Final Analysis and Business Valuation

FINAL : PAPER -

FINANCIAL ANALYSIS
AND BUSINESS
VALUATION
STUDY NOTES

The Institute of Cost Accountants of India
CMA Bhawan, 12, Sudder Street, Kolkata - 700 016

20

FINAL


First Edition : May 2013
Reprint of First Edition : April 2014
Second Edition : November 2014

Published by :
Directorate of Studies
The Institute of Cost Accountants of India (ICAI)
CMA Bhawan, 12, Sudder Street, Kolkata - 700 016
www.icmai.in

Printed at :
Repro India Limited
Plot No. 02, T.T.C. MIDC Industrial Area,
Mahape, Navi Mumbai 400 709, India.
Website : www.reproindialtd.com

Copyright of these Study Notes is reserved by the Insitute of Cost
Accountants of India and prior permission from the Institute is necessary
for reproduction of the whole or any part thereof.


Syllabus
Syllabus Structure
The syllabus comprises the following topics and study weightage:
A
B

Financial Analysis
Business Valuation

50%
50%

A
50%

B
50%

ASSESSMENT STRATEGY
There will be written examination (including case study / caselet analysis) paper of three hours
OBJECTIVES
To enable cost and management accountant professionals through analysis of financial statements to
calibrate the lens to bring the business into focus. To identify the imperfections in the financial statements
and frame strategic action to eradicate the dirt on the lens which may distort the financial picture. To

enable business decision making through appropriate analysis of statements. To gain knowledge of the
application of valuation principles and techniques in business environment.
Learning Aims
The syllabus aims to test the student’s ability to:
 Understand the financial statements for analysis
 A
pply appropriate measures for executing the financial analysis
 M
ake fundamental analysis through financial statement analysis
 T
ranslate the understanding for business valuation
 I
nterpret the statements for managerial decision-making
 Evaluate the results for setting strategies
 Recommend strategic financial decisions
Skill set required
Level C: Requiring skill levels of knowledge, comprehension, application, analysis, synthesis and evaluation.
Section A: Financial Analysis
1.Financial Modeling – concepts and application
2.The Analysis of the Statement of Shareholders’ Equity
3.The Analysis of the Balance Sheet and Income Statement
4. The Analysis of the Cash Flow Statement
5. The Analysis of Profitability
6.The Analysis of Growth and Sustainable Earnings
Section B : Business Valuation
7. Business Valuation Basics
8. Valuation in Mergers and Acquisitions
9. Fair Value in Accounting Measurement
10.Valuation of Intangibles

50%

50%


SECTION A: FINANCIAL ANALYSIS [50 MARKS]
1.

Financial Modeling for Project Appraisal



(a)Use of Functions like Net Present Value (NPV), Internal Rate of Return (IRR), etc.,



(b) Forecasting techniques

2.The Analysis of the Statement of Shareholders’ Equity


(a) The Analyst’s Checklist



(b) Reformulating the Statement of Owners’ Equity



(c) Comprehensive Income Reporting

(d)Financial Analysis – ratio analysis and report writing

3.The Analysis of the Balance Sheet and Income Statement


(a) The Analyst’s Checklist



(b) Reformulation of the Balance Sheet



(c)Reformulation of the Income Statement (Tax allocation, issues in reformulating income
statements)



(d)Comparative analysis of the Balance Sheet and Income Statement (Common size analysis;
trend analysis)

4.

The Analysis of the Cash Flow Statement

(a) The Analyst’s checklist



(b)GAAP Statement of Cash Flows and Reformulated Cash Flow Statements



(c)Analysis of cash flow statement and quality of earnings

5.

The Analysis of Profitability



(a) The Analyst’s Checklist



(b) Du Point Analysis



(c)Cutting to the Core of Operations (the analysis of profitability)



(i)First level breakdown ( distinguishing financing and operating activities and the effect of
leverage)

(ii)Second level breakdown (drivers of operating profitability)



(iii)Third level breakdown (profit margin drivers; turnover drivers; borrowing cost drivers)

6.

The Analysis of Growth and Sustainable Earnings



(a) The Analyst’s Checklist



(b) Growth Analysis



(c)The Analysis of Changes in Profitability and Sustainable Earnings



(i)

Analysis of changes in operations

(ii)

Issues in identifying sustainable earnings

(iii)
Operating leverage


(iv) Analysis of changes in financing



(d)

The Analysis of Growth in Shareholders’ Equity



(e)Growth, Sustainable Earnings, Evaluation of P/B Ratios and P/E Ratios



(i)How price-to-book ratios and trailing P/E ratios articulate



(ii)Training Price-Earnings Ratios and Transitory Earnings

(iii)P/E Ratios and Analysis of Sustainable Earnings

SECTION B: BUSINESS VALUATION [50 MARKS]
7.

Business Valuation Basics



(a)Principles and techniques of valuation – DCF, Multiple methods, Accounting based valuation



(b)Asset Valuation; Earning Valuation; Cash flow valuation; Other valuation basis

8.

Valuation in Mergers and Acquisitions



(a)Assets and Cash Flows – strengths and weaknesses of various valuation method



(b) Recognition of interest of various stakeholders

(c)Selection of appropriate cost of capital for valuation



(d) Synergistic benefits



(e) Forms of Consideration and terms of acquisitions



(f)



(g)Implications of regulations for business combinations



(h) Types of exit strategies and their implications



(i)

Shareholder Value Analysis

(j)

Exchange Ratio- Bases used for Computation

9.

Fair Value in Accounting Measurement



(a)Concept



(b)Measurement techniques and standards, Challenges



(c) Accounting treatment

Post merger integration process

10. Valuation of Intangibles


(a) Intellectual Property

(b)Intangibles



(c) Brand Valuation

(Syllabus contents are subject to modification as may be required)


Content
SECTION A – FINANCIAL ANALYSIS
Study Note 1 : Financial Modeling for Project Appraisal
1.1

Financial Statements Module Area

1.1

1.2

Financial modeling - Concepts and Application

1.13

1.3

Use of Functions Like Net Present Value (NPV), Internal Rate of Return (IRR), Etc.,

1.24

1.4

Forecasting Techniques

1.32

1.5

Financial Analysis

1.33

1.6

Financial Statement Analysis

1.37

Study Note 2 : The Analysis of the Statement of Shareholders’ EquitySection – A
2.1

The Analyst’s Checklist

2.1

2.2

Reformulating the Statement of Owners’ Equity

2.1

2.3

Comprehensive Income Reporting

2.6

2.4

Financial Analysis — Ratio Analysis and Report Writing

2.9

2.5

Miscellaneous Problems

2.60

Study Note 3 : The Analysis of the Balance Sheet and Income Statement
3.1

The Analyst’s Checklist

3.1

3.2

Reformulation of the Balance Sheet

3.2

3.3

Reformulation of the Income Statement

3.14

3.4

Comparative Analysis of the Balance Sheet and Income Statement

3.23

3.5

Analysis of Changes in Income

3.36

3.6

Distress Analysis

3.58

3.7

Off Balance Sheet Items

3.79

3.8

Corporate Debt Instrument Analysis (Bond Analysis)

3.83

3.9

Miscellaneous Problems

3.97


Study Note 4 : The Analysis of the Cash Flow Statment
4.1

The Analyst’s Checklist

4.1

4.2

GAAP Statement of Cash Flows And Reformulated Cash Flow Statements

4.3

4.3

Analysis of Cash Flow Statement

4.9

4.4

Quality of Earnings and Cash Flows

4.10

4.5

Miscellaneous Problems

4.14

Study Note 5 : The Analysis of Profitability.1
5.1

The Analyst’s Checklist

5.1

5.2

Cutting to the Core of Operations : The Analysis of Profitability

5.2

5.3

Du Pont Analysis

5.13

5.4

Miscellaneous Problems

5.14

Study Note 6 : The Analysis of Growth and Sustainable Earning
6.1

The Analyst’s Checklist

6.1

6.2

Introduction to Growth Analysis

6.4

6.3

The Analysis of Changes in Profitability and Sustainable Earnings

6.6

6.4

The Analysis of Growth in Shareholders’ Equity

6.23

6.5

Growth, Sustainable Earnings, and the Evaluation of P/B Ratios and P/E Ratios

6.25

SECTION B – BUSINESS VALUATION
Study Note 7 : Valuation Basics
7.1

Basis for Valuation – Introduction

7.1

7.2

Principles and Techniques of Valuation

7.11

7.3

Role of Valuation

7.21

Study Note 8 : Valuation Models
8.1

Valuation Models – Introduction

8.1

8.2

Discounted Cash Flow Valuation

8.4

8.3

Relative Valuation

8.10

8.4

Free Cash Flow Valuation

8.17

8.5

Valuation of Firm – Other Valuation Basis

8.24

8.6

Contingent Claim Valuation

8.29


Study Note 9 : Mergers and Acquisitions : Valuation
9.1

Business Strategy

9.1

9.2

Basics of Merger & Acquisition

9.3

9.3

Theories of Merger & Acquisition

9.14

9.4

Strengths And Weaknesses of Various Methods of Business Valuation

9.16

9.5

Concepts of Value in the Context of Mergers and Acquisition

9.19

9.6

Approaches to Valuation in Case of M&A

9.20

9.7

Selection of Appropriate Cost of Capital For Valuation

9.21

9.8

Forms of Consideration and Terms of Acquisition

9.22

9.9

Implication of Regulations for Business Combinations

9.35

9.10

Takeover

9.42

9.11

Post-Merger Integration Process

9.45

9.12

Types of Exit Strategies and Their Implications

9.63

9.13

Shareholder Value Analysis

9.70

9.14

Exchange Ratio-Based Used for Computation

9.71

Study Note 10 : VALUATION of Assets and Liabilities
10.1

Forms of Intellectual Property and Methods of Valuation

10.1

10.2

Valuation of Fixed Assets

10.20

10.3

Valuation of Inventories

10.28

10.4

Valuation of Investments

10.39

10.5

Valuation of Share

10.47

10.6 Human Resource Accounting

10.75

10.7 Valuation of Goodwill, Patents and Copyrights

10.84

10.8 Valuation of Brands

10.111

10.9 Valuation of Real Estate

10.123

10.10 Valuation of Liabilities

10.135

10.11 MM Hypothesis10.148

Section A
Financial Analysis



Study Note - 1
FINANCIAL MODELING FOR PROJECT APPRAISAL
This Study Note includes
1.1

Financial Statement Module Area

1.2

Financial Modeling – Concepts and Application

1.3

Use of Functions like Net Present Value (NPV), Internal Rate of Return (IRR), etc.,

1.4

Forecasting Techniques

1.5

Financial Analysis

1.6

Financial Statement Analysis

1.1 FINANCIAL STATEMENTS MODULE AREA
The Financial Statements Module Area is eight interconnected Module Areas of a spreadsheet model
as shown in the diagram below. These generic Module Areas can be used to develop a “whole-ofbusiness financial model”.
Financial Statements Module Area

2. Working
Capital
5. Taxation
3. Assets

6. Financial
Statements

7. Outputs/
Other

8. Checks

All Modules

4. Capital

1. Operational

The Financial Statements Module Area is comprised of three Module Types, representing each of
the three financial statements. Each of these financial statements has the purpose of summarising
a different component of an entity’s financial position. The three different Module Types within the

Financial Statements Module Area are:
1.

Income Statement;

2.

Balance Sheet; and

3.

Cash Flow Statement.

It is important to understand the purpose of each of these three Financial Statements Module Types,
and the functionalities that can be included within them to meet the requirements of model users. It is
also important to understand how they can be interlinked with modules from other Module Areas, to
ultimately create the required components of a spreadsheet model.

FINANCIAL ANALYSIS AND BUSINESS VALUATION I 1.1


Financial Modeling for Project Appraisal
Each of the Financial Statements Module Types that may be included in a spreadsheet model is briefly
explained below.
Financial Statements Modules Types
The three Financial Statements Module Types within the Financial Statements Module Area are defined
as follows:
Module Type

Definition

1. Income Statement

• Provide a summary of the revenues, costs and expenses of an entity during
an accounting period.
• An Income Statement is generally used to calculate the Net Profit after
Tax (NPAT) of an entity.
• Also referred to as a ‘Statement of Financial Performance’ or a ‘Profit &
Loss Statement’.

2. Balance Sheet

• Shows the status of an entity’s assets, liabilities and owner’s equity at a
point in time, usually the close of a month.
• A Balance Sheet provides a snapshot of the entity’s financial position,
including the cumulative results of the Income Statement and Cash Flow
Statement, at a point in time.
• Also referred to as ‘Statement of Financial Position’.

3. Cash Flow
Statement

• Shows how changes in Income Statement and Balance Sheet accounts
affect cash and cash equivalents during an accounting period.
• A Cash Flow Statement breaks the analysis down according to operating,
investing and financing activities.
• Also referred to as a ‘Statement of Cash Flows’

These three Financial Statement Modules can be built into a spreadsheet model independently, or
linked together to establish relationships between them – e.g. Income Statement, Balance Sheet and

Cash Flow Statement Modules might link in data from Operational, Working Capital and Assets Modules
and then link to each other such that live, linked financial statements can be analysed.
Financial Statements Module Location
The Financial Statements Module Area is an integral area in the spreadsheet modelling process,
bringing together many other Module Areas to analyse the financial position of an entity – e.g. an
Income Statement Module shows the profit/loss of an entity, sourcing information from Revenue, cost
of goods sold, operating expenditure, book assets, book intangibles, ordinary equity, debt and taxation
modules. Additionally, information from each Financial Statement Module Type can then be used by
other Modules – e.g. Net Profit After Tax (NPAT) can be used in an Ordinary Equity Module as a basis for
determining dividends declared in each period.
The diagram below shows each of the Module Types that can exist in a “whole of business financial
model”, organised into their respective Module Areas. It highlights the Financial Statements Module
Area and the potential links between the Financial Statements Modules and other modules from other
module areas:

1.2 I FINANCIAL ANALYSIS AND BUSINESS VALUATION


FINANCIAL ANALYSIS AND BUSINESS VALUATION I 1.3


Financial Modeling for Project Appraisal
1. Income Statement Module
The module collects revenues and expenses from Operational, Assets, Capital and Taxation Modules
(if included), and links out NPAT to the Balance Sheet (if included). The module also links out Earnings
Before Interest, Tax, Depreciation and Amortisation (EBITDA) to Valuation Modules (if included).

Layout
The diagram below shows an example of how an Income Statement might be laid out in order to
present a summary of the revenues and expenses of an entity in order to calculate its Net Profit After Tax

(NPAT). The diagram also shows where each of the Income Statement precedent modules would enter
the Income Statement and the type of information that would link in from each of these precedent
modules:
Income Statement Layout- example
Income Statement
Revenue

`1,500

— Revenue →

Cost of goods sold

(`200)

— Cost of goods sold →

Operating
expenditure
Book assets

(`300)

— Operating expenditure →

(`150)

— Book assets Depreciation →

Book intangibles

(`40)

— Book intangibles amortisation →

Ordinary equity

(`5)

— Ordinary equity fees (book)
amortisation →

1.4 I FINANCIAL ANALYSIS AND BUSINESS VALUATION

(`)

Revenue

1,500

Cost of goods sold

(200)

Gross Margin

1,300

Operating expenditure

(300)

EBITDA

1,000

Book assets
Depreciation
Book intangibles
amortisation
Ordinary equity fees
(book) amortisation

(150)
(40)
(5)


Debt

(`5) — Debt fees (book) amortisation →

Debt fees (book)
amortisation
Depreciation &
amortisation
EBIT

Debt

(`100)

— Interest expenses →

Interest expenses
Net profit before tax
(NPBT)

Taxation
Balance Sheet

(`210)
`490

— Tax expense →
← Net profit after tax (NPAT) —

Tax expense
Net profit after tax
(NPAT)

(5)
(200)
800
(100)
700
(210)
490

The layout of an Income Statement is governed by the accounting standards and reporting requirements

applicable to each entity. It is also governed by the choices the entity makes (within the boundaries
of its reporting requirements) as to how it structures the presentation of its revenues and expenses on
its Income Statement.
Location
The diagram below shows the Income Statement Module contained within the Financial Statements
Module Area and shows the potential links between the Income Statement Module and all other
Modules:

FINANCIAL ANALYSIS AND BUSINESS VALUATION I 1.5


Financial Modeling for Project Appraisal
2. Balance Sheet Module
The Balance Sheet Module provides a summary of an entity’s assets, liabilities and equity at designated
points in time.
The module collects asset, liability and equity balances from Working Capital, Assets, Taxation, Debt
and Ordinary Equity Modules (if included), as well as the Income Statement and Cash Flow Statement
Modules (if included). The module also links out Opening Cash at Bank and Opening Retained Profits
to the Ordinary Equity Module (if included), which uses this information as a basis for determining
dividends declared.

Layout
The diagram below shows an example of how a Balance Sheet might be laid out in order to present
a summary of the assets, liabilities and equity of an entity at a point in time. The diagram also shows
where each of Balance Sheet precedent modules would enter the Balance Sheet and the type of
information that would link in from each of these precedent modules:
Balance Sheet

(`)

Equity
Ordinary equity
Income statement
Ordinary equity

`750
`490

— Ordinary equity →
— Net profit after tax →

Ordinary equity

750

Opening retained profits

132

Net profit during period

490

(`115) — Ordinary equity dividends → Ordinary equity dividends
Retained profits
Total equity

(115)
507
1,257

Non-current liabilities
Debt
Taxation

`1,500
`85

— Debt balances →
— Deferred tax liabilities
balances →

1.6 I FINANCIAL ANALYSIS AND BUSINESS VALUATION

Debt
Deferred tax liabilities

1,500
85


Total Non-current liabilities

1,585

Current liabilities
Operating payables

`95

— Operating payables
balances →

Capital payables

`30

— Capital payables
balances  →

Taxation

`273

— Tax payables balances →

Tax payables

273

Debt

`175

— Debt interest payables →

Debt interest payables

175

`90

— Ordinary equity dividend
payables balances →

Ordinary equity dividend
payables

Ordinary equity

Operating payables

95

Capital payables

30

Total current liabilities
Total

90
663
3,505

Assets
Non-current assets
Book assets
Book intangibles

`2,250

— Book assets balances →

Book assets

`250

— Book intangibles →

Debt

`30

— Debt refinancing fees →

Ordinary equity

`10 — Ordinary equity refinancing Ordinary equity refinancing
fees balance →
fees

Taxation

`145

— Deferred tax assets
balances →

Book intangibles

Debt refinancing fees

Deferred tax assets
Total Non-current assets

2,250
250
30
10
145
2,685

Current assets
Cash flow statement
Operating
receivables

`295
`125

— Change in cash held →
— Operating receivables
balances →

Opening cash

400

Change in cash held

295

Cash

695

Operating receivables

125

Total current assets

820

Total

3,505

The layout of a Balance Sheet is governed by the accounting standards and reporting requirements
applicable to each entity. It is also governed by the choices the entity makes (within the boundaries
of its reporting requirements) as to how it structures the presentation of its assets, liabilities and equity
accounts on its Balance Sheet.
Location
The diagram below shows the Balance Sheet Module contained within the Financial Statements
Module Area and shows the potential links between the Balance Sheet Module and all other Modules:

FINANCIAL ANALYSIS AND BUSINESS VALUATION I 1.7


Financial Modeling for Project Appraisal

Balance Sheet Module Location

3. Cash Flow Statement Module
The Cash Flow Statement Module provides an analysis of the cash flows of an entity over a number of
accounting periods, showing how changes in and Income Statement and Balance Sheet items affect
cash and cash equivalents.
The module collects cash inflows and outflows Operational, Working Capital, Assets, Taxation, Debt
and Ordinary Equity Modules (if included), and links out the change in cash held during each period
to the Balance Sheet (if included). The module also links out cash flow available for dividends to the
ordinary equity module (which is used to determine dividends declared) and cash flow available to
equity and cash flow to capital providers to the Valuation Modules.

1.8 I FINANCIAL ANALYSIS AND BUSINESS VALUATION


Layout
There are two common methods used to lay out a Cash Flow Statement. These two methods are
summarised in the following table:
Method
Direct

Description
• The Cash Flow Statement is comprised purely of the cash inflows and
outflows of an entity during the accounting period.
• No reconciliation with Net Profit After Tax (NPAT) on the Income Statement
is undertaken.

Indirect

• The Cash Flow Statement is built up by starting with Net Profit After Tax

(NPAT) from the Income Statement.
• NPAT is adjusted for differences between Income Statement revenues and
expenses and actual cash inflows and outflows during the period.

FINANCIAL ANALYSIS AND BUSINESS VALUATION I 1.9


Financial Modeling for Project Appraisal
Direct Cash Flow Statement Layout
The diagram below shows an example of how a Cash Flow Statement might be laid out in order
to present the cash inflows and outflows of an entity during a period using the direct method. The
diagram also shows where each of the Cash Flow Statement precedent modules would enter the Cash
Flow Statement and the type of information that would link in from each of these precedent modules:
Cash Flow Statement Layout – Direct Method Example
(`)

Cash Flow Statement (Direct) (`)
Cash Flow from
Operating Activities

Revenue

1,500

— Revenue →

Operating Receivables

(200)

— Increase in operating
receivables →

Cost of Goods Sold

(200)

—Cost of Goods Sold→

Operating Expenditure

(300) —Operating Expenditure→ Operating Expenditure

Operating Payables

20

—Increase in Operating
Payables→

Revenue

1,500

Increase in Operating
Receivables

(200)

Cash Receipts

1,300

Cost of Goods Sold

(200)

Increase in Operating
Payables
Cash Payments

Debt
Taxation

(90)

—Debt Interest Paid→

(150)

—Tax Paid→

Debt Interest Paid
Tax Paid
Net Cash Flow from
Operating Activities

(300)
20
(480)

(90)
(150)
580

Cash Flow from Investing
Activities
Book Assets
Book Intangibles
Capital Payables

(200)

—Book Assets Capital
Expenditure→

(50)

—Book Intangibles Capital
Expenditure→

20

—Increase in Capital
Payables→

Book Assets Capital
Expenditure
Book Intangibles Capital
Expenditure
Increase in Capital

Payables
Net Cash Flow from
Investing Activities

(200)
(50)
20
(230)

Cash Flow from Financing
Activities
Debt

200

—Debt Drawdowns→

Debt Drawdowns

Debt

(100)

—Debt Repayments→

Debt Repayments

Debt

(4)

Ordinary Equity

50 —Ordinary Equity Raisings→ Ordinary Equity Raisings

—Debt Refinancing Fees
Paid→
—Ordinary Equity
Repayments→

Debt Refinancing Fees
Paid

Ordinary Equity

(100)

Ordinary Equity

(100) —Ordinary Equity Dividends Ordinary Equity Dividends
Paid→
Paid

1.10 I FINANCIAL ANALYSIS AND BUSINESS VALUATION

Ordinary Equity
Repayments

200
(100)

(4)
50
(100)
(100)


Ordinary Equity

(1)

—Ordinary Equity
Refinancing Fees Paid→

Ordinary Equity
Refinancing Fees Paid
Net Cash Flow from
Financing Activities

Balance Sheet

295

←Net Increase /
Net Increase /
(Decrease) in Cash Held— (Decrease) in Cash Held

(1)
(55)
295

Note that when the direct method is used to lay out a Cash Flow Statement, no reconciliation is
undertaken with Net Profit After Tax (NPAT) on the Income Statement – i.e. all line items within a Direct
Cash Flow Statement are actual cash inflows or outflows, not revenues or expenses.
The layout of a Cash Flow Statement is governed by the accounting standards and reporting
requirements applicable to each entity. It is also governed by the choices the entity makes (within the
boundaries of its reporting requirements) as to how it structures the presentation of its cash inflows and
outflows on its Cash Flow Statement.
Indirect Cash Flow Statement Layout
The diagram below shows an example of how a Cash Flow Statement might be laid out in order to
present the cash inflows and outflows of an entity during a period using the indirect method. The
diagram also shows where each of the Cash Flow Statement precedent modules would enter the Cash
Flow Statement and the type of information that would link in from each of these precedent modules:
Cash Flow Statement Layout – Indirect Method Example
(`)

Income Statement

490

Income Statement
Income Statement

210
100

Income Statement

200

Operating Receivables

Operating Payables

(200)
20

Debt
Taxation

(90)
(150)

Book Assets

(200)

Book Intangibles

(50)

—Net Profit After Tax
(NPAT)→
—Tax Expense→
—Debt Interest Expense→

Cash Flow Statement (Indirect) (`)
Cash Flow from Operating
Activities
Net Profit After Tax (NPAT)
490

(Add Back) Tax Expense
(Add Back) Debt Interest
Expense
—Depreciation &
(Add Back) Depreciation
Amortisation→
& Amortisation
—Increase in Operating Increase in Operating
Receivables→
Receivables
—Increase in Operating Increase in Operating
Payables→
Payables
—Debt Interest Paid→
Debt Interest Paid
—Tax Paid→
Tax Paid
Net Cash Flow from
Operating Activities
Cash Flow from Investing
Activities
—Book Assets Capital
Book Assets Capital
Expenditure→
Expenditure
—Book Intangibles Capital Book Intangibles Capital
Expenditure→
Expenditure

210

100
200
(200)
20
(90)
(150)
580

(200)
(50)

FINANCIAL ANALYSIS AND BUSINESS VALUATION I 1.11


Financial Modeling for Project Appraisal
Capital Payables

20

Debt
Debt
Debt

200
(100)
(4)

Ordinary Equity
Ordinary Equity

50
(100)

Ordinary Equity

(100)

Ordinary Equity

(1)

Balance Sheet

295

—Increase in Capital
Payables→

Increase in Capital
Payables
Net Cash Flow from
Investing Activities
Cash Flow from Financing
Activities
—Debt Drawdowns→
Debt Drawdowns
—Debt Repayments→
Debt Repayments
—Debt Refinancing Fees Debt Refinancing Fees
Paid→

Paid
—Ordinary Equity Raisings→ Ordinary Equity Raisings
—Ordinary Equity
Ordinary Equity
Repayments→
Repayments
—Ordinary Equity Dividends Ordinary Equity Dividends
Paid→
Paid
—Ordinary Equity
Ordinary Equity
Refinancing Fees Paid→ Refinancing Fees Paid
Net Cash Flow from
Financing Activities
←Net Increase /
Net Increase /
(Decrease) in Cash Held— (Decrease) in Cash Held

20
(230)

200
(100)
(4)
50
(100)
(100)
(1)
(55)
295

Note that when the indirect method is used to lay out a Cash Flow Statement, a reconciliation is
undertaken with Net Profit After Tax (NPAT) on the Income Statement – i.e. NPAT is used as a starting
point, after which adjustments are made for non-cash items in order to determine the cash inflows and
outflows during the period.
The layout of a Cash Flow Statement is governed by the accounting standards and reporting
requirements applicable to each entity. It is also governed by the choices the entity makes (within the
boundaries of its reporting requirements) as to how it structures the presentation of its cash inflows and
outflows on its Cash Flow Statement.
Location
The diagram below shows the Cash Flow Statement Module contained within the Financial Statements
Module Area and shows the potential links between the Cash Flow Statement Module and all other
Modules:

1.12 I FINANCIAL ANALYSIS AND BUSINESS VALUATION


1.2 FINANCIAL MODELING - CONCEPTS AND APPLICATION
Financial modeling is the task of building a financial model, or the process of using a financial model for
financial decision making and analysis.  It is an abstract representation of a financial decision making
situation.  By abstract representation, we really mean a mathematical model, and to be practical,
a computer based mathematical model.  The model usually represents an ongoing business, or a
project that requires investment.  Financial models are not limited to profit making entities.  Non-profits,
governments, personal finances – all can be represented by financial models.
A financial model illustrates relationships using real (realistic) numbers so that it can answer “what if?”
questions or make projections. Hence, a Model specifies the relationship between inputs and outputs.
Uses of Financial Modeling
Financial modeling is used to do historical analysis of a company’s performance, and to do projections
of its financial performance into the future.  Project finance is another area that lends itself to financial
models.  A project (such as a real estate investment or a new factory) can be analyzed using a financial

model.  It does not have to be complete business.
Financial Modeling is not just for the Accountant or Financial Consultant, who are called upon to
develop financial projections, but also for business owners and managers.  With improved user interfaces
and heavy use of graphics, it is now feasible for non-technical people to use a financial model to test
options and make decisions based on the projected impact on profits and cash flow.
Types of Financial Models
Financial models are often developed over the course of months and years, and many financial
analysts get caught up the grind of building, auditing and maintaining existing financial models on a

FINANCIAL ANALYSIS AND BUSINESS VALUATION I 1.13


Financial Modeling for Project Appraisal
daily basis, losing the big picture of understanding best practice modeling solutions used in business
and economic decision analysis.
It is therefore useful for a good financial analyst to take a step back, examine the broad categories of
financial models that are commonly used, and determine the optimal approach for the financial and
business modeling of different scenarios and situations.
Let us first re-visit the basics, and look at how financial models can be related to its usage in modeling
an economy, industry or company.
(i) Macroeconomic Financial Models
The models are usually econometric analysis based, built by government departments, universities
or economic consulting firms, and used to forecast the economy of a country. Macroeconomic
models are used to analyze the like effect of government policy decisions on variables such as foreign
exchange rates, interest rates, disposable income and the gross national product (GNP).
(ii)Industry Financial Models
Industry models are usually econometric based models of specific industries or economic sectors.
Industry models are often similar to macroeconomic models, and typically used by industry associations
or industry research analysts to forecast key performance indicators within the industry in question.
(iii) Corporate Financial Models

Corporate financial models are built to model the total operations of a company, and often perceived
to be critical in the strategic planning of business operations in large corporations and startup companies
alike.
Almost all corporate financial models are built in Excel, although specialized financial modeling
software are increasingly being used especially in large corporations to ensure standardization and
accuracy of multiple financial models.
Now that we’ve looked at the context of financial models from an economic and financial analysis
perspective, let us now examine financial models specifically from a financial modeling build
perspective. Financial models can generally be classified into 3 categories:
• Deterministic Financial Models
• Simulation Based Financial Models
• Specialized Financial Models
(a) Deterministic Financial Models


In a deterministic model, a financial analyst enters a set of input data into a spreadsheet, programs
the spreadsheet to perform a series of mathematical calculations, and displays an output result.



A Deterministic Model generates the same output every time you calculate.



Most deterministic financial models are built by performing an analysis on historical data to derive
the relationship between key forecast variables. In a corporate context, historical accounting
relationships are often used to forecast key revenue and cost variables.

Most deterministic models use one or two dimensional sensitivity analysis tables built into the model
to analyze the question of risk and uncertainty in the model’s output results. Each sensitivity analysis
table allows a financial analyst to perform a “what if” analysis on 1 or 2 variables at a time. The
advantage of sensitivity tables are its simplicity and ease of integration into existing deterministic
financial models that have already been built.



Multiple sensitivity analysis tables can be combined in a scenario manager. The scenario manager
is useful when there are interdependencies between the changing variables, as financial analysts
can configure and change multiple variables in each scenario.

1.14 I FINANCIAL ANALYSIS AND BUSINESS VALUATION