the c ode sets the obj ec t w as a variable name W ork sheet. Line 2 ensures that eac h sheet in the w ork book is look at. Line 3 ig nores a errors and avoids run time messag ing . Line 4 selec ts the nex t sheet. Line 5 ensures that the sheet is hidden. Line 6 selec ts the nex t sheet in the loop .

Illustration 119 Hide Sub HideSheets() 'hides each sheet in the workbook 1 Dim Sheet As Worksheet 2 For Each Sheet In ActiveWorkbook.Sheets 3 On Error Resume Next 4 ActiveSheet.Select 5 Sheet.Visible = xlSheetHidden 6 Next Sheet End Sub Source: Modelling Solutions

Exercise Excel VBA Use one of your c omp leted inanc ial models f rom any sec tion of this book in order to add the f ollow ing f unc tionality. ● ● ● ●

M enu bars to selec t eac h inp ut and outp ut sheet or ac tivate a c alc ulation routine of your c hoic e. Unp rotec t eac h of the inp uts c ells in your inanc ial model and add a VB A routine that p rotec ts eac sheet and the entire w ork book w ith a p assw ord of your c hoic e. A dd a VB A routine that unp rotec ts eac h sheet and the entire w ork book w ith a p assw ord of your c A dd a timeout f ac ility that w ill destruc t a demonstration version of your inanc ial model in ive days f rom the date of issue.

121

Section 6

Reviewing and auditing corporate inance models

Limited scope inancial model reviews

T here w ill be c ertain c irc umstanc es w hen a limited review of the inanc ial model is nec essary. T his c be in times w hen there is not time f or a f ull audit or indeed a f ull model audit is not nec essary. I of ten hear p eop le c onf using a limited review or a q uic k look at a inanc ial model as an audit. A n audit is a m deinitive w ord look ing in muc h f uller sc op e and it is imp ortant f or a review er to mak e this p oint ap p a A limited sc op e review c an be undertak en by either an individual or a p rof essional irm. How ever, due to its nature ( that is, a limited sc op e) it is rec ommended that an op inion letter is not p resented reg arding this typ e of review . It is ap p arent that the sc op e w ill be so limited that it w ill be dif ic ult to c onc lude w het inanc ial model materially meets its obj ec tive. Indeed, it is normal p rac tic e to simp ly rep ort a list of inding s and disc uss these w ith the model develop er based up on the ag reed limited sc op e. A very imp ortant c aveat t use at the start of the ex erc ise and at the rep orting stag e is w ording suc h as, ‘You have ask ed us to undertak a limited review of the inanc ial model, ac c ording ly our w ork is limited and there may be errors that ex ist that are beyond the sc op e of our review ’. G etting a g rip on a larg e and c omp lex inanc ial model is a real c halleng e, p artic ularly w hen time the essenc e. W hen under p ressure, the tec hniq ues w hic h I w ill illustrate here c an sw if tly reduc e, but not eliminate, modelling risk . How ever, being f oc used on w hat is imp ortant and being c reative w ith your test tec hniq ues c an ensure that the g reatest value is obtained f rom the time sp ent review ing the inanc ial model. Understand the struc ture and low of the inanc ial model throug h a disc ussion w ith the modeller. T his c an be sup p lemented by the use of a sp readsheet audit tool suc h as S p readsheet Prof essional. A g ree w ith the modeller w hat the k ey outp uts of the model are and w hether any areas are low risk or c ould even be ig nored. Conseq uently, it is imp ortant to reac h an ag reement on p otential risk s w ith the model builder/ dec ision mak er bef ore c ommenc ing the review . It may be that c ertain c omp onents of the model c arry a hig her risk in terms of mak ing or break ing th deal or indeed c omp lex ity or risk of c alc ulation. O ther areas c ould be low risk or c ould even be ig nore It is f rom suc h disc ussions that a risk based testing p lan c ould be struc tured. T he f ollow ing outlines the available tools and tec hniq ues that p otentially c ould be used w hen less time is available or f ull inanc ial model audit is not ap p rop riate. ●

Design review it: is nec essary to mak e a q uic k assessment of w hether the model ap p ears to be it f or the p urp ose and is built to an adeq uate standard. A model desig n review is usef ul f or a q uic k it- f or- p urp ose test and this should be done bef addressing any other areas bec ause if the model is p oorly desig ned it w ill need sig niic ant rew ork – in other w ords sp ot the dog s q uic k ly! T he ap p roac h that I sug g est involves the f ollow ing task s, w hic h are intended to p rovide a basi c omp arison to g ood p rac tic e build standards. A sp readsheet auditor tool suc h as S p readsheet Prof sional, O A K and so on c an help identif y c ertain p otential desig n issues. T he irst c hec k is the d 123

Corp orat e F in an ce Mod ellin g a n d A n alysis

●

●

●

124

of hard c oded c ells ( that is, those w hic h rep resent mere numeric al inp uts – obviously, these w ill also not c hang e w hen the assump tions are c hang ed) . T he sec ond c hec k is the deg ree of sep aration of inp c alc ulations and outp uts. T he third is the deg ree of inc onsistenc y in f ormula c op ying . T he f ourth the deg ree of embedded assump tions w ithin f ormulae. It is imp ortant to disting uish betw een c onstants and embedded assump tions. Constants are req uired in order to p erf orm the c alc ulations f rom the inp ut assump tions, f or ex amp le, dividing annual c ash low s by 52 in order to c alc ulate a w eek ly result. A risk ex ists w ith embedded assump tions bec ause they w ill not be up dated as the model’s inp uts or the sc enarios c hang e. T he results f rom the f or k ey desig n tests c an be assig ned risk rating s in terms of hig h medium, low desig n risk s. A summary risk c ateg orisation c an be made reg arding the overall desig n or build q uality of the model. Analytical review this : tec hniq ue involves review ing the model’s ‘big p ic ture’. It is g ood f or detec ting p otentially larg e errors f or one model run, typ ic ally the base c ase, but c an be used w hen review ing sensitivity c ases. K ey areas should be g rap hed bec ause this f ac ilitates interp retation and show s p atterns and ‘blip s’ not visible f rom the numbers alone and c ould indic ate errors. Degree of integration and reconciliation of inancial statement f orecasts: this issue is imp ortant bec ause the f ailure to p rop erly integ rate p roit and loss, balanc e sheet and c ash low is a c ommon error. F inanc ial statement f orec asts should f ollow double entry p rinc ip les and rec onc iliation in terms of the c ash balanc e in the balanc e sheet and c ash low movement over the f orec ast p eriod f rom the c ash low . I rec ommend a w alk throug h review of the inanc ial statement f orec asts c ode, c hec k ing w the balanc e sheet c ash ig ure c omes f rom. If it is not f rom the c ash low , be on g uard f or a f udg ed balanc e sheet. Varying the model’s inp ut assump tions and c hec k ing that the balanc e sheet still balanc es and c ash balanc e rec onc iles to the c ash low any dif f erenc e arising f rom the c omp arison should be rationalised and investig ated as ap p rop riate. Flex testing and sensitivity review this : is a tec hniq ue that is used f or review ing the reasonableness of the model’s sensitivity runs. It is imp ortant at this stag e to dif f erentiate lex testing f rom sensitivity testing . S ensitivity testing is w here a stated sensitivity is review ed ( f or ex amp le, a 1 0 % inc rease g eneral inlation p er annum) . How ever, there are oc c asions w here there is the req uirement to test w hether the model’s log ic al integ rity is c ap able of stress testing . T his w ill involve the lex ing of the k inp ut drivers in the model and the risk areas w hic h are lik ely to be varied by the user. Conseq uently, in the c ase of lex testing it w ill not be k now n w hat ex ac tly the values of the inp uts values are lik ely to b at the review or testing stag e. I rec ommend the f ollow ing ap p roac h is tak en. # T here is the need f or a transp arent audit trail to be c reated f rom the inanc ial model’s inp uts to the inanc ial model’s outp uts. T his w ill help to remove the blac k box risk and sp ot p otential errors more easily. T his c an be ac hieved by f reez ing the sp ec iic inanc ial model’s w ork sheets in a ref erenc e sheet and ex trac ting the varianc e and p erc entag e varianc e betw een the test c ase and the model’s c urrent results. # T he inp ut assump tions should be varied f or eac h lex or sensitivity c ase to be tested. # T he ef f ec t on the c alc ulations and results of eac h test should be review ed f or reasonableness g iven the sc enario. Here w e are look ing f or reasonable c hang es w here w e ex p ec t to see them and no c hang es w here w e do not ex p ec t to see them. # It is rec ommended that the varianc es or % varianc es that do not ap p ear log ic al g iven the test c ase are investig ated. # It is advisable to also use the c omp arison of the log ic movements tog ether w ith the analytic al review of the inanc ial statements. A f urther review tec hniq ue w ould involve the rank ing of the

Sect ion 6 R eviewin g a n d a u d it in g corp orat e fin an ce m od els

#

●

●

shareholder returns and lenders ratios and investig ations should be made w here the ex p ec ted c onditions do not hold. Illustration 1 2 0 ( see Illustration1 2 0 . x ls) show s an ex amp le of a how to set up a lex test t f or review . T he sheets as in the illustration should be inserted in a test c op y of the ex isting inanc ial model in the k ey outp uts sc hedules, that is, typ ic ally the p roit and loss ac c ount, c ash low , balanc sheets, lenders’ ratios and shareholder returns. Essentially, the orig inal log ic sheet req uires f reez ing throug h the use of a c op y and p aste. T he orig inal log ic w ill have to be k ep t unc hang ed varianc e betw een the orig inal and f roz en sheet ex trac ted. A inal sheet should be inserted into the temp late w hic h c omp ares the varianc e as a p erc entag e of f roz en.

Illustration 1 2 0 ( Illustration1 2 0 . x ls) show s the ef f ec t of a 50 % inc rease in the senior lende interest rates. T he P& L, c ash low , balanc e sheet and summary sheets are all analysed by the use of a f roz en, a varianc e and a % varianc e sheet. Eac h line item should be review ed and c ommented up on in terms of the varianc e and % varianc e to ensure that c hang es are made w here they are ex p ec ted and to the mag nitude ex p ec ted. T his analysis should be sup p orted by an analytic al review of the reasonableness o the inanc ial statements and the summary. Look ing at the G eneral Inp uts sheet B 1 7 w e c an see a 50 % inc rease in senior debt rates been selec ted. T urning to the P& L varianc e and % varianc es there ap p ears to be c hang es only as ex p ec ted is, the interest p ayable has inc reased) , the c orp oration tax has inc reased and there has been a reduc tion in dividends. Look ing at the c ash low varianc e and % varianc e there ap p ears to be c hang es only as ex p e ( that is, the interest p ayable has inc reased) , the c orp oration tax has inc reased and there has been a reduc tion in dividends. T he senior debt interest has inc reased by ex ac tly the 50 % assump tion. Look ing at the balanc e sheet varianc e and % varianc e an imp ac t c an be observed on the overdraf t, retained p roit reduc tion and c orp oration tax reduc tion as ex p ec ted. T he summary show s a relatively marg inal imp ac t on the internal rate of returns ( IR R s) and a drop in the lenders’ ratios at a reasonable level as ex p ec ted, but the minimums c annot be met due to the overdraf t. F rom an analytic al review p ersp ec tive the p roj ec tions look reasonable f rom a top level. F or ex p le, all the c hec k s in the Chec k s sheet are still z ero. T he debt sc hedules in the balanc e sheet rec onc to z ero at the end of term. P arallel or shadow modelling: p arallel or shadow modelling is a rep erf ormanc e tec hniq ue w hic h c a be used either f or the model as a w hole, w hic h I believe is an audit ap p roac h f or c ertain p rof essiona irms, or f or the areas that are p erc eived as the k ey risk areas either due to materiality of an outp ut area or indeed due to the c omp lex ity behind the c alc ulation. T he f ollow ing ap p roac h is rec ommended: # the rebuild of the area under review ; # the c omp arison of the k ey results derived f rom the rep erf ormanc e to the orig inal model, g iven the inp ut assump tions are the same; and # the dif f erenc es w hic h arise f rom the c omp arison should be rationalised and investig ated as ap p rop riate. M acro reviewthis : tec hniq ue is usef ul w hen the models k ey c alc ulations are reliant on mac ro c ode. M odels are inc reasing ly using more c omp lex mac ros and to a larg e deg ree this w as due to introduc tion of Ex c el’s inc reased p rog rammability throug h Visual B asic f or A p p lic ations ( VB need to dif f erentiate betw een low and hig h risk mac ros. Low risk typ ic ally desc ribes a mac ro or p 125

Corp orat e F in an ce Mod ellin g a n d A n alysis

of Ex c el VB A c ode that is non- c omp lex , relatively small w ith no p rog ram c ontrol struc ture p rob rec orded w ith the obj ec tive of undertak ing neg ative k ey strok es. A t the other end of the sp ec trum lies the hig h risk c ase w hic h typ ic ally desc ribes a p iec e of Ex VB A c ode that is c omp lex , relatively larg e and inc ludes p rog ram c ontrol struc tures,IF f or ex amp le, ‘ TH EN ’, ‘DO U NTIL ’, and ‘F O R NEX ’. T W e are p rimarily c onc erned w ith hig h risk VB A c ode that is c omp lex and derives numbers. A g ood p rac tic e ap p roac h to review ing VB A mac ro c ode is as f ollow s. T he irst p art w understand the p urp ose of the VB A routine or mac ro. S ec ondly, you p erf orm a w alk throug h of the c o auditing ag ainst the doc umented p urp ose. T hirdly, the c ode should be annotated at every tw o or three lines by p lac ing an ap ostrop he at the end of the relevant line to rec ord your interp retation of the c ode as ap p rop riate. W here the ac tual log ic dif f ers f rom the doc umentation, c learly this w ill need investig ating . A nd inally, onc e the intentions and ac tual op erations are understood, test runs should be desig ned, the mac ro run and the results review ed by ref erenc e to the test data. T his is imp ortant bec ause the review of the mac ro’s c ode in isolation may not be c omp letely reliable, and so c ollaboration w ith test data p rovides additional assuranc e.

Exercise self-testing your corporate inance model

Now that you have f ollow ed this book f rom the start, you p robably have a version of a c orp orate inanc ial model to w hic h you w ill w ant to ap p ly some self tests and c hec k s and debug any f ound errors as ap p rop ri Undertak e the f ollow ing self - test p lan f or your c orp orate inanc e model: ● ● ● ● ● ● ●

undertak e an analytic al review of the statement f orec asts; undertak e a k ey outp uts review of the lenders’ c redit ratios and shareholders’ returns; ensure that eac h menu bar op erates as intended; ensure that eac h c hec k inc luded in the ‘Chec k s’ module is z ero; ensure that eac h of the c ross c hec k s built into the blue outp uts modules are eq ual to z ero; c olour c ode the inanc ial model using a c olour c oding tool, ensure adeq uate f ormula c op ying , and inp uts are only inc luded in the yellow modules; and undertak e a c oding review of k ey uniq ue f ormula, look ing f or any p otential p roblems, f or ex amp those that f orm the k ey outp uts or is p artic ularly c omp lex in nature.

Please ref erenc e the sec tions p roviding g uidanc e on review tec hniq ues throug hout this book .

Financial model audits – corporate inance models

Prior to the c lose of a c orp orate inanc e transac tion the p arties to the p roj ec t ( that is, shareholders and or lenders as the c ase may be) may req uire a f ull sc op e inanc ial model audit. Illustration 1 2 1 show s a typ ic al sp ec imen inanc ial model audit op inion letter f rom a p rof essional servic es irm. It is important to note that this section is based upon the view s of the author only and not those of any P rofessional S ervices irm . A typ ic al f ull sc op e f or a inanc ial model audit inc ludes the w ording ‘that w ithin the bounds of materiality that the model meets its obj ec tive’. T he obj ec tive f or a inanc ial model f or a leverag ed buyout is typ ic ally to p roduc e yearly p roit and loss ac c ounts, c ash low s and balanc e sheets, lenders’ ratios and shareholder returns over the lif e of the f orec ast. M ateriality is a c onc ep t adop ted in an audit that c onsiders w hether the errors inherent w ill g reatly c hang e the dec ision ( that is, w here there are lenders’ c redit 126

Sect ion 6 R eviewin g a n d a u d it in g corp orat e fin an ce m od els

ratios targ et of 1 . 2 0 ) , does a k now n error, g iven that w e are c alc ulating a result of 1 . 1 8 , c lending dec ision? In basic terms, a c orp orate inanc e model is not p erf ec t but should g ive materially ac c urate c alc ulations. Certain thing s c an be inc luded in the sc op e of the audit or ex c luded f rom the sc op e of the audit as the c ase may be. F irstly, the c omp lianc e of the ap p rop riate ac c ounting treatment c an be inc luded in or outside of the sc How ever, I need to ex p lain w hy it is imp ortant that the adop tion of the ap p rop riate ac c ounting treatm may be imp ortant to inc lude. W ell, ac c ounting treatment is w hat usually drives the tax ation and dividend distributions f or the c omp any or p roj ec t. T he sp ec iic ac c ounting treatment f or a c omp anyGc an A beAUK P, IF R S or the loc al ac c ounting trea ment dep ending up on the c irc umstanc es. O bviously, f rom, an eq uity p rovider’s p oint of view the ac c ounting and tax ation treatment is imp orta in resp ec t of their IR R . F rom a lender’s p oint of view ac c ounting treatment is also imp ortant as the le needs to saf eg uard ag ainst any p otential over distribution of dividends and p robably ensure that the dividend is only p aid af ter the rep ayment of their interest and p rinc ip al. O bviously, the tax ation c ash low w ill im up on the lenders ratios. T here is also the c onsideration of w hether the data book is inc luded w ithin the sc op e of the model audit. T his involves the review of the data book in the inanc ial model. T he book of assump tions outlines the p roj ec ts inp ut and log ic assump tions and of ten the basis f or the k ey outp uts. It is rec ommended th w here the data book is inc luded in the sc op e that it is c omp rehensively p rep ared in terms of the assump tio and material log ic . T he p roj ec t’s leg al ag reements c an be deined as w ithin the sc op e of the inanc ial model audit. He similar to the data book review , this involves the review of the various p roj ec t’s ag reements, suc h as the Credit A g reement, the Proj ec t A g reement. T hese are very leng thy doc uments and it is of ten rec ommended that sp ec iic sec tions are inc luded w ithin the sc op e as nec essary or c ritic al p arts inc luded in the data book . W e of ten see a sec tion on undoc umented assump tions in an op inion letter. T his relates to the assump tions or log ic in the inanc ial model that are not inc luded in the data book or leg al doc umentation.

Illustration 121 Specimen model audit opinion [Funder(s)] Address Street City Postcode

Date Our ref: xxxxxxxxx Project [Name]

[Sponsor(s)] Address Street City Postcode continued 127

Dear Sirs Financial Model Audit: The project (the “Project”) 1 Introduction This report (the “Report”) is addressed to the funder(s) (the “Funder(s)”) and the sponsor(s) (the “Sponsor(s)”), (together the “Client”, the “Addressee” or “you”), and its contents will be solely for your use and may not be disclosed to any other parties except in accordance with the terms of our engagement and as noted in this Report. In accordance with the scope of professional services, as detailed in Appendix A of our engagement letter (“Engagement Letter”) dated [the date], we have completed a review of the Project’s inancial model (the “Model”) that was prepared using Excel spreadsheets. 1.1 Models Following initial review of the Model, an updated version relecting agreed changes to the Model was reviewed. The inal version of the Model (the “Final Model”) was updated for inputs at inancial close (the “Financial Close Model”). The Financial Close Model, on which our Report is based, is identiied below: Description Initial Model Final Model Financial Close Model

File name [File Name] [File Name] [If applicable]

File size (kb) x,xxx x,xxx x,xxx

Date and time [Date and Time] [Date and Time] [Date and Time]

1.2 Documentation We were provided with the following of the Project’s inancing documentation in the course of our work: Description Credit Agreement Project Agreement Payment Mechanism

File name [File Name] [File Name] [File Name]

File size (kb) x,xxx x,xxx x,xxx

Date and time [Date and Time] [Date and Time] [Date and Time]

2 Model Audit Objectives The objective of the model audit was to assist you in conirming, within the bounds of materiality: a b c d e

that the calculations in the model are arithmetically correct and that the results are materially reliable, accurate, complete and consistent with the assumptions contained in the model; that the credit ratios are calculated correctly and in line with the deinitions from the credit agreement; that the accounting treatments and assumptions applied within the Model are consistent with current [LOCAL] GAAP [or IFRS] and with key provisions of the Project’s inancing documentation as provided; that the tax assumptions applied within the Model are consistent with current [LOCAL] tax legislation and with key provisions of the Project’s inancing documentation as provided; that any unexplained trends or variations in key inancial and banking indicators in Model outputs are identiied through analytical review;

continued

f

g h

that any unexplained inconsistent or unintuitive cash-low trends (including revenues, costs, taxes, depreciation) or variations in key inancial indicators based on the inputs and the Project’s commercial structure are identiied through analytical review of Model outputs; that the results produced from changes to underlying assumptions accurately and completely relect the potential impact of those changes; and [For operational model audits] that the model is consistent is with latest statutory and management accounts.

3 Findings Based on our review of the Models we raised issues for all exceptions that came to our attention with regards to the objectives set out above and discussed these issues with you. We note the following matters: ➢ [Matters that require documenting in the report]. A summary of the undocumented assumptions noted and representations received during the review are included in Appendix A. A full list of issues raised during the course of our review is available upon request as an Annex to this report. It should be noted that: ➢ it is not practicable to test a computer model to an extent whereby it can be guaranteed that all errors have been detected and, accordingly, we can only give assurance on the Model within the bounds of materiality and for deined scenarios; ➢ our work did not include any work in the nature of a inancial audit and we did not verify any of the assets or liabilities of the companies involved in the Project; and ➢ we make no comment on the validity of the assumptions, and express no opinion as to how closely the results actually achieved will compare with the Model’s projections. 4 Conclusion On the basis of the work performed [subject to the matters noted in paragraph 1], the model audit objectives referred to in paragraph 2 have been met. 5 Distribution Unless expressly agreed the reports are intended for exclusive use by you unless speciied in the terms of our engagement. Yours faithfully,

[Signatory]

For and on behalf of xxxxxxxxx xxxxxxxxxx xxxxxxx

continued

Corp orat e F in an ce Mod ellin g a n d A n alysis

Appendix A: Undocumented assumptions and representations We note the following undocumented assumptions and representations received: ➢ [Note undocumented assumptions and representations received]. Source: Modelling Solutions

I w ill assume that most lenders and shareholders w ill only c are that they g et an op inion letter to their req uired sc op e in resp ec t to their c orp orate inanc e p roj ec t. How ever, there w ill be others among st us w w ill really w ant to k now how ex ac tly does a inanc ial model auditor f orm the op inion suc h as that outlined in illustration 1 2 1 . W hat typ e of w ork are they c arrying out to g et here? B ased up on my k now ledg e and ex p erie inanc ial model audits, the f ollow ing typ e of ap p roac h is typ ic ally tak en. ●

130

Scoping. W hen a p rof essional irm rec eives a inanc ial model f rom a bank or a sp onsor f or c orp orate inanc e transac tion c lose it w ill have to g o throug h a sc op ing ex erc ise. T his typ ic ally involves a re tively q uic k insp ec tion of the inanc ial model. T he sc op ing insp ec tion w ill involve a hig h level look the model very similar to a shorter version of an ‘A nalytic al R eview ’. A review of the model’s desig n may also be undertak en w hic h may be similar to the ‘desig n review ’ outlined in the sec tion above. I w ould also ex p ec t that the model auditor runs his sp readsheet audit sof tw are ( S Prof p readsheet essional, O A K and so on) w hic h w ill help to identif y the model’s f ormula siz e and c omp lex ity amon other thing s. B ased up on the inanc ial c lose model that w e have built I w ill tak e you throug h a typ ic al inanc ial model auditor’s sc op ing ex erc ise w ith ref erenc e to some outp uts g enerated by the S p readsheet Prof essional sp readsheet audit add in and the use of my in- house built c olour c oding tool. # F ormula c omp lex ity is a k ey area w hen c onsidering the siz e of a model audit task f ac ing a mode auditor. It is p retty obvious that the more c omp lex a f ormula the long er it w ill tak e to understand. T he rec ommended ap p roac h f or this task is to use a similar tool suc h as S p readsheet Prof essional to p rovide a listing of the entire inanc ial model’s uniq ue f ormula on a sheet by sheet basis and mak e an assessment of the averag e deg ree of f ormula c omp lex ity f or eac h w ork sheet. A n ex am is show n in Illustration 1 2 2 of suc h a f ormula listing obtained f rom the S p readsheet Prof essional sof tw are. B ased up on the typ e of outp ut in Illustration 1 2 2 w e c an very q uic k ly assess c omp lex ity of eac h w ork sheet.

Illustration 1 2 2 Formula complexity Ref

Label

Calculation

Result

=NOW() B1

EQUITY RETURNS AND LENDERS RATIOS

=NOW()

22/03/2011 15:12

=NOW() =YEAR(C3) C1

EQUITY RETURNS AND LENDERS RATIOS

=YEAR(Period Ending)

2011

=YEAR(31/12/2011) =IF(Project_Name="","",Project_Name) A2

undeined

=IF(Project_Name="","",Project_Name)

COMPANY A

=IF(Project_Name="","",Project_Name) =EOMONTH(C3,-12) B3

Period Ending

=EOMONTH(Period Ending,-12)

31/12/2010

=EOMONTH(31/12/2011,-12) =EOMONTH(Model_Start_Date,11) C3

Period Ending

=EOMONTH(Model_Start_Date,11)

31/12/2011

=EOMONTH(Model_Start_Date,11) =EOMONTH(C3,12) D3

Period Ending

=EOMONTH(Period Ending,12)

31/12/2012

=EOMONTH(31/12/2011,12) ='Balance Sheet'!A22 A10

undeined

=Senior Debt

Senior Debt

=Senior Debt =SUM('Balance Sheet'!B22:L22)-SUM(B10:L10) M10

undeined

=SUM(Senior Debt:Senior Debt)-SUM(undeined:undeined)

0

=SUM(12.1:0.0)-SUM(12.1:0.0) ='Balance Sheet'!B22 B13

Senior Debt

=Senior Debt

12.1

=12.1

continued

=SUM('Balance Sheet'!B22:L22)-SUM(B13:L13) M13

Senior Debt

=SUM(Senior Debt:Senior Debt)-SUM(Senior Debt :Senior Debt )

0

=SUM(12.1:0.0)-SUM(12.1:0.0) ='Balance Sheet'!B28 B14

Equity

=Equity

16.8

=16.8 =SUM('Balance Sheet'!B28:L28)-SUM(B14:L14) M14

Equity

=SUM(Equity:Equity)-SUM(Equity:Equity)

0

=SUM(16.8:21.8)-SUM(16.8:21.8) ='Balance Sheet'!B21 B15

Shareholder Loan

=Shareholder Loan

8.1

=8.1 =SUM(B13:B15) B16

Total Debt & Equity =SUM(Senior Debt :Shareholder Loan)

37

=SUM(12.1:8.1) =IF(ROUND(B10,0)=0,"N/A",B10/B16) B18

Debt to Equity Ratio

=IF(ROUND(undeined,0)=0,"N/A",undeined/Total Debt & Equity)

0.327027027

=IF(ROUND(12.1,0)=0,"N/A”",12.1/37.0) =MAX(B18:L18) B19

Debt to Equity Ratio Maximum

=MAX(Debt to Equity Ratio:Debt to Equity Ratio)

0.327027027

=MAX(32.7%:N/A) =INDEX($B$3:$L$3,MATCH(Debt_to_Equity_Ratio_ Maximum,$B$18:$L$18,0)) B20

Debt To Equity Maximum Date

=INDEX(Period Ending:Period Ending,MATCH(Debt to Equity Ratio Maximum,Debt to Equity Ratio:Debt to Equity Ratio,0))

31/12/2010

=INDEX(31/12/2010:31/12/2020,MATCH(32.7%,32.7%:N/A,0)) =AVERAGE(B18:L18) B21

Debt To Equity Average

=AVERAGE(Debt to Equity Ratio:Debt to Equity Ratio)

0.247994363

=AVERAGE(32.7%:N/A) =Cashlow!C13 C25

undeined

=undeined

8.918432555

=8.9 =SUM(Cashlow!C13:L13)-SUM(C25:L25) M25

undeined

=SUM(undeined:undeined)-SUM(undeined:undeined)

0

=SUM(8.9:23.5)-SUM(8.9:23.5) continued

=SUM(B24:B25) B26

Free Cash Flow

=SUM(undeined:undeined)

0

=SUM(undeined:undeined) ='Balance Sheet'!C22 C29

Senior Debt

=Senior Debt

12.72138114

=12.7 =SUM('Balance Sheet'!C22:L22)-SUM(C29:L29) M29

Senior Debt

=SUM(Senior Debt:Senior Debt)-SUM(Senior Debt :Senior Debt )

0

=SUM(12.7:0.0)-SUM(12.7:0.0) =SUM(B29:B29) B30

Total Debt

=SUM(Senior Debt )

0

=SUM(undeined) =IF(ROUND(B30,0)=0,"N/A",B26/B30) B32

Free Cashlow to Debt Ratio

=IF(ROUND(Total Debt ,0)=0,"N/A",Free Cash Flow/Total Debt )

N/A

=IF(ROUND(0.0,0)=0,"N/A",0.0/0.0) =MIN(B32:L32) B33

Free Cashlow to Debt Ratio Minimum

=MIN(Free Cashlow to Debt Ratio:Free Cashlow to Debt Ratio)

0.701058514

=MIN(N/A:N/A) =INDEX($B$3:$L$3,MATCH(Free_Cashlow_to_Debt_Ratio_ Minimum,$B$32:$L$32,0)) B34

Free Cashlow to Debt Ratio Minimum Date

=INDEX(Period Ending:Period Ending,MATCH(Free Cashlow to Debt Ratio Minimum,Free Cashlow to Debt Ratio:Free Cashlow to Debt Ratio,0))

31/12/2011

=INDEX(31/12/2010:31/12/2020,MATCH(70.1%,N/A:N/A,0)) =AVERAGE(B32:L32) B35

Free Cashlow to =AVERAGE(Free Cashlow to Debt Ratio:Free Cashlow to Debt Ratio) Debt Ratio Average

3.638155197

=AVERAGE(N/A:N/A) ='Balance Sheet'!C22 C40

Senior Debt

=Senior Debt

12.72138114

=12.7 =SUM('Balance Sheet'!C22:L22)-SUM(C40:L40) M40

Senior Debt

=SUM(Senior Debt:Senior Debt)-SUM(Senior Debt :Senior Debt )

0

=SUM(12.7:0.0)-SUM(12.7:0.0) continued

=SUM(C39:C40) C41

Total Debt

=SUM(undeined:Senior Debt )

12.72138114

=SUM(undeined:12.7) ='Proit & Loss'!C10 C44

EBITDA

=EBITDA

29.5

=29.5 =SUM('Proit & Loss'!C10:L10)-SUM(C44:L44) M44

EBITDA

=SUM(EBITDA:EBITDA)-SUM(EBITDA:EBITDA)

0

=SUM(29.5:29.1)-SUM(29.5:29.1) =SUM(C44:C44) C45

EBITDA

=SUM(EBITDA)

29.5

=SUM(29.5) =IF(ROUND(C41,0)=0,"N/A",C41/C45) C47

Debt to EBITDA Ratio

=IF(ROUND(Total Debt,0)=0,"N/A",Total Debt/EBITDA)

0.431233259

=IF(ROUND(12.7,0)=0,"N/A",12.7/29.5) =MAX(B47:L47) B48

Debt to EBITDA Ratio Maximum

=MAX(Debt to EBITDA Ratio:Debt to EBITDA Ratio)

0.431233259

=MAX(undeined:N/A) =INDEX($B$3:$L$3,MATCH(B48,$B$47:$L$47,0)) B49

Debt to EBITDA Ratio Minimum Date

=INDEX(Period Ending:Period Ending,MATCH(Debt to EBITDA Ratio Maximum,Debt to EBITDA Ratio:Debt to EBITDA Ratio,0))

31/12/2011

=INDEX(31/12/2010:31/12/2020,MATCH(43.1%,undeined:N/A,0)) =AVERAGE(B47:L47) B50

Debt to EBITDA Average

=AVERAGE(Debt to EBITDA Ratio:Debt to EBITDA Ratio)

0.269671124

=AVERAGE(undeined:N/A) ='Balance Sheet'!B22 B54

Senior Debt

=Senior Debt

12.1

=12.1 =SUM('Balance Sheet'!C22:L22)-SUM(C54:L54) M54

Senior Debt

=SUM(Senior Debt:Senior Debt)-SUM(Senior Debt :Senior Debt )

0

=SUM(12.7:0.0)-SUM(12.7:0.0) =SUM(B53:B54) B55

Total Debt

=SUM(undeined:Senior Debt )

12.1

=SUM(undeined:12.1) continued

='Balance Sheet'!B24 B58

Net Assets

=Net Assets

16.8

=16.8 =SUM('Balance Sheet'!C24:L24)-SUM(C58:L58) M58

Net Assets

=SUM(Net Assets:Net Assets)-SUM(Net Assets:Net Assets)

0

=SUM(39.4:95.0)-SUM(39.4:95.0) =SUM(B58:B58) B59

Net Assets

=SUM(Net Assets)

16.8

=SUM(16.8) =IF(ROUND(B55,0)=0,"N/A",B55/B59) B61

Debt to Net Assets Ratio

=IF(ROUND(Total Debt,0)=0,"N/A",Total Debt/Net Assets)

0.720238095

=IF(ROUND(12.1,0)=0,"N/A",12.1/16.8) =MAX(B61:L61) B62

Debt to Net Assets Ratio Maximum

=MAX(Debt to Net Assets Ratio:Debt to Net Assets Ratio)

0.720238095

=MAX(72.0%:N/A) =INDEX($B$3:$L$3,MATCH(Debt_to_Net_Assets_Ratio_ Maximum,$B$61:$L$61,0)) B63

Debt to Net Assets Ratio Maximum Date

=INDEX(Period Ending:Period Ending,MATCH(Debt to Net Assets Ratio Maximum,Debt to Net Assets Ratio:Debt to Net Assets Ratio,0))

31/12/2010

=INDEX(31/12/2010:31/12/2020,MATCH(72.0%,72.0%:N/A,0)) =AVERAGE(B61:L61) B64

Debt to Net Assets Average

=AVERAGE(Debt to Net Assets Ratio:Debt to Net Assets Ratio)

0.277054871

=AVERAGE(72.0%:N/A) ='Proit & Loss'!C13 C68

EBIT

=EBIT

26.68562364

=26.7 =SUM('Proit & Loss'!C13:L13)-SUM(C68:L68) M68

EBIT

=SUM(EBIT:EBIT)-SUM(EBIT:EBIT)

0

=SUM(26.7:26.3)-SUM(26.7:26.3) =SUM(B68:B69) B70

EBIT

=SUM(EBIT:Cash Interest / (Expense))

0

=SUM(undeined:undeined) continued

='Proit & Loss'!C16 C73

Interest - Senior Debt

=Interest - Senior Debt

0.945058267

=0.9 =SUM('Proit & Loss'!C16:L16)-SUM(C73:L73) M73

Interest - Senior Debt

=SUM(Interest - Senior Debt:Interest - Senior Debt)-SUM(Interest Senior Debt:Interest - Senior Debt)

0

=SUM(0.9:0.0)-SUM(0.9:0.0) =SUM(B73:B73) B74

undeined

=SUM(Interest - Senior Debt)

0

=SUM(undeined) =IF(ROUND(B73,1)=0,"N/A",B70/B74) B76

Interest Cover Ratio

=IF(ROUND(Interest - Senior Debt,1)=0,"N/A",EBIT/undeined)

N/A

=IF(ROUND(undeined,1)=0,"N/A",0.0/0.0) =MIN(B76:L76) B77

Interest Cover Ratio Minimum

=MIN(Interest Cover Ratio:Interest Cover Ratio)

28.56024364

=MIN(N/A:N/A) =INDEX($B$3:$L$3,MATCH(Interest_Cover_Ratio_ Minimum,$B$76:$L$76,0)) B78

Interest Cover Ratio Minimum Date

=INDEX(Period Ending:Period Ending,MATCH(Interest Cover Ratio Minimum,Interest Cover Ratio:Interest Cover Ratio,0))

31/12/2011

=INDEX(31/12/2010:31/12/2020,MATCH(28.6,N/A:N/A,0)) =AVERAGE(B76:L76) B79

Interest Cover Ratio Average

=AVERAGE(Interest Cover Ratio:Interest Cover Ratio)

59.12358685

=AVERAGE(N/A:N/A) =B86*(1+Inlation_Per_Annum) C86

General Inlation Index

=General Inlation Index*(1+Inlation_Per_Annum)

1.025

=1.000*(1+Inlation_Per_Annum) =-Cashlow!C19 C88

Equity Drawn

=-Equity Drawn

-5

=-5.0 =SUM(Cashlow!C19:L19)+SUM(C88:L88) M88

Equity Drawn

=SUM(Equity Drawn:Equity Drawn)+SUM(Equity Drawn :Equity Drawn )

0

=SUM(5.0:0.0)+SUM(-5.0:0.0) continued

=-Cashlow!C27 C90

Dividends Paid

=-Dividends Paid

0

=-0.0 =SUM(Cashlow!C27:L27)+SUM(C90:L90) M90

Dividends Paid

=SUM(Dividends Paid:Dividends Paid)+SUM(Dividends Paid :Dividends Paid )

0

=SUM(0.0:-18.3)+SUM(0.0:18.3) =-Cashlow!C17 C92

Subordinated Debt Total - Drawn

=-Shareholders Loan Drawn

1.198273573

=--1.2 =SUM(C92:L92)+SUM(Cashlow!C17:L17) M92

Subordinated Debt Total - Drawn

=SUM(Subordinated Debt Total - Drawn:Subordinated Debt Total Drawn)+SUM(Shareholders Loan Drawn:Shareholders Loan Drawn)

0

=SUM(1.2:0.0)+SUM(-1.2:0.0) =-Cashlow!C20 C93

Subordinated Debt Total - Repayment

=-Shareholders Loan Principal

1.380345285

=--1.4 =SUM(Cashlow!C20:L20)+SUM(C93:L93) M93

Subordinated Debt Total - Repayment

=SUM(Shareholders Loan Principal:Shareholders Loan Principal)+SUM(Subordinated Debt Total – Repayment:Subordinated Debt Total - Repayment)

0

=SUM(-1.4:0.0)+SUM(1.4:0.0) =-Cashlow!C22 C94

Subordinated Debt Total - Interest

=-Shareholders Loan - Interest

1.125129482

=--1.1 =SUM(C94:L94)+SUM(Cashlow!C22:L22) M94

Subordinated Debt Total - Interest

=SUM(Subordinated Debt Total - Interest:Subordinated Debt Total - Interest)+SUM(Shareholders Loan - Interest:Shareholders Loan Interest)

0

=SUM(1.1:0.0)+SUM(-1.1:0.0) =-Cashlow!C24 C95

Subordinated Debt Total - Fees Paid

=-Shareholders Loan - Fees

-0.017974104

=-0.0 continued

=SUM(C95:L95)+SUM(Cashlow!C24:L24) M95

Subordinated Debt Total - Fees Paid

=SUM(Subordinated Debt Total - Fees Paid:Subordinated Debt Total - Fees Paid)+SUM(Shareholders Loan - Fees:Shareholders Loan Fees)

0

=SUM(0.0:0.0)+SUM(0.0:0.0) =SUM(C92:C95) C96

Net Shareholders Loan Cashlow

=SUM(Subordinated Debt Total - Drawn:Subordinated Debt Total Fees Paid)

3.685774237

=SUM(1.2:0.0) =IF(ISERROR(IRR(C100:L100,0.1)),0,IRR(C100:L100,0.1)) B100

Equity IRR Nominal

=IF(ISERROR(IRR(Equity IRR - Nominal:Equity IRR - Nominal,0.1)), 0,IRR(Equity IRR - Nominal:Equity IRR - Nominal,0.1))

1.688836976

=IF(ISERROR(IRR(-5.0:18.3,0.1)),0,IRR(-5.0:18.3,0.1)) =C88+C90 C100

Equity IRR Nominal

=Equity Drawn +Dividends Paid

-5

=-5.0+0.0 =IF(ISERROR(IRR(C102:L102,0.1)),0,IRR(C102:L102,0.1)) B102

Equity IRR - Real

=IF(ISERROR(IRR(Equity IRR - Real:Equity IRR - Real,0.1)),0,IRR(Equity IRR - Real:Equity IRR - Real,0.1))

1.623255587

=IF(ISERROR(IRR(-4.9:14.3,0.1)),0,IRR(-4.9:14.3,0.1)) =C100/C86 C102

Equity IRR - Real

=Equity IRR - Nominal/General Inlation Index

-4.87804878

=-5.0/1.025 =IF(ISERROR(IRR(C104:L104,0.1)),0,IRR(C104:L104,0.1)) B104

Equity & Sub Debt IRR - Nominal

=IF(ISERROR(IRR(Equity & Sub Debt IRR - Nominal:Equity & Sub Debt IRR - Nominal,0.1)),0,IRR(Equity & Sub Debt IRR - Nominal:Equity & Sub Debt IRR - Nominal,0.1))

7.348401049

=IF(ISERROR(IRR(-1.3:18.3,0.1)),0,IRR(-1.3:18.3,0.1)) =C88+C90+C96 C104

Equity & Sub Debt IRR - Nominal

=Equity Drawn +Dividends Paid +Net Shareholders Loan Cashlow

-1.314225763

=-5.0+0.0+3.7 =IF(ISERROR(IRR(C106:L106,0.1)),0,IRR(C106:L106,0.1)) B106

Equity & Sub Debt IRR - Real

=IF(ISERROR(IRR(Equity & Sub Debt IRR - Real:Equity & Sub Debt IRR - Real,0.1)),0,IRR(Equity & Sub Debt IRR - Real:Equity & Sub Debt IRR - Real,0.1))

7.144781512

=IF(ISERROR(IRR(-1.3:14.3,0.1)),0,IRR(-1.3:14.3,0.1)) continued

Sect ion 6 R eviewin g a n d a u d it in g corp orat e fin an ce m od els

=C104/C86 C106

Equity & Sub Debt IRR - Real

=Equity & Sub Debt IRR - Nominal/General Inlation Index

-1.282171477

=-1.3/1.025 S ource: S p readsheet Prof essional S of tw are

#

T henumber of uniq ue f ormula is a k ey area w hen c onsidering the siz e of a model audit task f ac ing a model auditor. It Is p retty obvious that the more f ormulae that a model has the long er it w ill tak e to understand. A uniq ue f ormula c an be deined as an Ex c el f ormula that w hen c op ac ross the c olumns and dow n the row s w hic h have identic al log ic that holds. In terms of the nee to understand the inanc ial model, other thing s being eq ual, the more uniq ue f ormula a model has the long er it w ill tak e to understand. T he rec ommended ap p roac h f or this task is use a similar too suc h as S p readsheet Prof essional to p rovide a c ount of all the inanc ial model’s uniq ue f ormula on a sheet by sheet basis, see Illustration 1 2 3 . You c an see f rom the rep ort that althoug h the sp ec iic w ork sheet has 46 8 f ormula only 8 0 are uniq ue.

Illustration 123 Unique formula count Summary statistics Range analysed Number of numeric inputs Number of formulas Number of unique formulas

A1:M106 1 468 80

Unique cells are those that are not copies of the cell to the left or above. Percentage of unique formulas Number of labels

17% 98

Potential errors summary Possible error condition

Frequency

No precedents

1

Blank cells referenced

3

Forward row reference

8

Forward column reference

2

IF function

10 continued 139

Numeric rule

18

Complex calculation

9

Date reference

4

Two digit integer reference

1

Protection not enabled. This sheet is not protected. Users can overwrite the contents of any cell even if the cell is locked. Test notes. Only unique cells have been tested. Remember to check cells that are a copy of the cells shown on this report. Individual cells within range references not tested. No precedents This formula does not depend on any other cells. Usually this implies that an input has been entered as a combination of values. Potential errors to watch for: 1. Unless the individual values that make up the input are documented then it will be impossible to subsequently understand how the results were derived. B1 Blank cells referenced The following calculations reference a blank cell. Potential errors to watch for: 1. An input value has not been entered. 2. The calculation contains an incorrect reference. 3. There may be no error at present but users may subsequently enter values or formulas into the blank cells causing inconsistent results. B30, B74, B76 Forward row reference The following calculations refer to a row after the row in which they are situated. Potential errors to watch for: 1. Well written spreadsheets should be read from top to bottom like a book. Forward references often indicate a late additional piece of code which has been inadequately checked. 2. The calculation contains an incorrect reference. C1, A2, C3, A10, B13:B15, C86 continued

Forward column reference The calculation refers to a column to the right of the column in which it is situated. Potential errors to watch for: 1. Well written spreadsheets should be read from left to right like a book. Forward references often indicate a late additional piece of code which has been inadequately checked. 2. The calculation contains an incorrect reference. A2, B3 IF function The following calculations contain an IF statement. Potential errors to watch for: 1. The calculation used is dependent on the input values to the spreadsheet therefore these cells must be checked particularly carefully. A2, B18, B32, C47, B61, B76, B100, B102, B104, B106 Numeric rule The following calculations contain a number. This is the most common cause of errors within a spreadsheet. Potential errors to watch for: 1. A number has been added to the calculation as a ‘quick ix’ and not been subsequently removed. 2. A number has been used within the calculation even though it is also input elsewhere on the spreadsheet. Changing the input then has no effect. 3. The number is being used to convert from one set of units to another (000s to millions and so on). This is often performed incorrectly. B3:D3, B18, B20, B32, B34, C47, B49, B61, B63, B76, B78, C86, B100, B102 B104, B106 Complex calculation This calculation is particularly complex and therefore likely to contain errors. Potential errors to watch for: 1. Errors can be of all types. B18, B32, C47, B61, B76, B100, B102, B104, B106 Date reference This calculation references a date. Potential errors to watch for: 1. This calculation may not work over the year 2000. Check formula. C1, B3:D3 continued

Corp orat e F in an ce Mod ellin g a n d A n alysis

Two digit integer reference This calculation references a two digit integer. It may be a date. Potential errors to watch for: 1. If this two digit integer is a date, there is a high probability that the formula may not work past the year 2000. B18 Source: Spreadsheet Professional Software

List worksheets. It is also normal to g et a listing of the sheets by name so you c an c ollate the sc op ing on a sheet by sheet basis. T he rec ommended ap p roac h f or this task is to use a similar tool suc h as S p readsheet Prof essional to p rovide a sheet listing , see Illustration 1 2 4.

●

Illustration 124 Worksheet listing Filename

FinancialCloseModelExample.xls

Filename

CorporateFinanceTemplateModelV8.xls

Last modiied at

22/03/2011 15:10:21

Author

DWhittaker

Title Subject Comments Instructions for use

List of sheets Worksheet name

Description

Cover Version Control Change Control User & Technical Guide continued 142

Sect ion 6 R eviewin g a n d a u d it in g corp orat e fin an ce m od els

General Inputs Sales - Costs - Accounting Financing & W.Capital Taxation Equity Returns & Lenders Ratios Proit & Loss Cash low Balance Sheet Summary Checks Source: Spreadsheet Professional Software

●

●

V B A macros. T he auditor w ould review the siz e, c omp lex ity and g eneral nature of any mac ros or VB c ode inc luded in the inanc ial model. T hose of p artic ular interest w ill be those that drive the numbers and not those that c hang e the model’s p resentation, unless of c ourse the c lient has a p artic ular need to p lac e emp hasis up on p resentational mac ros. T he auditor w ill then disc uss the sc op e of w ork and the typ e of op inion ideally req uired w it lender and or the eq uity p roviders. Work plan. B ased up on the req uired sc op e f or the inanc ial model audit the auditor w ill p rep are a w o p lan. T he w ork w ill relec t the hours req uired f or eac h ac tivity and the staf f alloc ated to the task s p lan and the resourc es req uired to deliver this w ill obviously be tied in to the overall deliverables of the op inion letter. T he rec ommended ap p roac h f or p rep aring a w ork p lan f or a inanc ial model audit is show Illustration 1 2 5.

Illustration 1 2 5 Financial model audit work plan Filename

CorporateFinanceTemplateModelV8.xls

Last modiied at

22/03/2011 15:10:21

Author

DWhittaker

Title

Formula Complexity

Subject

Low

Comments

Medium

1.5

High

2.0

Mins / UF 1.0

continued 143

Corp orat e F in an ce Mod ellin g a n d A n alysis

Instructions for use Average

Mins Per

No Of Unique Formula

Complexity

UF

Hours

Cover

0

Low

1.0

0.0

Version Control

1

Low

1.0

0.0

Change Control

1

Low

1.0

0.0

User & Technical Guide

0

Low

1.0

0.0

General Inputs

31

Low

1.0

0.5

Sales-Costs-Accounting

54

Medium

1.5

1.4

Financing & W.Capital

83

Medium

1.5

2.1

Taxation

139

Medium

1.5

3.5

Equity Returns & Lenders Ratios

80

Medium

1.5

2.0

Worksheet name

Proit & Loss

25

Medium

1.5

0.6

Cash low

24

Medium

1.5

0.6

Balance Sheet

37

Medium

1.5

0.9

Summary

38

Medium

1.5

1.0

Checks

9

Medium

1.5

0.2

Total Coding Review

12.8

Analytical Review

No Of Sensitivities

Sensitivity Review

5

7.0 3

Hours Each

15.0

Databook & Legal Agreements

25.0

Tax Review

7.0

Accounting Review

7.0

Senior Review

14.0

Partner Review

7.0

Total Planned Man Hours

94.8

S ource: M odelling S olutions

W e c an see in Illustration 1 2 5 the inf ormation draw n out f rom the sc op e req uired f rom the disc ussion w ith the sp onsor or the lenders and the insp ec tion of the inanc ial model p rovided f or sc op ing p urp oses that w e have been able to w ork out the number of man hours req uired to c omp lete the inanc ial model audit task . In this p artic ular c ase a f air amount of the 9 5 man hours are sp ent on the c oding review w hic h has been c alc ulated by tak ing into ac c ount the siz e and c omp lex ity of the inanc ial mod M ore sp ec iic ally, w e have tak en ac c ount of the number of uniq ue f ormulae, the c omp lex ity of th

144

Sect ion 6 R eviewin g a n d a u d it in g corp orat e fin an ce m od els

●

and using a number of minutes p er uniq ue f ormula c omp uted the man hours f or the c oding review . Yo w ill also notic e that the man hours to c omp lete the other task s have also been estimated. T hese inc lude the review of the data book and leg al ag reements, tax and ac c ounting , sensitivity review and othe senior review time. T he above p lan w ill typ ic ally be used to alloc ate the g rade and sp ec ialism to th model audit p roj ec t g iven the ag reed timesc ales and f or g eneral p roj ec t manag ement p urp oses. It also be used as a basis f or setting the f ee q uote w ith the c lient. A n elec tronic ex amp le is show n in Illustration 1 2 6 ( see Illustration1 2 6 . x ls) . C oding review . A c oding review is the p roc ess of review ing every uniq ue f ormula in terms of underlying log ic . You c an either use the map s or the c olour c oding of the model derived by sp readsheet audit sof tw are. A sec tion of the inanc ial c lose model is show n in Illustration 1 2 7 .

Illustration 1 2 7 Coding review 22/03/2011 15:24

2011

Year Ending :-

Year Ending :-

31 December 2010

31 December 2011

Actual

Forecast

£s Millions

£s Millions

12.1

12.7

Senior Debt

12.1

12.7

Equity

16.8

21.8

Shareholder Loan

8.1

5.5

Total Debt & Equity

37.0

40.0

Debt to Equity Ratio

32.7%

31.8%

Debt to Equity Ratio Maximum

32.7%

Debt to Equity Maximum Date

31 December 2010

EQUITY RETURNS AND LENDERS RATIOS COMPANY A Period Ending

LENDERS RATIOS Debt to Equity Ratio

Senior Debt Total Debt & Equity

Debt to Equity Average

24.8% continued 145

Free Cash low to Debt 8.9 Free Cash Flow

0.0

8.9

Total Debt Senior Debt

12.7

Total Debt

0.0

12.7

Free Cash low to Debt Ratio

N/A

70.1%

Free Cash low to Debt Ratio Minimum Free Cash low to Debt Ratio Minimum Date Free Cash low to Debt Ratio Average

70.1% 31 December 2011 363.8%

Debt To EBITDA Senior Debt

12.7

Total Debt

12.7

EBITDA

29.5

EBITDA

29.5

Debt to EBITDA Ratio Debt to EBITDA Ratio Maximum Debt to EBITDA Ratio Minimum Date Debt to EBITDA Average

43.1% 43.1% 31 December 2011 27.0%

Debt to Net Assets Senior Debt

12.1

12.7

Total Debt

12.1

12.7

Net Assets

16.8

39.4

Net Assets

16.8

39.4 continued

Debt to Net Assets Ratio

72.0%

Debt to Net Assets Ratio Maximum

72.0%

Debt to Net Assets Ratio Maximum Date Debt to Net Assets Average

32.3%

31 December 2010 27.7%

Interest Cover EBIT

26.7

Cash Interest / (Expense)

0.3

EBIT

0.0

Interest - Senior Debt

27.0

0.9 0.0

0.9

Interest Cover Ratio

N/A

28.6

Interest Cover Ratio Minimum

28.6

Interest Cover Ratio Minimum Date Interest Cover Ratio Average

31 December 2011 59.1

SHAREHOLDERS RETURNS Equity Cash lows General Inlation Index

1.000

1.025

Equity Drawn

-5.0

Dividends Paid

0.0

Subordinated Debt Total – Drawn

1.2

Subordinated Debt Total – Repayment

1.4

Subordinated Debt Total – Interest

1.1

Subordinated Debt Total – Fees Paid

0.0

Net Shareholders Loan Cash low

3.7 continued

Corp orat e F in an ce Mod ellin g a n d A n alysis

Equity Returns Equity IRR - Nominal

168.88%

-5.0

Equity IRR - Real

162.33%

-4.9

Equity & Sub Debt IRR – Nominal

734.84%

-1.3

Equity & Sub Debt IRR – Real

714.48%

-1.3

S ource: M odelling S olutions

●

●

●

●

●

148

T he ex trac t f rom the inanc ial model above show s eac h uniq ue f ormula in dark g rey. Eac h dark g rey f ormula w ould have to be insp ec ted. T he c olour c oding show s a uniq ue f ormula as a dark g r c ell and c op y dow n or ac ross of the uniq ue f ormula is a lig hter shade of g rey. M id g rey c ells are labe and lig htest g rey is an inp ut or hard c oded c ell. In g eneral dif f erent p rop rietary tools w ill have a dif f erent c olour c ode k ey but the p rinc ip al of the uniq ue f ormula should remain the same reg ardless of the tool used. Analytical review. T he p roc ess f or an analytic al review has been outlined in S ec tion 1 . A relatively senior member of the team w ill undertak e the analytic al review , p ossibly mak ing the other members of the team aw are of areas that look unreasonable and that may req uire f urther attention. . T he p roc ess f or review ing the data book or leg al doc umentation Data b ook and legal documentation in the inal model is to c ross ref erenc e eac h of the sp ec iic doc umentation sec tions in terms of w here the tex t c an be f ound in the inanc ial model ( that is, R ang e B 4 to C6 F unding sheet) . W here areas of t doc umentation c an be q uantiied and the inanc ial model does not c omp ly w ith or is not relec ted in the inanc ial model an issue or c omment should be log g ed and raised w ith the inanc ial modeller. Tax. A tax sp ec ialist f rom the p rof essional irm w ill review the tax treatment in the model ag ainst the treatment f or the req uired model audit. F or ex amp le, does the c orp oration tax and value added tax treatment materially c omp ly w ith UK tax treatment? Comments or issues w ill be raised by the tax sp ec ialist g iven c lear g uidanc e of the nature of the inanc ial models c alc ulations outlined to them by a member of the inanc ial model audit team. Accounting. A n ac c ounting sp ec ialist f rom the p rof essional irm w ill review the ac c ounting treatme in the model ag ainst the treatment f or the req uired model audit. F or ex amp le, does the ac c ounting treatment materially c omp ly w ith UK G A A P, IF R S , or loc al ac c ounting treatment? Comments or issues w ill be raised by the ac c ounting sp ec ialist g iven c lear g uidanc e of the nature of the inanc ial models c alc ulations outlined to them by a member of the inanc ial model audit team. comments . R eview c omments w ill be p rovided to the modeller by the inanc ial model R view e audit team.

Sect ion 6 R eviewin g a n d a u d it in g corp orat e fin an ce m od els

●

●

●

●

I terations and b ase case clearance process . T he audit team w ill p resent the review c omments to the inanc ial model builder based up on the c urrent version of the model until the base c ase c omments are c leared. Sensitivities. It is standard p rac tic e that af ter the c learanc e of the base c ase p roj ec tions that eac sensitivity c ase is review ed on a c ase by c ase basis. T his w ill be a similar methodolog y to that adop ted in the sensitivity or lex testing ap p roac h outlined in the limited review sec tion of this book ( that is, the use of lex testing tec hniq ues) . If there are any issues arising f rom the sensitivity review these w ill be raised as review c omments and the model or the deinition of the sensitivity in the data book w ould even amend the sensitivity log ic to relec t the issues and g ain overall c learanc e. Second senior review. O nc e the eng ag ement manag er is hap p y that he is ready f or sig n of f of t op inion letter, it is normal that a sec ond senior review er look s at the review w ork p erf ormed, c arries ou some f urther analytic al review . It is also c ritic al that he double c hec k s the basis of the lenders’ ratios and shareholder returns ag ainst the f ac ility ag reement or data book as ap p rop riate. T he double c hec k i of the k ey outp uts is c ritic al g iven that any error at the hig hest level c an of ten p roduc e one of the mos material sourc es of error. P artner sign of. fO nc e the inanc ial model audit team have satisf ac torily c omp leted their w ork and the p rof essional servic es irm c an sup p ort their op inion the p artner w ill be able to sig n the op inio letter. O f c ourse an op inion letter c an be issued p rior to all the review c omments being c leared, but th outstanding p oints w ill c learly have to be attac hed as inding s or q ualiic ations to an op inion.

149

Section 7

Financial modelling management issues

Project management

T he p roj ec t manag ement of the inanc ial modeller or a inanc ial modelling team is of ten c ritic al to ensur that inanc ial modelling p roj ec ts suc h as those outlined in this book are delivered to the req uired sc op e, q uality, timesc ale and budg et. T his is of p artic ular c onc ern w hen an org anisation uses a less ex p erie inanc ial modeller or has multip le p roj ec ts op erating c onc urrently. Essentially, I rec ommend the use of the inanc ial modelling best p rac( FticMe B P) p roc ess is adop ted as f ar as p ossible. T he c ritic al starting p oint is alw ays to have a c learly doc umented sc op e or model sp ic ation w hic h the inanc ial modeller and the p roj ec t manag er have both boug ht into. I rec ommend that the ac tivities req uired to c omp lete suc h a inanc ial modelling p roj ec t are doc umented in a p roj ec t timel tog ether w ith an assoc iated budg et f or the task s req uired. T he task s should be in seq uential order and shoul assig n resp onsibility. A n ex amp le is show n in Illustration 1 2 8 ( see Illustration1 2 8 . x ls) . In Illustration 1 2 8 you w ill see the date at the top of the sheet at w eek ly intervals. Eac h task is brok dow n, this inc ludes stag es of F M B P, but ag ain there should be some lex ibility along the w ay. T here is ac tivity alloc ated f or sc op ing , testing and doc umentation among st other ac tivities. T he task s are alloc a a budg et by eac h ac tivity. D uring the c ourse of a inanc ial model build p roj ec t, w ork in p rog ress draf ts of the model shoul submitted to the p roj ec t manag er f or interim review to ensure that the w ork to date ap p ears on targ et g iv the sc op e timesc ale and q uality. It is almost needless to say that numerous inanc ial modelling p roj ec ts have not met q uality or timesc ales due to inadeq uate p roj ec t manag ement. O n oc c asions inanc ial models are delivered ex c eeding late due to the lac k of p rog ress up dates and f ailure to review the w ork in p rog ress. It is rec omme that the p roj ec t manag er should either be a senior / ex p erienc ed inanc ial modeller or a senior inanc ial manag er w ith f amiliarisation of p roj ec t manag ement and F M B P p roc edures. I rec ommend that remo sharing sof tw are devic es are used f or both p roj ec t manag ement and c lient trac k ing , and review p rog ress monitoring . S ome readers w ill undoubtedly ask the q uestion how any ex p erienc ed and ex p ert inanc ial model should be manag ed. T his is an interesting p oint as here the end c lient does not nec essarily have to have p roj ec t manag ement sk ill c oup led w ith k now ledg e of F M B P. Here the situation c omes dow n to a c o and g ood listening end c lient and the senior inanc ial modeller p roviding assistanc e in the f orm of p roj ec manag ement and F M B P up f ront and both sides buying in to the ap p roac h.

Exercise F or the c orp orate inanc e model p roj ec t that you have underg one during the c ourse of this book p rep a task related timeline w hic h w ill allow you to manag e a more j unior modeller and remain in c ontrol of the deliverable.

151

Corp orat e F in an ce Mod ellin g a n d A n alysis

The use of generic and template inancial models ●

●

A template inancial model is a basic struc ture or inanc ial model struc ture w here the log ic is later added to mak e the inanc ial model p roj ec t sp ec iic . It has all the bare bones lik e the timeline, sheet names and the more basic c alc ulations. T he advantag e that a temp late inanc ial model w ill g ive is that it is enoug h to g ive a q uic k start. It is easy to understand and c an be tailored to sp ec iic p roj ec t req uirements. You do not have to build the c ore c omp onents f rom sc ratc h. F or the temp late to be leverag ed on a number of j obs, it needs to be w ell desig ned and w ell imp lemented. T here’s an added disadvantag e that up f ront c osts are req uired but if the temp late is used f or enoug h p roj ec ts then the p aybac k is obviously ac hieved. A generic inancial model is w here the model is all thing s to all men. T he inanc ial modeller w ill add all the f unc tionality w hic h c an p ossibly be enc ountered. Indeed in my op inion it is about g etting a sensible and req uired balanc e. It is deined as an all inc lusive inanc ial model that seek s to have as muc h f unc tionality or log ic , or c ater f or almost all p ossible log ic req uirements. If you strik e the balanc e c orrec tly, you w ill g et a q uic k er start than a temp late and you c an sig niic antly reduc e the develop ment time tak en f rom the temp late inanc ial model ap p roac h. T he disadvantag e of trying to be all thing s to all men means that the inanc ial model c an bec ome too c omp lex , too larg e and too slow to c alc ulate. Ex c el has its limits. M odels g reater than 8 0 meg abytes w ill be slow . G eneric models c an be error p rone and hig h ris If the model is audited onc e or tw ic e f or a f ew p roj ec ts by dif f erent irms you w ill be look ing at hig model audit f ees due to the need to look at the w hole model bef ore p roviding an op inion. In order f or a g eneric inanc ial model to be suc c essf ul the model needs to be w ell desig ned and w ell imp lemented using an F M B P typ e ap p roac h. T he c osts up f ront w ill be sig niic antly more than a temp late model and c onseq uently a hig her p roj ec t volume is req uired f or the g eneric model to a w orthw hile investment. M y p ersonal advic e is to try to steer aw ay f rom a g eneric inanc ial model and I enc ourag e adop tion of temp late inanc ial model w here there is the p ossibility.

Exercise generic and template inancial models F or the c orp orate inanc e model that you have built during the c ourse of this book draw a half p ag e list – one side listing g eneric model f eatures and the other side listing a temp late c orp orate inanc e model. T ry to c onsider eliminating unnec essary log ic to ind a value added temp late model. If you c an c rac k this area, this w ill really help you and your org anisation’s inanc ial modelling p roduc tivity. You c ould even g o on to adj ust your inal c orp orate inanc e model built to date to relec t new f unc tionality that p rovides a sensible balanc e betw een a g eneric and temp late p osition.

152

Section 8

Other approaches to risk

T here are c ertain ap p roac hes that c an be tak en to measure inanc ial and business risk that c an be undertak e using Ex c el modelling tec hniq ues. D uring this sec tion w e w ill disc uss the various ap p roac hes to risk that c an be tak en.

Data tables

T his is a method in Ex c el that show s a c ombination of results f or a k ey outp ut f or a c ombination of variabl or inp ut c hang es. In summary, a data table is simp ly a rang e of c ells that show s the results of substituting dif f erent values in to the log ic of the inanc ial model. T he limitation of this tec hniq ue f or risk analysis is tha you c an only have a 1 or 2 variable data table at the most. Ex amp les of the use of data tables c an be seen in S ec tion 3 , under ‘S ale and lease bac k dec isions’ and in S ec tion 9 , under ‘Cap ital rec onstruc tion’.

Scenario manager

Ex c el’s sc enario manag er allow s us to c reate multip le sc enarios in order to measure risk f or a variety of outc omes w ith ease. Illustration 1 2 9 ( see Illustration1 2 9 . x ls) p rovides us w ith an ex amp le of tw o as f ollow s: ● ●

inlation – look s at the ef f ec t of c hang ing inlation to 5% on the real eq uity internal rate of return ( IR R and inlation inc rease and trade debtor inc rease – look s at the ef f ec t of c hang ing inlation to 5% and trade debtor days to 40 days.

In order to imp lement the sc enarios w e must alw ays ensure that the k ey outp uts that w e w ant to run the sc enario ag ainst are in the same sheet as the inp uts that are being c hang ed f or the sp ec iic sc enario. S ee c E1 3 6 of the G eneral inp uts sheet, here you w ill see that this k ey outp ut measure has been link ed to the resul in our inanc ial model. In order to set up a sc enario in Ex c el 2 0 0 7 you simp ly selec t the ribbons in the f ollow ing order: D W hat If s, and S c enario M anag er. You selec t ‘A dd’ to enter the sc enario name, the c ells to c hang e and enter the desc rip tion in the c omments box . I rec ommend that all of the inp uts used f or your sc enario p lanning are g iven a log ic al rang name w hic h is similar to the labels of the inp ut variable or the k ey outp ut. T he S ummary button is selec ted in order to p roduc e the sc enario rep ort as in the S c enario S ummary sheet in the inanc ial modelling ex amp le. T he advantag es of using the sc enario manag er f or risk analysis c an be summarised as f ollow s. ● ●

We c an run and store a vast number of sc enarios w ith ease that c an be seen at any time. It p romp ts the inanc ial modeller to deine and doc ument the sc enario.

antag es of using the sc enario manag er f or risk analysis c an be summarised as f ollow s. T he disadv

153

Corp orat e F in an ce Mod ellin g a n d A n alysis

●

●

T he outp uts to run the sc enario ag ainst must be p erf ormed on the same w ork sheet as the orig inal inp uts that need to c hang e. T his is not c omp liant w ith rec og nised best p rac tic e inanc ial model desig n stan dards of k eep ing a sep aration betw een inp uts c alc ulations and outp uts. W e c annot see the underlying sc hedules that sup p ort the k ey outp uts, that is, the p roit and loss, c ash low and balanc e sheet f orec asts, w hic h w ould be usef ul to review f or reasonableness using analytic al review tec hniq ues.

Goal seek

Ex c el’s g oal seek f ormula allow s the inanc ial modeller to w ork bac k w ards to ind a desired result. T his usef ul in a dec ision mak ing or neg otiating sc enario. In order to run a g oal seek in Ex c el 2 0 0 7 you simp ly selec t the ribbons in the f ollow ing order: D a W hat If s, and G oal S eek . You simp ly set the targ et to the req uired value by c hang ing a deined assump tion Illustration 1 3 0 ( see Illustration1 3 0 . x ls) p rovides us w ith an ex amp le of a g oal seek dec mak ing sc enario. ●

W hat is the level of turnover or sales f or 2 0 1 1 in order to ac hieve a 1 0 0 % the p lanned sales mix f or the c omp any’s p roduc t rang e?

real return on eq uity g iv

In order to imp lement this g oal seek c alc ulation you w ill notic e that an inp ut assump tion has been c reated in c ell B 8 of the G eneral Inp uts sheet that has been c alled revenue f or 2 0 1 1 in £ million. W e c an see have shared out the sales in ac c ordanc e w ith an eq ual p roduc t mix but it c ould, of c ourse, be a dif f erent mix w hic h eq uals 1 0 0 % ac ross all p roduc ts. In order to run the g oal seek f or the above you simp ly targ et the real eq uity IR R ( see C8 of the S ummary sheet) to eq ual 1 ( that is, 1 0 0 % ) by c hang ing the sales value in the G eneral Inp uts sheet B 8 . Not the annual revenue f or 2 0 1 1 is 8 1 . 2 million in order to ac hieve a 1 0 0 % real return on eq uity.

Risk exercise B ased up on the inanc ial model built to date, add f unc tionality using data tables and the sc enario manag er to c omp ute c hang es in the senior debt interest rates. Use the g oal seek f unc tionality to see w hat minimum sales are req uired in the irst f orec ast year to ac hieve a z ero c ash balanc e.

154

Section 9

Financial failure and liquidation

T his sec tion of the book is not assoc iated w ith g row ing a suc c essf ul c omp any but look ing at the ve of inanc ial f ailure, rec onstruc tion of the c orp oration and p otential liq uidation. T his area w ill help u understand how to reac t to any p otential inanc ial dif ic ulties that the c orp orate may enc ounter. Let us irstly look at the typ es of f ailure that c an oc c ur. T ec hnic al insolvenc y is w here a irm is c on ered a f ailure w hen it c annot meet its c urrent liabilities. T his may be desp ite the c ase that its total assets are indeed g reater than its total liabilities. T here is also leg al insolvenc y w hen a c omp any c annot p ay its debts w hen c onsidering its assets and liabilities. T he p otential remedies that are available to the manag ement of a f ailed c orp oration w ill be the disc ussion of the rest of this sec tion. A c omp any should only be liq uidated in the event that a business c annot be saved by ef f ec ting a reorg anisation or rec onstruc tion. W hen a c omp any is w ound up this c an be done voluntarily by either the ow ne or shareholders of the c omp any, or by a c ourt. W hen undertak ing a liq uidation there is a c ertain order of p ayment f or the c omp any’s c reditors: ● ● ● ● ● ●

the p rof essional f ees and liq uidators’ ex p enses inc urred in the c ourse of the w ind up ; then c omes the p ref erential c reditors suc h as any emp loyees’ w ag es and salaries, any tax es due; sec ured c reditors suc h as a lenders’ debt w ill have p ayment made to them f rom the assets that w here p ledg ed f or sec urity p urp oses; any unsec ured c reditors suc h as unp aid sup p liers; p ref erenc e shareholders; and ordinary shareholders.

In Illustration 1 3 1 ( see Illustration1 3 1 . x ls) w e c an see an ex amp le of how a liq uidation ac tually w T he balanc e sheet of an insolvent c omp any is show n in Illustration 1 3 2 and of c ourse thing s look p g rim g iven the f ac t that the c omp any’s inanc ial p osition show s £2 0 . 2 million of debt outstanding , a overdraf t of £4. 5 million and no trade debtors that c an be c ollec ted and c onverted to c ash.

Illustration 1 3 2 Liquidation BALANCE SHEET INSOLVENT COMPANY Period Ending

31 December 2010 Actual £ million

Fixed Assets – Net Book Value

20.0

continued 155

Corp orat e F in an ce Mod ellin g a n d A n alysis

Capitalised Arrangement Fees

0.3

Current Assets Cash

−4.5

Accounts Receivable

0.0

Stock

2.5

Other Current Assets

3.0 1.0

Current Liabilities Accounts Payable

3.4

Vat Payable / (Receivable)

0.6

Tax Payable

4.6 8.6

Long Term Liabilities Shareholder Loan

8.1

Senior Debt

12.1 20.2

Net Assets

−7.5

Financed By Equity

16.8

Retained Earnings

−24.3

Shareholders Funds

−7.5

S ource: M odelling S olutions

W e must remember that the balanc e sheet in Illustration 1 3 2 is stated at historic c ost and w hat is ac tually realised in the f orm of c ash rec eip t in order to p ay the c laims on the c omp any’s assets. W e c an see f rom the balanc e sheet in our ex amp le that w e have ix ed assets of £2 0 million and c urrent assets of £1 million. Unf ortunately w e have only been able to obtain £1 8 million on liq uidation of c omp any’s assets. S o w hic h p arties g et the £1 8 million? Let us assess this in the order of p riority outlined earlier. T he liq uidation summary show s the p osition of the c omp any and its c laims up on its inal w ind up , see Illustration 1 3 3 .

156

Illustration 1 3 3 Liquidation summary LIQUIDATION SUMMARY INSOLVENT COMPANY £m Resale Value of Fixed and Current Assets

18.000

Order of Claims:

Paid

Unpaid

Check

Professional Fees for Wind Up

0.007

0.000

Employees Salaries Outstanding

1.000

0.000

Corporation Tax

4.630

0.000

VAT

0.577

0.000

Secured Creditors: Senior Debt

0.314

0.000

Unsecured Creditors

3.375

0.000

Shareholder Loan

8.100

0.000

16.800

0.000

28.589

0.000

11.786

Ordinary Shareholders Total Claims Check

18.000 0.000

Reconciliation £m Total Claims Per Balance Sheet Other Claims

45.582 1.007 46.589

Claims Paid

18.000

38.6%

Unpaid Claims

28.589

61.4%

46.589 S ource: M odelling S olutions

Corp orat e F in an ce Mod ellin g a n d A n alysis

T he liq uidation summary show s the £1 8 million rec eip t w hic h is raised throug h the sale of the c urrent and ix ed assets. T his alloc ation in the sp ec iic typ e of order outlined earlier. W e c an see that the p rof essional f ees, salaries and tax es are all p aid. T he maj ority of the senior debt is p aid. How ever, the maj ority of the c laims are unp aid, that is, p art of the senior lenders’ debt and all of the trade c reditors or ac c ounts p ayable outstanding . It c an be seen that all of the shareholders loan and ordinary shareholder’s c ap ital c annot be rep aid. You c an see that the analysis has been p rop erly rec onc iled by look ing at the c laims and alloc ating in the c orrec t order. W e c an ac tually see w hat the unp aid c laims of £2 8 . 58 9 c omp rise. W e shall now turn our attention to how w e c ould rehabilitate a p otential inanc ial f ailing irm. T here may be c ertain irms that are better of f restruc turing their inanc ial p osition and c arrying on business as a g oing c onc ern. T his may be a c omp any that has had a f ew bad trading years but has g ood f uture p otential.

Capital reconstruction

W here a business should not be allow ed to be w ound up , it c an be resc ued and maintained as a g oing c onc ern bec ause there may w ell be g reat beneits in ex erc ising a c ap ital rec onstruc tion sc heme. T he deinition of a c ap ital rec onstruc tion is w hereby the c omp any that has f ailed is p lac ed in voluntary liq uidation and the assets are sold to an alternative c omp any w ith the same name and same shareholders, how ever, w ith a strong er inanc ial p osition. T he ex amp le in Illustration 1 3 4 c onsiders a c omp any w hic h, althoug h has g reat f uture p rosp ec ts, had a toug h rec ent trading p eriod w hic h mak es realising suc h p otential very dif ic ult indeed. In order to undertak e a c ap ital rec onstruc tion sc heme it is very imp ortant to demonstrate to your c reditors that the f uture p lan is better than the liq uidation or w inding up op tion. T here is a need to modif y the c laims to ensure the c omp any’s g oing c onc ern status.

Illustration 1 3 4 General assumptions insolvent company GENERAL INPUT INSOLVENT COMPANY £ million Resale Value of Fixed and Current Assets

5.000

Order of Claims: Professional Fees for Wind Up

0.033

Employees Salaries Outstanding

0.900

Corporation Tax

Per Balance Sheet

VAT

Per Balance Sheet

Secured Creditors: Senior Debt

Per Balance Sheet continued

158

Sect ion 9 F in an cial f ailu re a n d liq u id at ion

Unsecured Creditors

Per Balance Sheet

Ordinary Shareholders

Per Balance Sheet

Scheme of Reconstruction New Debt Issue

7.000

Issue Senior Debt Holder with Shares

5.000

Repay Unsecured Creditors Balance to Increase Working Capital S ource: M odelling S olutions

T he balanc e sheet of an insolvent c omp any is show n in Illustration 1 3 5 and of c ourse thing s look p r g rim g iven the f ac t that the c omp any’s inanc ial p osition show s £8 million of debt outstanding , a overdra of £0 . 3 million and no trade debtors that c an be c ollec ted and c onverted to c ash.

Illustration 1 3 5 Balance sheet insolvent company BALANCE SHEET INSOLVENT COMPANY Period Ending

31 December 2010 Actual £ million

Fixed Assets – Net Book Value

2.8

Current Assets Cash

-0.3

Accounts Receivable

1.0

Stock

4.0

Other Current Assets

14.9 19.6 continued 159

Corp orat e F in an ce Mod ellin g a n d A n alysis

Current Liabilities Accounts Payable

1.5

Vat Payable / (Receivable)

0.2

Tax Payable

0.3 2.0

Long Term Liabilities Senior Debt

8.0 8.0

Net Assets

12.4

Financed by Equity

15.0

Retained Earnings

-2.6

Shareholders Funds

12.4

S ource: M odelling S olutions

W e must remember that the balanc e sheet in Illustration 1 3 5 is stated at historic c ost and w hat is ac tually realised in the f orm of c ash rec eip t in order to p ay the c laims on the c omp any’s assets. W e c an see f rom the balanc e sheet in our ex amp le that w e have ix ed assets of £2 . 8 million and c urrent assets of £1 9 . 6 mil lion. Unf ortunately w e have only been able to obtain £5 million on liq uidation of c omp any’s assets. S o w hic h p arties g et the £5 million? Let us assess this in the order of p riority outlined earlier. T he liq uidation summary show s the p osition of the c omp any and its c laims up on its inal w ind up , see Illustration 1 3 6 .

160

Sect ion 9 F in an cial f ailu re a n d liq u id at ion

Illustration 1 3 6 Liquidation summary 2 LIQUIDATION SUMMARY 2 INSOLVENT COMPANY £ million Resale Value of Fixed and Current Assets

5.000

Order of Claims:

Paid

Professional Fees for Wind Up

0.033

0.000

Employees Salaries Outstanding

0.900

0.000

Corporation Tax

0.300

0.000

VAT

0.200

0.000

Secured Creditors: Senior Debt

3.567

Unsecured Creditors Ordinary Shareholders Total Claims

5.000

Check

0.000

Unpaid

Check

4.433

0.000

1.500

0.000

15.000

0.000

20.933

0.000

Reconciliation £ million Total Claims Per Balance Sheet Other Claims

25.000 0.933 25.933

Claims Paid Unpaid Claims

5.000

19.3%

20.933

80.7%

25.933 S ource: M odelling S olutions

T he liq uidation summary show s the £5 million w hic h is raised throug h the sale of the c urrent and ix ed assets. T his alloc ation is in the sp ec iic typ e of order outlined earlier. W e c an see that the p rof essional f e salaries and tax es are all p aid. T he maj ority of the senior debt is p aid. How ever, the maj ority of the c laims are unp aid, that is, p art of the senior lenders’ debt and all of the trade c reditors or ac c ounts p ayable are outstanding and all of the shareholders’ loan and ordinary shareholders’ c ap ital c annot be rep aid. You c an see that the analysis has been p rop erly rec onc iled by look ing at the c laims and alloc ating in the c orrec t order W e c an ac tually see w hat the unp aid c laims of £2 0 . 9 3 3 million c omp rise. 161

Illustration 1 3 7 New Co post reconstruction BALANCE SHEET Period Ending

Fixed Assets – Net Book Value

INSOLVENT CO

NEW CO

31 December 2010

31 December 2010

Actual

DR

CR

Actual

£ million

£ million

£ million

£ million

2.8

2.8

Current Assets Cash Accounts Receivable Stock Other Current Assets

−0.3

7.0

−1.5

5.2

1.0

1.0

4.0 14.9

4.0 14.9

19.6

7.0

−1.5

25.1

−1.5

0.0

Current Liabilities Accounts Payable

1.5

Vat Payable / (Receivable)

0.2

0.2

Tax Payable

0.3

0.3

2.0

0.0

−1.5

0.5

−5.0

3.0

7.0

Long Term Liabilities Senior Debt

8.0

New Debt Total Debt

8.0

0.0

2.0

7.0 10.0

Net Assets

12.4

7.0

−2.0

17.4

Equity

15.0

5.0

Retained Earnings

−2.6

Shareholders Funds

12.4

Financed by

ce: M odelling S olutions S our

20.0 −2.6

5.0

0.0

17.4

Sect ion 9 F in an cial f ailu re a n d liq u id at ion

T he above ex amp le c an be seen elec tronic ally in Illustration 1 3 8 ( see Illustration1 3 8 . x ls) . T he sc heme of arrang ement f or rec onstruc ting the c omp any’s inanc es inc ludes the f ollow ing : ● ● ●

to raise £7 million of new debt f rom the mark et; c onvert £5 million of the senior debt to £1 ordinary shares; and settle the ac c ounts p ayable of £1 . 5 million.

T his has the ef f ec t of rec onstruc ting the c omp any’s balanc e sheet as show n in Illustration 1 3 7 . W e c an see that the c omp any’s c ash p osition has imp roved to £5. 2 million, the debt has inc reased marg in ally f rom £8 million to £1 0 million and of c ourse the eq uity has inc reased f rom £1 5 million to £2 0 million It c an be c onc luded that under the c ap ital rec onstruc tion sc heme that all c reditors and the shareholders bec ome better of f . T he ordinary shareholders’ c ontrol is diluted by the new ordinary shareholders, how ever, at least they w ill rec eive f uture dividends f rom the sc heme. T he ordinary shareholders w ould not have rec eived anything under a liq uidation c ase. T he q uestion is w hether the c omp any is viable in the long er term. In order to answ er this q uestion it is nec essary to dig into our inanc ial modelling and analysis tec hniq ues onc e ag ain. Essentially w e need to tak e a look at the rec onstruc ted p osition and ask ourselves c an w e sup p ort the revised c ap ital struc based up on the f uture p rosp ec ts or g row th p lans of the c omp any. W e must mak e p roj ec tions and p our c ap ital rec onstruc tion is inanc ially viable f or all of our new c omp any inanc ial stak eholders. F or p urp ose I w ould lik e to direc t your attention to Illustration 1 3 9 ( see Illustration1 3 9 . x ls) . W e c an see in the G eneral Inp uts sheet that w e have inc luded the rec onstruc ted c omp any balanc e sh as in our rec onstruc tion p lan in Illustration 1 3 7 and inc luded the normally rec og nised assump tion req uired to look at our c omp any p roj ec tions annually over a 1 0 year f orec ast p eriod. You w ill notic e that the revi debt and eq uity struc ture and their assoc iated terms have also been inc luded. T he p roit and loss, c ash low and balanc e sheets inc lude p roj ec tions that inc lude the log ic f or the new debt interest and rep ayments. T lenders’ ratios inc lude the new debt f or c alc ulation p urp oses. W e c an see f rom Illustration 1 40 that the c omp any that has been rec onstruc ted look s viable based up o the base c ase assump tions and thus p roj ec tions. F irstly, w e c an see that the new shareholders g et nomina rate of return of 42 % and a real rate of return of 3 8 % . T he c omp any is also c ash p ositive w ith a c balanc e of £1 1 2 . 1 million. A ll of the lenders’ c redit ratios meet or ex c eed the targ ets req uired.

Illustration 1 40 Reconstructed company results PROJECT ECONOMICS

Nominal

Real

COMPANY CASH POSITION £ million

Equity IRR – New Shareholders

41.71%

38.25%

Minimum Balance

5.2

Year of Minimum Balance

31 December 2010

Maximum Balance

112.1

Year of Maximum Balance

31 December 2020 continued 163

Corp orat e F in an ce Mod ellin g a n d A n alysis

LENDERS CREDIT RATIOS

Minimum

Target

OK

Target Maximum

33.3%

80.0%

OK

Target Maximum

Free Cash low to Debt – Min

390.3%

60.0%

OK

Target Maximum

Debt To EBITDA – Max

33.3%

60.00%

OK

Target Maximum

57.5%

90.00%

OK

Target Minimum

41.2

2.0

Debt to Equity Ratio – Max

Debt To Net Assets – Max Interest Cover – Min

Year of Min / Max

Average

31 December 2010

22.1%

31 December 2012

648.1%

31 December 2011

17.0%

31 December 2010

19.8%

31 December 2011

97.1

S ource: M odelling S olutions

How ever, in order to really test the robustness of our inanc ial p roj ec tions w e need to f urther address the business p lanning p roj ec tions w ith a series of sensitivities W hat or Ifs f or the k ey risk areas. T ak ing a look at our G eneral Inp uts sheet w e c an see that there are three main risk areas in terms of the p rosp ec ts f or this c omp any. T hese are as f ollow s: ● ● ●

revenue risk ; marg in risk ; and op erating c ost risk .

W hatsIfon these areas to ind the level of risk assoc iated w ith the g row th p rosp ec ts S olet us p erf orm some and p roj ec tions of our rec onstruc ted c omp any. Illustrations 1 41 to 1 43 show the ef f ec t of the varying k ey risk areas and the ef f ec t up on the k ey ou measures. D ata tables have been added to the S ummary sheet in the ex amp le f or a rang e of S ales, G ross M arg in and O p erating Cost assump tions ag ainst the f ollow ing k ey outp ut sc hedules. ● ● ● ● ● ●

Nominal Eq uity IR R . R eal Eq uity IR R . D ebt to Eq uity R atio M ax . F ree Cash F low to D ebt M in. A ssets M ax . D ebt to Net Interest Cover M in.

T he base c ase levels have been hig hlig hted in dark g rey. T he levels that beg in to breac h the targ eted levels are hig hlig hted in lig ht g rey. W e c an summarise the p osition as f ollow s. ● 164

S ales need toall f by 50 %

of the c urrent base c ase levels bef ore returns bec ome neg ative.

Sect ion 9 F in an cial f ailu re a n d liq u id at ion

● ●

G ross M arg ins need to f all by 52 % of the c urrent base c ase levels bef ore returns bec ome neg ative. O p erating Costs need to inc rease by 1 2 0 % of the c urrent base c ase levels bef ore returns bec o neg ative.

O f c ourse these are the k ey risk variables that are c onsidered in isolation w hic h in the real c ourse of business are lik ely to vary tog ether. D esp ite this w e c an c onc lude that based up on the p roj ec tions p rovided t ap p ears to be a relatively hig h deg ree of saf ety.

Illustration 1 41 Sales effect on key outputs Sales

Nominal – Equity IRR

Real – Equity IRR

Debt to Equity Ratio – Max

41.71%

38.25%

33.3%

10.0

0.0%

0.0%

33.33%

20.0

0.0%

0.0%

33.33%

30.0

0.0%

0.0%

33.33%

40.0

0.0%

0.0%

33.33%

50.0

−6.2%

−8.4%

33.33%

60.0

11.0%

8.3%

33.33%

70.0

21.2%

18.3%

33.33%

80.0

29.2%

26.0%

33.33%

90.0

35.8%

32.5%

33.33%

100.0

41.7%

38.3%

33.33%

110.0

47.0%

43.4%

33.33%

120.0

51.9%

48.2%

33.33%

130.0

56.5%

52.7%

33.33%

140.0

60.8%

56.9%

33.33%

150.0

64.9%

60.9%

33.33%

160.0

68.8%

64.6%

33.33%

170.0

72.5%

68.3%

33.33%

180.0

76.1%

71.8%

33.33%

190.0

79.5%

75.1%

33.33%

200.0

82.9%

78.4%

33.33%

Sales

Free Cash low to Debt – Min

Debt to EBITDA – Max

390.3%

33.3%

10.0

−886.8%

33.33%

20.0

−617.7%

33.33% continued 165

30.0

−348.6%

33.33%

40.0

−79.3%

33.33%

50.0

56.3%

33.33%

60.0

123.1%

33.33%

70.0

189.9%

33.33%

80.0

256.7%

33.33%

90.0

323.5%

33.33%

100.0

390.3%

33.33%

110.0

457.1%

33.33%

120.0

523.9%

33.33%

130.0

571.2%

33.33%

140.0

617.3%

33.33%

150.0

663.4%

33.33%

160.0

709.6%

33.33%

170.0

755.7%

33.33%

180.0

801.8%

33.33%

190.0

847.9%

33.33%

200.0

894.0%

33.33%

Sales

Debt to Net Assets – Max

Interest Cover – Min

57.5%

41.2

10.0

606.2%

−144.4

20.0

128.4%

−100.5

30.0

125.1%

−56.7

40.0

57.5%

−14.0

50.0

57.5%

6.1

60.0

57.5%

13.1

70.0

57.5%

20.1

80.0

57.5%

27.1

90.0

57.5%

34.1

100.0

57.5%

41.2

110.0

57.5%

48.2

120.0

57.5%

55.2

130.0

57.5%

62.2

140.0

57.5%

69.2

150.0

57.5%

76.2

160.0

57.5%

83.3 continued

170.0

57.5%

90.3

180.0

57.5%

97.3

190.0

57.5%

104.3

200.0

57.5%

111.3

S ource:M odelling S olutions

Illustration 1 42 Gross margin effect on key outputs Gross Margin

Nominal – Equity IRR

Real – Equity IRR

Debt to Equity Ratio – Max

41.71%

38.25%

33.3%

6.0%

0.00%

0.00%

33.33%

10.0%

0.00%

0.00%

33.33%

14.0%

0.00%

0.00%

33.33%

18.0%

0.00%

0.00%

33.33%

22.0%

0.00%

0.00%

33.33%

26.0%

−1.99%

−4.38%

33.33%

30.0%

10.73%

8.03%

33.33%

34.0%

19.28%

16.37%

33.33%

38.0%

26.08%

23.01%

33.33%

42.0%

31.89%

28.67%

33.33%

46.0%

37.03%

33.69%

33.33%

50.0%

41.71%

38.25%

33.33%

54.0%

46.02%

42.46%

33.33%

58.0%

50.05%

46.39%

33.33%

62.0%

53.84%

50.09%

33.33%

66.0%

57.44%

53.60%

33.33%

70.0%

60.87%

56.95%

33.33%

74.0%

64.16%

60.15%

33.33%

78.0%

67.32%

63.24%

33.33%

82.0%

70.37%

66.21%

33.33%

86.0%

73.32%

69.09%

33.33%

90.0%

76.18%

71.88%

33.33%

94.0%

78.96%

74.59%

33.33%

98.0%

81.66%

77.23%

33.33% continued

Gross Margin

Free Cash low to Debt – Min

Debt to EBITDA – Max

390.3%

33.3%

6.0%

−839.10%

33.33%

10.0%

−623.31%

33.33%

14.0%

−407.51%

33.33%

18.0%

−191.71%

33.33%

22.0%

14.98%

33.33%

26.0%

68.44%

33.33%

30.0%

122.08%

33.33%

34.0%

175.72%

33.33%

38.0%

229.36%

33.33%

42.0%

282.99%

33.33%

46.0%

336.63%

33.33%

50.0%

390.27%

33.33%

54.0%

443.90%

33.33%

58.0%

497.54%

33.33%

62.0%

551.18%

33.33%

66.0%

604.82%

33.33%

70.0%

658.45%

33.33%

74.0%

712.09%

33.33%

78.0%

765.73%

33.33%

82.0%

819.37%

33.33%

86.0%

873.00%

33.33%

90.0%

926.64%

33.33%

94.0%

980.28%

33.33%

98.0%

1033.91%

33.33%

Gross Margin

Debt to Net Assets – Max

Interest Cover – Min

57.5%

41.2

6.0%

347.5%

−141.1

10.0%

128.4%

−105.5

14.0%

232.0%

−69.8

18.0%

86.1%

−34.3

22.0%

57.5%

0.3

26.0%

57.5%

7.5

30.0%

57.5%

13.1

34.0%

57.5%

18.7 continued

38.0%

57.5%

24.3

42.0%

57.5%

29.9

46.0%

57.5%

35.5

50.0%

57.5%

41.2

54.0%

57.5%

46.8

58.0%

57.5%

52.4

62.0%

57.5%

58.0

66.0%

57.5%

63.6

70.0%

57.5%

69.2

74.0%

57.5%

74.8

78.0%

57.5%

80.5

82.0%

57.5%

86.1

86.0%

57.5%

91.7

90.0%

57.5%

97.3

94.0%

57.5%

102.9

98.0%

57.5%

108.5

S ource:M odelling S olutions

Illustration 1 43 Operating costs’ effect on key outputs Operating Costs

Nominal – Equity IRR

Real – Equity IRR

Debt to Equity Ratio – Max

41.71%

38.25%

33.3%

60.0

0.00%

0.00%

33.3%

56.0

0.00%

0.00%

33.3%

52.0

0.00%

0.00%

33.3%

48.0

0.00%

0.00%

33.3%

44.0

−16.49%

0.00%

33.3%

40.0

6.53%

3.93%

33.3%

36.0

17.06%

14.21%

33.3%

32.0

24.80%

21.76%

33.3%

28.0

31.19%

27.99%

33.3%

24.0

36.73%

33.40%

33.3%

20.0

41.71%

38.25%

33.3% continued

24.0

36.73%

33.40%

33.3%

28.0

31.19%

27.99%

33.3%

32.0

24.80%

21.76%

33.3%

36.0

17.06%

14.21%

33.3%

40.0

6.53%

3.93%

33.3%

44.0

−16.49%

0.00%

33.3%

48.0

0.00%

0.00%

33.3%

52.0

0.00%

0.00%

33.3%

56.0

0.00%

0.00%

33.3%

60.0

0.00%

0.00%

33.3%

64.0

0.00%

0.00%

33.3%

68.0

0.00%

0.00%

33.3%

72.0

0.00%

0.00%

33.3%

76.0

0.00%

0.00%

33.3%

Operating Costs

Free Cash low to Debt – Min

Debt to EBITDA – Max

390.3%

33.3%

60.0

−778.5%

33.3%

56.0

−547.2%

33.3%

52.0

−315.9%

33.3%

48.0

−84.5%

33.3%

44.0

53.7%

33.3%

40.0

109.8%

33.3%

36.0

165.9%

33.3%

32.0

222.0%

33.3%

28.0

278.1%

33.3%

24.0

334.2%

33.3%

20.0

390.3%

33.3%

24.0

334.2%

33.3%

28.0

278.1%

33.3%

32.0

222.0%

33.3%

36.0

165.9%

33.3%

40.0

109.8%

33.3%

44.0

53.7%

33.3%

48.0

−84.5%

33.3%

52.0

−315.9%

33.3%

56.0

−547.2%

33.3% continued

60.0

−778.5%

33.3%

64.0

−1009.8%

33.3%

68.0

−1241.2%

33.3%

72.0

−1472.5%

33.3%

76.0

−1703.8%

33.3%

Operating Costs

Debt to Net Assets – Max

Interest Cover – Min

57.5%

41.2

60.0

152.4%

−134.5

56.0

3532.5%

−96.0

52.0

150.3%

−57.4

48.0

57.5%

−19.0

44.0

57.5%

6.6

40.0

57.5%

12.4

36.0

57.5%

18.1

32.0

57.5%

23.9

28.0

57.5%

29.6

24.0

57.5%

35.4

20.0

57.5%

41.2

24.0

57.5%

35.4

28.0

57.5%

29.6

32.0

57.5%

23.9

36.0

57.5%

18.1

40.0

57.5%

12.4

44.0

57.5%

6.6

48.0

57.5%

−19.0

52.0

150.3%

−57.4

56.0

3532.5%

−96.0

60.0

152.4%

−134.5

64.0

655.0%

−173.0

68.0

57.5%

−211.5

72.0

57.5%

−250.1

76.0

57.5%

−288.6

S ource:M odelling S olutions

Conclusion

It is p ossible to mak e inf ormed and risk minimised inanc ial dec isions based up on the tec hniq ues and analysis demonstrated in this book . O f c ourse, if readers undertak e eac h ex erc ise it w ill imp rove both the inanc ial analysis and modelling sk ills, thus allow ing them to add g reater value to the dec ision mak ing c ap ability of an org anisation. I w ould lik e to tak e this op p ortunity to w ish you every suc c ess in dep lo suc h tec hniq ues to max imise the value of your c omp any or business venture.

173

Glossary Acid test T his is a ratio that is of ten used in c orp orate inanc e that ex p resses c urrent assets less stoc k or inventory divided by c urrent liabilities. T his rep resents a liq uid ratio or q uic k ratio w hic h assumes that stoc k tak w hile to c onvert to debtors and then c ash and is theref ore the most illiq uid of w ork ing c ap ital items.

Acq uisition T he p urc hase of one c omp any by another f or a c ertain c onsideration p ac k ag e. T his c onsideration p c an be made up of c ash, shares and debt ac c ording to how the p arties see it. T he ac q uirer obviously ha c ontrolling interest over the targ et c omp any.

Annual report A rep ort reg arding the c omp any’s p erf ormanc e over the last year w hic h is made available to the c omp a shareholders.

B ack to b ack loan T his a long term c urrenc y hedg ing mec hanism under w hic h the p arties lend to eac h other matc hing sum dif f erent c urrenc ies on matc hing terms. B asis point T his relates to interest rates f rom lenders, a basis p oint rep resents one hundredth p art of one p erc ent.

B eta T his is the mark et risk p remium that is added to the c omp any’s c ost of eq uity using the linear relationship that is assumed by the CA PM .

B ond T his is a long term sourc e of inanc ing used f or a p iec e of neg otiable money mark et p ap er having a mat of ive years or more. B ullet A sourc e of debt that has a maturity date f or the rep ayment of the p rinc ip al made at one deined date in the f uture. C apital investment A investment n in long term assets w hic h usually have a lif e of more than a year, that is, p lant and eq uip ment, and land and building s.

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C AP M T he c ap ital asset p ric ing model measures the realtionship betw een risk and return f or a c omp any’s shares. T he risk f ree rate of return is usually the g overnment bond rate. It is essentially a linear relationship that look s at the risk f ree rate of return p lus a p remium f or risk rep resented f or a beta based up on the shareholders’ ex p ec ted rate of return. C ash low Cash low is very imp ortant area of c orp orate inanc e as it is ef f ec tively a lif eline f or business. Cash has a maj or bearing up on the ability to p ay and stay liq uid and even solvent. C hinese w alls T his is a name g iven to a p roc ess adop ted by a bank or inanc ial adviser that ensures that c onidentiality is maintained betw een the dif f erent teams in the same org anisation. C ommitment f ee T his is a lenders’ f ee that is based up on a p erc entag e of the undraw n and c ommitted f ac ility amount. C onvertib le A bond, debenture or loan stoc k w hic h has an op tion f or the lender to ex c hang e it f or some other typ e of alternative investment. C onvertib le deb t T his is w here a debt is issued at a variable rate of interest but c arries an op tion to allow p redetermined ix ed rate of interest.

c onversion to a

Deb t capacity T his rep resents the total amount of debt that a c omp any is able to borrow . Deb t to eq uity ratio T his is the amount of long term debt ex p resses to the total debt and eq uity f or a c omp any. Diluted earnings per share T his is usually a c omp arative c alc ulation that is made w hen other typ es of instrument c an be c onverted to ordinary shares. Divestment T his is the op p osite of investment. It rep resents the ac tion of disp osing of a c omp any’s asset throug h sale.

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Glossary

Dividend policy T his is w here a c omp any c onsiders how muc h of its p roits to distribute to its shareholders in the f orm of dividend. It is imp ortant to note that dividend stream has a bearing up on the f uture valuation of a c omp any’s shares and there may be the mutually ex c lusive ac tion of retaining the f unds and investing in internal business p roj ec ts that may in turn inc rease the c omp any’s f uture earning s and indeed share p ric e. E arnings per share A c omp any’s earning s p er share is the p roit af ter tax divided by the number of ordinary shares in issue.

E B I T DA T his stands f or ‘earning s bef ore interest tax dep rec iation and amortisation’. It is a f airly p op ular measure in c orp orate inanc e as it is the starting p oint f or c alc ulating c ertain c ash low numbers. E nterprise value Enterp rise value is a measure that relec ts the mark et value of the w hole business. Enterp rise value c an be deined as: O rdinary shares ( eq uity) at mark et value Plus D ebt at mark et value Plus Pref erenc es shares at mark et value Less c ash. Free cash low F ree c ash low is a c omp any’s EB IT D A p lus w ork ing c ap ital movement adding bac k dep amortisation deduc ting tax and c ap ital ex p enditure. It is ef f ec tively the c ash low bef ore inanc ing . Future value T his rep resents the value of an investment at a f uture date in time based up on a c ertain interest rate and the amount invested p eriodic ally. G earing T his is a measure of the deg ree of long term debt to a c omp any’s net assets. It is used as p otential risk indic ator f or both shareholders and lenders. G oodw ill T his rep resents the amount of value attributed to a business f or its brand, emp loyees and c lientele w hic h has built up over time. It also relates to the ex c ess of p urc hase p ric e of a business over the net assets of the targ et c omp any.

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I nterest cover T his is a ratio typ ic ally used by lenders f or c redit analysis p urp oses. It is a p roit rather than a c ash based ratio that uses the c omp any’s op erating p roit and divided it by interest p ayable f or the p eriod. I nterest rate loor T his rep resents the interest rate w here a p ayment is made in order to p rotec t ag ainst a f all of the interest rate to a minimum level. I nterest rate risk T his rep resents the volatility in interest rates w hic h c an be manag ed throug h various interest rate risk manag ement mec hanisms. I nterest rate sw ap A n interest rate hedg ing instrument that mak es an ag reement to sw ap an interest rate to another ix ed or variable rate at a c ertain date in time. I nterim dividend A dividend that is usually dec lared and p aid half w ay throug h a year. I nterest cover A measure of the c ap ac ity of a c orp orate to meet its interest oblig ations. T his is normally ex p ressed by dividing the p roit bef ore interest and tax by the interest c harg e in the p roit and loss ac c ount. IP O T his is an initial p ublic of f ering or the irst time that a p rivate c omp any has issued shares to the g eneral p ublic . O f c ourse suc h shares w ill be issued on the stoc k ex c hang e.

IR R T his relates to a disc ounted c ash low tec hniq ue w hic h inds the disc ount rateNPV w here eq uals the z ero. T hus the name internal rate of return. T he IR R is a result that arises f rom a series of c ash low s w hic h c an be c omp ared to the w eig hted averag e c ost of c ap ital, that is, w here the IR R is g reater than the W A CC ac c ep t as the NPV is lik ely to add to the c omp any valuation.

LI B I D A n ac ronym w hic h rep resents an interest rate w hic h stands f or London Inter B ank B id rate. T his is th interest rate at w hic h bank s bid f or f unds in the euromark et.

Lib or A nac ronym w hic h rep resents an interest rate w hic h stands f or London Inter B ank O f f er R ate. T his is interest rate at w hic h bank s w ill lend f unds to eac h other at dif f erent maturities.

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Glossary

Liq uidity A measure of a c omp any’s holding of c ash or c ash eq uivalents. M anagement b uy in T his is w hen an ex isting c omp any is ac q uired by a new manag ement team. M anagement b uy out T his is w hen a manag ement team ac q uires the c omp any that they are orig inally emp loyed by.

M erger A business c ombination of tw o c omp anies bring ing tog ether the op erations on c ertain inanc ing terms, is, share ex c hang es, debt or c ash inanc ing .

M ez z anine deb t S ometimes ref erred to as j unior debt. T his is a f orm of debt w hic h has a c laim on the assets of a c omp an and rank s f or p ayment only af ter the senior debt has been p aid.

O rdinary shares O rdinary shares are ef f ec tively shareholders w ho have voting rig hts and are entitled to a dividend in the c omp any. T hese are non p ref erenc e shares and c an either be p rivate c omp anies or p ublic limited c omp a P ayout ratio T his is a ratio that ex p resses the amount of dividend as a p erc entag e of the p roit af ter interest and tax . P rivate eq uity T his is the investment of f unds in a p rivate limited c omp any by an investment irm. T he p rivate eq uity irm assists w ith the c omp any’s g row th and has a p lanned ex it date.

P rospectus A doc ument that p rovides detailed inf ormation reg arding the c omp any w hic h is used f or share and deb issues. R atio T he P/ E ratio or earning s multip le, is the latest c losing share p ric e divided by the earning s p er share. R einancing A reinanc ing is w hen old debt is rep lac ed w ith debt that has more f avourable terms, that is, interest rate, rep ayment term and so on.

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R evolving credit f acility A typ e of bank c redit w hereby the borrow er c an draw and rep ay w ithin c ertain p redeined limits.

R ights issues A rig hts issue is a c ap ital raising ex erc ise that involves selling new shares to its ex isting shareholders. T h shares are usually of f ered in p rop ortion to its ex isting shareholding p erc entag e. Sale and lease b ack A leg al arrang ement w hereby a c orp oration ag rees to sell an asset to a inanc ial institution and lease it bac k at ag reed terms. It is simp ly a mec hanism of releasing c ash low in order to inanc e the business and k eep ing ow nership of the asset. Scrip dividend T his is a bonus issue of shares issued to ex isting shareholders in lieu of a dividend p ayment.

Secured deb t T his is debt w hic h is bac k ed w ith or sec ured by c ollateral or assets in order to reduc e lending risk . A ex amp le in the c orp orate inanc e sp here is w here a p rop erty c omp any uses its ex isting p rop erty’s mar value f or sec urity ag ainst p otential loan def ault. Shareholder value T he value p rovided to shareholders in resp ec t of dividend g row th, earning s and the share p ric e g row th. Spread T his is the amount of interest w hic h is ex p ressed in p erc entag e or basis p oints terms, over the mark er rate w hic h a borrow er p ays on a variable rate debt f ac ility. Sub ordinated deb t T his is a f orm of debt w hic h has a c laim on the assets of a c omp any and rank s f or p ayment only af ter the senior debt has been p aid. Sw ap – interest rate T his is an arrang ement w hereby a c omp any having a liability w hic h c arries a ix ed rate of interest ex c hang it f or a variable rate liability f or another c omp any. Systematic risk T his is the mark et risk of a share or investment that c annot be diversiied aw ay.

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T erm sheet A leg al ag reement that is sig ned by p arties to the borrow ing f ac ility setting out the terms of interest, f e rep ayment p eriods and so on.

T erminal value A terminal value ap p roac h is the p resent value based up on a p oint in time of all f uture c ash low s at g row th rate into the f uture. T here are tw o main methods of the terminal value c alc ulations, that is, EB IT D multip le ap p roac h and the p erp etuity g row th ap p roac h. T reasury b ill A short- term g overnment sec urity issued w ith a maturity not ex c eeding one year and is c onsidered to rep resent the mark et’s risk f ree rate of return as a g overnment is unlik ely not to p ay. V enture capital T his is an investor that p rovides eq uity c ap ital to start up s and seed businesses and normally ex its at a p lanned year of ten by the IPO route.

Weighted average cost of capital ( WAC C ) T he w eig hted averag e c ost of c ap ital is a method of c alc ulating the req uired rate of return based up c omp any’s c ap ital struc ture and the c ost of c ap ital f or both debt and eq uity is w eig hted in order to in disc ount rate f or c ap ital investment p urp oses.

Working capital W ork ing c ap ital ref ers to low f rom c urrent assets and c urrent liabilities into c ash low . S toc k , deb c reditors w ill all be turned into c ash low items during the trading c yc le, how ever the c redit timing attac to eac h usually varies. Y ield curve T his is the relationship betw een interest rates and the maturity f or f unds borrow ed or dep osited.

Z scores T his is a c onc ep t that w as develop ed by Prof essor A ltman. It is a tec hniq ue of p redic ting a p o c omp any f ailure by using a selec tion of inanc ial ratios based up on f reely available and p ublished statutory ac c ounting inf ormation.

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