financial modelling final

8/8/2019 Financial modelling final

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Financial Modeling:

PRESENTED BY

SMITA GUPTA

RAJVI SINGHI

SNEHA RAJARAM

SMRITI JAIN

SHUBHAM AGARWAL


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Introduction

Financial modeling is the task of building an abstractrepresentation (a model) of a financial decision makingsituation.

[1] This is a mathematical model designed to represent (asimplified version of) the performance of a financialasset or a portfolio, of a business, a project, or anyother investment

[2] financial modeling is synonymous with cash flowforecasting.

[3] This usually involves the preparation of large, detailedmodels, which are used for management decisionmaking


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Contd.

Application Include:

Business valuation, especiallydiscounted cash flow, but includingother valuation problems

Capital budgeting

Cost of capital or WACC

Financial statement analysisProject finance


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Process Of Financial Modeling


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Steps in Financial Modeling

Feasibility Study

Model construction

Compatibility of the model with the tools used Model validation

Model implementation

Model review and update

Documentation


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Validating Financial Models

Create a Framework for Ensuring theDevelopment of Valid Financial Models

Decompose Financial Model Validity into Selected

Components in Order to Facilitate Better ModelDevelopment

Consider How You Can Build More Valid Models

Apply Spreadsheet Auditor Software Capability to

Your Existing Model Explore How Colleagues in Other Organizations

Validate Their Financial Models


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Financial decisions - Leverage

Break Even Analysis :

Break even sales is also referred to as a point where total revenue and

total cost coincides & after this point profit starts occurring.

Variable costs are expected to change at the same rate as the firms

level of sales.

VC are constant per unit, so as more units are sold the total variable

cost also rises. E.g.: Sales commission, costs of raw materials etc

Fixed costs are those costs that are constant regardless of the quantity

produced, over some relevant change of production.

Total FC per unit will decline as the no. of units increases. E.g.: rent,

salaries etc

Mathematically,

BEP = Fixed Costs

Sales- Variable costs


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Limitations ofBreak even Analysis:

Costs Segregation

Assumption with regard to consistency in Fixed costs

Assumption with regards to consistency in Revenue and Variablecosts.

Assumptions with regard to a multi- product firm

Financial Break even point


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Types of Leverage

Operating Leverage:

Operating leverage refers to the use of fixed cost in the operation

of a firm and it increases or decreases the firms operating profit

(EBIT) with the change in sales.

Mathematically, it can be given as;

DOL = % change in Operating Profit

% change in sales

OR

DOL = Contribution

EBIT


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Financial Leverage:

The use of fixed charges such as debt and preference capital along

with the owners equity in the capital structure, is described as

financial leverage. The financial leverage employed by the company is intended to

earn more on the fixed charges funds than their costs.

It can be defined as a measure to gauge the changes in EPS

because of the change in EBIT due to fixed financial interest charge.

A company can raise funds from various sources which can becategorized as:

Those sources which involve fixed interest charge

Those sources which do not involve fixed interest charge

Mathematically, its given as;

DFL = % change in EPS

% change in EBIT


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Combined Leverage:

The degrees of operating and financial leverages can be combined

to calculate the effect of total leverage on EPS associated with a

given change in sales. The degree of combined leverage (DCL) is given by the following

equation:

DCL = % change in EPS

% change in sales

Illustration:A company known as Vikas Limited planned to invest 8 lakhs. It

expected a sales of 20 lakhs. The selling price p.u. of a product was

Rs. 10 and the variable cost p.u. was Rs. 5. The fixed cost of the

company for the year is expected to be around 5 lakhs. The

companys D/E ratio is 40:60. The interest on debt is at 10%. Themanagement of the company wants to know the resultant affect of

25% increase in sales on the EPS of the company. Each share of the

company has a face value of Rs. 100. Tax rate is 35%


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Base Increase of 25% in sales

Total capital employed 800000 800000

Ratio of debt in capital structure 40% 40%

Debt 320000 320000

Equity 480000 480000Sales in unit 200000 250000

Selling price per unit 10 10

Variable cost per unit 5 5

Revenue 2000000 2500000

Variable cost 1000000 1250000

Fixed cost 500000 500001

EBIT 500000 749999Interest on debenture 32000 32000

EBT 468000 717999

Tax 163800 251299.65

Earning after taxes/PAT 304200 466699.35

No. of shareholder 4800 4800

EPS 63.375 97.22903125

% change is sales 0.25% change in EBIT 0.499998

% change in EPS 0.534185897

Degree of FL 1.068376068

Degree of OL 1.999992

Combined leverage 2.13674359


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Leverage and Risks:

Leverage magnifies the EPS and also tends to increase its variability

which leads to two types of risks:

1. Operating Risks:

a) Defined as variability of EBIT which results from changes in the

environment which are beyond ones control

b) A firm with high fixed costs will be largely affected than the

firm which has less fixed costs and high variable costs

c) It is an unavoidable risks

2. Financial Risks:

a) The variability of EPS because of the use of financial leverage is

called financial risks

b) It is an avoidable risks - by not employing any debt or external

finance in the companys capital structure


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Financing Decisions

Capital Structure


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Flow Of Discussion

Meaning OfCapital Structure

EBIT-EPS Analysis Significance of Leveraging

Calculation Of Indifference point

Capital Structure Theories


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Capital Structure

Relates to a firms decision to divide its cash flows into two

broad components:

-Debt

-Equity

Influences Shareholders Return and Risk

Helps management in deciding the optimum financing mix


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EBIT-EPS Analysis (Using Excel)

Using Financial Leverage Increases the EPS when the

Economic Conditions are very good.

Also using high debt percentage when the economicconditions are very poor erodes shareholders wealth each

year. (E.g. Plan 4 with 75% debt)

Option of No Debt is the best if not sure of future economicconditions


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Indifference Points

A point where EPS of two Financing Plans remains the same

despite differences in their capital structure composition

The Formula to find the Break even level of EBIT (withdifferent compositions):

(1-T)EBIT = (1-T)(EBIT-Interest)No of shares (N1) No of Shares in plan 2


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Capital Structure Theories

Net Income Approach

Net Operating Income Approach

Modigliani-Miller Approach

Traditional Approach


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Working capital Management

To run day-to-day business activities

Determinants

1. Nature of business2. Production cycle

3. Business fluctuation

4. Credit availability


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Case Study on Cash Budgeting

Cash budgting.xls

CASE STUDY FM.docx


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Cash Management Strategies

Decrease cash conversion cycle

Stretching accounts Payable

High Inventory turnover

Decentralize Collection system

Lock box system

financial modelling final

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