Computerized Financial

Modeling
• Finance management combines management and accounting, using
the financial management cycle to create strategic plans for
customers.

• The strategic planning, organizing, directing, and controlling of

financial undertakings (activities and events) of a firm.

• It also includes applying management principles to the financial

assets of an organization, while also playing an important part in fiscal
management.
Basic Objectives of a Firm
1. Profit Maximization:
Strategic decisions involve investments, financing, and operations

Producing maximum output for a given amount of input

Using minimum input to produce a given output

Earning a profit is the main objective of every business activity

Basic Objectives of a Firm:
2. Wealth Maximization: Firms aim to create value for shareholders
by generating profits and increasing stock prices.

Any financial action that has a positive NPV creates wealth for
shareholders and is therefore desirable.

Wealth will be maximized if the NPV criteria is followed in

making financial decisions.

NPV is the difference between the present value benefits and

present value costs of an investment option.
The objectives of the Firm:
3. Ensuring Long-Term Viability: Balancing short-term profits with
sustainable growth.
Managing risks and adapting to changing market conditions.

4. Meeting Stakeholder Expectations: Satisfying customers, employees,

creditors, and society.
Operating ethically and positively impacting the community.
The Role of Financial
Management
Capital Management: They estimate the capital requirements of the
organization from time to time, determine the capital structure and
composition, and make the choice of source of funding for the capital
needs.

Allocation and utilization of financial resources(Capital budgeting):

They ensure that all financial resources of the organizations are used
and invested effectively and efficiently so that the organization is
profitable, sustainable, and viable in the long run.
The Role of Financial
Management
• Cash flow management: Financial management tracks accounts payable and
receivable to ensure there is the adequate cash flow available at all times.

• Working Capital Management: They manage short-term assets (inventory,

accounts receivable) and liabilities (accounts payable).

• Disposal of surplus: Make decisions on how the surplus or profits of the

organizations is utilized. They decide if dividends should be distributed and
how much, and the proportion of profits that must be retained and invested
back into the business.
The Role of Financial
Management
Financial Reporting: They maintain essential reports related to the
firm’s finances and use them as the database for forecasting
and planning financial activities.

Risk Management: Prepares the organization to forecast risks (interest

rate, currency), put in place mitigation plans as well as meet
unforeseen risks and emergencies effectively
Role of Financial Management

Estimating Valuation: Determine the value of the firm or its assets

using methods like discounted cash flow (DCF) analysis.

Budgeting and Forecasting: Create budgets and predict future

financial performance based on assumptions and historical data.
Key decisions of a financial manager
Financing Decision: (Raising Funds) –Deciding from where, when,
and how to acquire funds to meet business needs. Determining the
appropriate portion of the debt and equity mix.

Investment Decision (Capital Budgeting): Capital budgeting is the

process of deciding how to invest money in long-term assets, like
equipment & buildings, that will yield earnings in the future.

There is uncertainty about returns, therefore, evaluate proposals in terms

of expected returns and risks.
Key decisions of a financial
manager
Dividends Decision: Deciding whether to distribute all profits as
dividends or retain them or distribute part and retain part. Whether to
give it in the form of cash or stock dividends.

Working Capital Decision: A decision about how to invest in current

assets. This has an implication on the firm’s profitability and liquidity

Balancing flows between Current Assets and Liabilities

Working Capital Decision
• Working Capital is the difference between a company’s current assets and current
liabilities.

• Current Assets (CA) are things like cash, inventory, and receivables (money owed to
the company).

• Current Liabilities (CL) are obligations that the company needs to pay off soon, like
accounts payable (money the company owes to others) and short-term loans.

• Formula:
• Working Capital=CA−CL
Why Working Capital Decision
• Liquidity: It measures a company’s ability to cover its short-term
obligations.

• Positive working capital means the company can pay off its short-term
debts and invest in its operations. Negative working capital could
indicate financial trouble.

• Operational Efficiency: Proper working capital management ensures

that the company has enough cash flow to support its daily
operations without interruption.
Key Working Capital Decisions
1. Inventory Management:
• Objective: To balance between having enough inventory to meet customer demand
and not overstocking, which ties up cash.

• Decision Points: Determine reorder levels, maintain optimal inventory, and decide
on the right amount of safety stock.

2. Accounts Receivable/Trade Debtors:

• Objective: Ensure that money owed to the company is collected in a timely manner.

• Decision Points: Set credit terms for customers, manage credit limits, and
implement efficient collection processes.
 Key Working Capital Decisions
3. Accounts Payable/Trade Creditors:
Objective: Manage when and how much to pay suppliers to maintain good relationships
and take advantage of any discounts.

Decision Points: Negotiate payment terms with suppliers and determine the optimal
timing for payments to balance cash flow.

4. Cash Management:
Objective: Ensure that there’s enough cash on hand to meet daily expenses and invest in
opportunities.
Decision Points: Forecast cash flows, manage cash reserves and decide on investments
in short-term securities.
 Key Working Capital Decisions
Key Considerations
• Trade-Offs: Effective working capital management often involves trade-
offs. For example, holding more inventory reduces the risk of stockouts
but ties up cash. Similarly, extending credit to customers might increase
sales but also increase the risk of late payments.

• Industry Norms: Working capital needs can vary significantly between

industries. For example, a retail company might need a higher inventory
level compared to a service-based company.

• Seasonality: Some businesses experience seasonal fluctuations. Working

capital decisions need to account for these variations to ensure smooth
operations throughout the year.
Managing investment in long-
term assets (Capital Budgeting
Decisions)
• A process of assessing whether an investment project is worthwhile or
not.

• This is usually done whenever a firm has to make a decision to invest

in long term assets e.g. plant, machinery, equipment, furniture,
Information system, software.

• The major task here is to evaluate proposals for investment in long

term assets and select one that can maximize the value of the firm
 Why Capital Budgeting
• It determines which permanent assets the firm will hold (Asset Mix) and this
determines the type of business. & as well as the business risk

• Its very difficult to and costly to reverse

• The benefits from these investments are spread over a future period and yet the
decision to acquire them & commit company resources is made at the present.

• There is a high risk that the future expected cash flows from the asset may not
be realized.
Capital Budgeting Process
1. Identify Potential opportunities. Ascertain all possible
alternative investment ideas in which a firm can invest in and
ensure that they fit the firm’s strategy.

2. Project Operating Costs. Estimate all the costs to be

incurred to complete the project. This task may involve
research, getting quotes, and exploring alternatives.

3. Estimate cashflows. Prepare cash-flow estimates starting

with projected revenues and deduct operating expenses,
including loan payments.
Capital Budgeting Process
4. Analyze the project. Use NPV to determine if future revenues less
expenses, when discounted to the present, will exceed the initial
investment outlay.

5. Assess Risks. Use what-if analysis tools (e.g. analyze how much
money the firm could lose if the project fails? What if the revenues are
less than expected? Or what if expenses are higher than projected? Will
the investment still make sense?

6. Implementation and follow up to ensure that the assets acquired are

used as planned and adjustments made where necessary.
 Concept of Time Value of Money(TVM)
• The Time Value of Money is a fundamental principle in financial
management that states that a shilling today is worth more than a
shilling in the future.

• This is because money available today can be invested to earn interest,

making it grow over time.
Why Time Value of Money (TVM)
• Investment Decisions: It helps in evaluating the value of investments,
comparing different investment opportunities, and making informed
financial decisions.

• Loan Decisions: When borrowing money, TVM helps determine how

much you will pay in total interest over the life of the loan.
Future Value of Money (FV)
Calculates how much an investment made today will grow to
in the future, given a certain interest rate.
FV =PV×(1+r)^n
FV=PV×(1+r)^n
Where;
PV: Present Value (initial amount of money)
r: Interest rate per period
n: Number of periods (years, months, etc.)
• 5,000,000 for 5years at 10% per year. How much will I get after 5years
FV=PV*(1+r)^n
FV=Future Value
PV=Present Value(5,000,000)
R=Interest Rate(10%)
N=No of Periods Yrs (5)
FV=5,000,000*(1+0.1)^5
FV=5,000,000*(1.1)^5
FV=5,000,000*1.6=8,000,000
Present Value of Money (PV)
Determines the current value of a future amount, discounted back to today’s value.
PV=FV/(1+r)^n
Where;
FV: Future Value
r: Interest rate per period
n: Number of periods
Example: If Ivan’s target is to earn 8,052,550 in 5 years from an insurance company offering
interest rate of 10% per annum, how much he invest now:
PV=FV/(1+r)^n
PV=8052,550/(1+0.1)^5
PV=8,052,550/(1.1)^5
PV=8,052,550/1.61
PV=5,000,000
Computerized Financial
Modeling
• Financial modeling is the process of building a forecast of an organization's future
financial performance using spreadsheets, other financial instruments, and
quantitative methods.

• A process of creating a numerical representation of your company’s current

financial situation.

• The primary goal of financial modeling is to help businesses make well-informed

decisions by providing an accurate understanding of the financial implications of
various scenarios.
 Financial Model
• A financial model is a tool used for analyzing the past, present, and
future performance of a business, project, or investment.

• A financial model is a spreadsheet usually built in Microsoft Excel,

that forecasts a business’s financial performance into the future.

• The forecast is typically based on the company’s historical

performance and assumptions about the future, and requires preparing
an income statement, balance sheet, cash flow statement, and
supporting schedules. Examples??
 Goals of Financial Modeling
Financial modeling aims to achieve several key goals including:
• Predict Future Performance: One major goal is to estimate how a business or investment will
perform in the future. This can be done by forecasting future revenue, expenses, and profits using
current data and assumptions.

• Evaluate Scenarios: Help businesses explore different scenarios and their potential impacts. E.g.
testing how changes in market conditions, or strategies might affect the financial outcomes.

• Support Decision-Making: Analyze data to make informed choices about investments, projects, or
business strategies. This could be deciding whether to invest in a new project, acquire another
company, or adjust your business strategy.

• Assess Risk: Analyzing different scenarios helps you Identify potential risks and plan ways to handle
them.
• Communicate Insights: Communicate complex financial information clearly to stakeholders, such as
investors, managers, or board members, making it easier for them to understand and make decisions
based on the data.
Types of Financial Models
The most common types of financial models are:
1. 3-statement model: Combines a company’s income statement, cash
flow statement, and balance sheet into a single interactive model.

• The income statement shows the company’s revenues, expenses, and

profits over a given time
• The Balance sheet shows assets, liabilities, and equity,
• The cash flow statement shows the company’s inflows and outflows
• The 3statements are interconnected, and changes in one impact the
others.
• This model is used to project the financial performance over time to
predict the revenue, expenses, profits, assets, liabilities, and cash flows.
Types of Financial Models
2. Discounted cash flow (DCF): This model estimates the company’s value
based on it’s future cash flows.

• The discounted cash flow analysis considers the time value of money,
implying that forecasted cash flows are discounted to their current value.

• To build this model, one has to make assumptions about a company’s future
cash flows, growth, and discount rate.

• When making an investment decision, a DCF model helps you estimate the
company’s future revenue and discount it back to their present value, taking
the time value of money into account.
Types of Financial Models
3. Initial Public Offering (IPO) model: This model is used to estimate
the fair value of a company’s shares when it goes public.

• It uses the company’s financials, growth forecasts, and market

conditions.

• It’s used by investors and sponsors to estimate the offering price of

the shares.
Types of Financial Models
4. Merges &Acquisitions (Mergers) Model: This model evaluates the
financial results of mergers and acquisitions.

• It makes use of cash flows and valuations of both the acquiring and
target companies.

• It helps investors and analysts determine whether an M&A makes

financial sense.
Components of Financial
Modeling
Four critical components must be in place before building a financial model.
1. Financial statements: Financial statements include:
a) The income statement: This shows the revenues, expenses, and profits of a
company over a period such as a year).

• It shows how the company generates revenue from its operations and other
sources and gets funding for operating expenses.

• The company’s net income or earnings appear at the bottom of an income

statement.
Components of Financial
Modeling
b) Balance sheet: This statement displays the assets, liabilities, and equity of a
company, at the end of a financial year.

• It shows what the company owns and owes, and how much it is worth.

• The balance sheet must follow the equation: Assets = Liabilities + Equity.
 Components of Financial
Modeling
c) Cash flow statement: A cash flow statement shows the inflows and outflows of money for a
company.
• It shows how the company generates and uses the money from operating, investing, and
financing activities.

• The net change in cash on the cash flow statement should be equal to the change in cash on
the balance sheet.

d) Debt schedule: The debt schedule shows the amount of debt that a company has, such as
loans, bonds, or leases.

A debt schedule shows how much interest and principal payments the company has to make
on its debt, and how it affects its cash flow and leverage ratio analysis.
Components of Financial
Modeling
2. Assumptions: Assumptions involve making informed predictions performance of a
business.

For instance we can assume that firm’s revenue will grow by 5% in year and 20% and
the following years. We can also assume operating expenses will be 30% of revenue
per year.

3. Valuation: Valuation involves determining the worth of a business or investment.

4. Sensitivity Analysis: Sensitivity analysis involves testing scenarios to see how they
would impact the financials of a business.
Steps of Building financial
models
1. Define the purposes/objective of the model. This helps you
understand what data to gather and what assumptions to make
( forecasting a company’s revenue).

2. Gather Relevant Data: Data gathered depends on the purpose of

the model.

For example,
If the purpose of the model is to predict a company’s revenue, then you
need data on the company’s previous revenue, market trends, and
economic indicators.
Steps of Building financial
models
3. Identify key drivers: Next, you have to identify the key drivers that will affect the financial
outcomes of the model. Such as sales growth rates, the total number of products or services
sold, and interest and tax rates.

4. Create Assumptions: Assumptions are estimates about the future based on the data you
have gathered.

For example, if the purpose of the financial model is to predict a company’s revenue, then
we can assume that revenue will grow at a certain rate

5. Create a forecast/model. Use the collected data and reports to forecast future
income, balance sheet, and cash flow statements.
You can do this by reversing the original calculations for historical ratios and metrics.
Specifically, use your previous assumptions to build out the forecasted statements.
Steps of Building financial
models
6. Perform Sensitive Analysis: A technique used in financial modeling to test the
effects of changing assumptions on the financial performance of a company.

It helps identify the most significant assumptions in a financial model and their
potential impact on the company’s financial performance.

7. Review & Refine: This is supposed to be an ongoing process.

As new data becomes available, the assumptions used in the model may need to
be adjusted. Reviewing the financial model regularly and refining it as necessary
can help ensure that the model remains accurate and useful for decision-making
 Application/Uses of Financial Models

• Forecasting and Business Planning: Financial models help predict how a

business will do in the future by analyzing past data and making assumptions.
This helps companies plan ahead, set goals, and use their resources more
effectively.

• Cost Estimating: Companies use financial models to create budgets, which are
detailed plans showing expected income, expenses, and cash flow for a certain
period. This helps them manage their money and allocate resources properly.

• Strategic Insight: Financial Models allow users to see the impact of past
decisions and how future decisions could affect the company.
 Application/Uses of Financial Models
• Estimate Business Value: Financial models are used to estimate the value of
companies, projects, or investments. Techniques like comparing similar businesses
or calculating future cash flows are often used to estimate worth.

• Investment Analysis: Investors use financial models to assess the potential risks
and returns of different investment options, such as stocks, bonds, and real estate.
This helps them make informed investment decisions.

• Communication Tool: Financial models are used to explain a company's

financial situation to stakeholders like investors, lenders, and employees.
They give a clear numerical picture of how the company is doing and
what its future looks like, this helps in getting funding, loans, or support
from within the company.