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Limited preview of IMS Proschools Handbook of Financial Modeling.

This handbook prepares you for NSE India Financial Modeling Certification.
For more information visit: www.proschoolonline.com

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Financial Modeling Session - 1

Financial Modeling
Introduction

This section briefly describes financial modeling and its application. The section will help you to get an overall perspective on how building this skill can help different finance professionals.

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What is a Financial Model?


It is a representation for numerical flow of any financial data.

It is a decision making and planning tool for finance professionals. It is performed with the help of a spreadsheet or some dedicated financial software.
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Who makes financial models and why?


Various finance professionals It is widely used in financial decision making and planning who use financial modeling are: processes to answer Bankers questions such as:
Is the stock undervalued or overvalued? Whether to make investment in the project or not?

Investment Bankers Project Finance professionals Equity Researchers

Should loan be given for a


project or not? What is the rating of the project or company?
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Financial Planning
Advisors PE & VCs Hedge Funds
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What does a model look like?


A models can be very basic , perhaps a single excel sheet OR It can be 30-40 sheets or even multiple workbooks with several macros and can be fairly detailed and complex. It largely depends on the end use that you have in mind. If used for internal analysis it may remain a simple Excel worksheet or the final output may be a well done report.

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Example

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Attributes of Good Models


Realistic
Assumptions used in the model should be realistic to get realistic output else a common

saying prevalent among financial modeling professionals is Garbage in, Garbage out.

Error-Free
Many financial decisions are based on models, hence it should be error free for non-

erroneous decision.

Flexible
Changes are inevitable, hence the model should be flexible enough to incorporate any level of changes.

Easy to use
The model should make it easy for a user to understand the movement of figures.

Easy to understand
Should not be a one mans language.
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Prerequisites for Learning Financial Modeling


Knowledge of MS Excel Basics of Economics Accounting Fundamentals Financial Management

Knowledge of Financial
Market

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Financial Modeling Session - 2

Financial Modeling
Handling Spreadsheets
As you may have noticed, financial models are created in spreadsheets generally in Microsoft Excel though it could be in open office or other spreadsheets. So learning to handle spreadsheets is a preliminary requirement for financial modeling. This sections covers key functions and utilities within Excel that are critical for building financial models. It is highly recommended that you attempt and practice the exercises in this section and not just read through them, for obvious reasons.
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Financial Modeling

KEY EXCEL FUNCTIONS


THIS SECTIONS WALKS YOU THROUGH IMPORTANT EXCEL FUNCTIONS THAT ARE FREQUENTLY USED IN FINANCIAL MODELING. ITS IMPORTANT TO TRY THESE OUT IN EXCEL.

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Excel Functions What are Excel Functions ?

Excel Functions are built-in formulas based on predefined logic that makes it easy to calculate the output for a given data.
How to insert a Function?
Click Formulas tab in Excel. Within the Formulas tab click Insert Function. The dialog box shown on the right would appear on the screen. Desired function type can be selected from the drop down list.
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Excel Functions-Example

Find the total sales of the following particulars using excel:

How to insert a Function?


Click Formulas tab in Excel. Within the Formulas tab click Insert Function. In the dialog box select Sum function. Insert the numbers to be added in the text box of the sum dialog box.

Particulars Sales Iron Rods 105288 Iron Gurders 452278 Steel Sheets 265887 Iron Plates 248566 Total 1072019

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Excel Functions-Example

Find the total sales of the following particulars using excel:

Insert the cell references whose numbers is to be added.

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Excel Functions
Excel Functions Functions types used in Financial Modeling

Financial
Date & Timing

Text

Excel Functions
Statistical Logical

Math & Trig

Lookup & Reference


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Excel Functions Commonly used Functions in Financial Modeling


o Lookup & References Choose Offset Lookup VLookup HLookup Match o Sum Sum Sumif Sumifs Sumproduct Average Averageifs o Count Count Countif Countifs Counta CountBlank o Dates Year Month Day Date Date360 Edate

o If statement & its alternative If And Or Max Min

o Financial PV FV PMT Rate NPER IPMT

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Excel Functions Lookup and References

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Excel Functions Sum functions

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Excel Functions Count functions

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Excel Functions If statement and its Alternatives

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Excel Functions

CHOOSE Function: Find the sales of the particular - Iron Rods:


Formula: =CHOOSE(2,C2,C2:C5) Understanding of formula: 2nd figure from C2 from the range C3:C5.

OFFSET Function: Find the sales of the fourth particular:


Formula: =OFFSET(B1,4,1,1,1) Understanding of formula: In column B, get the value of particular in 4th row and 1 column from B.
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Excel Functions

Lookup Function: Find the sales of the Steel Sheets:


Formula: =LOOKUP("Steel Sheets",B2:B5,C2:C5) Understanding of formula: Looks up Steel Sheets in column B, and returns the value from column C that's in the same row (265887).

Match Function: Find the sales less than 150000:


Formula: =MATCH(150000,C2:C5,1) Understanding of formula: In column C, get the row whose value is less than 150000. Output: 1

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Excel Functions

HLookup Function: Find the sales value of the fifth row:


Formula: =HLOOKUP(C1,B1:C5,5,FALSE) Understanding of formula: Looks for the sales value of fifth row i.e. for Iron Plates.

VLookup Function: Find the sales values of Iron Plates:


Formula: =VLOOKUP(B5,B1:C5,2,FALSE) Understanding of formula: Looks up Sales value of Iron Plates in column C, from the range of particulars and sales.
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Excel Functions

FV Function: FV(rate,nper,pmt,pv,type) Find the FV of insurance premium paid where premium is 1000, risk free rate is 10% and time is 5 years:
Formula: =FV(B3,B4,-B2,0,0) Output: 6,105.10

PMT Function: PMT(rate,nper,pv,fv,type) Find the amount to be invested every year to get an amount of 6105.10 at the end of 5 years and risk free rate is 10%:
Formula: =PMT(B3,B4,0,-B2,0) Output: 1000
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Excel Functions

NPER Function: NPER(rate, pmt, pv, fv, type) Find the number of years of investment to get 6105.10 by making a payment of 1000 annually and risk free rate is 10%:
Formula: =NPER(B3,-B4,0,B2,0) Output: 5

RATE Function: RATE(nper,pmt,pv,fv,type,guess) Find the investment rate at which 1000 invested annually for 5 years would yield 6105.10:
Formula: =RATE(B3,-B4,0,B2,0,0) Output: 10%
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Financial Modeling

ERRORS IN EXCEL FORMULA BUILDING


HOWEVER EXPERT YOU MAY BE WITH EXCEL, YOU ARE LIKELY TO ENCOUNTER SOME OF THESE ERRORS WITH REASONABLE REGULARITY. UNDERSTANDING HOW TO CORRECT THESE MAY BE THE DIFFERENCE BETWEEN GOING HOME BEFORE OR AFTER MIDNIGHT.

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Errors in Excel formula building

Errors in Excel

Formatting

Division by Zero

Reference Error

Syntactical

Numeric

Circular Reference

######

#Div/0!

#Ref!

#Name?

#Null!

#Num!

Logical mistake

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Errors in Excel formula building

Error Type: Formatting Error ( ####)


Cause:
o This type of error occurs in a situation where the width of a column is not wide enough to show the data of a cell completely. o The formula in the cell produces a result that is too wide for the cell. o There is a negative number in the cell that has been formatted for dates or times. Dates and times in Excel must be positive values.

Rectification: (Either of them)


o Increase the width of column o Change the number format that suits the column width.
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Errors in Excel formula building

Error Type: Division by zero (#DIV/0!)


Cause: This type of error occurs when a non-zero number is divided by zero. Rectification: o Divisor can be changed to a non-zero number. o Cell reference can be changed. o Use a combination of IF statement and the ISERROR formula or IFERROR formula in 2007 excel.
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Financial Modeling

DATA VALIDATION AND ITERATION


AS ANALYSTS ARE BOMBARDED WITH A LOT OFF DATA, ONE SHOULD BE ABLE TO CHECK DATA VERACITY. THIS IS WHERE THE DATA VALIDATION FUNCTIONS COME IN HANDY. FEW EXCEL FUNCTIONS INCORPORATE POWER OF ITERATIONS. APPLICATION OF THESE CAN SIGNIFICANTLY IMPROVE THE TASKS ONE CAN DO IN EXCEL.

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Data Validation
It prevents invalid data entry in a worksheet.
o Select a cell. o Go to Data tab, Data Tools group and click Data Validation. o Validation tool can be selected from drop down list. o On selecting the Data Validation from the drop down list, the dialog box named Data Validation appears on the screen. o Validation rule can selected from the list.
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Data Validation-Example
In the data furnished below, there is a limitation while projecting the Commission/Bonuses. It should be whole number and should not be greater than 5000. handle the situation with Data Validation.
Account Employee Costs 110 Payroll 120 IRS/FICA/Wk comp/State/SDI 140 Retirement Plan 125 Commissions/Bonuses Subtotal Subcontractors & Services 201 Telecommunication Services 254 Advertising Subtotal Total Actual 45328 15997 6249 2720 70294 637 40 677 70971 Projected 60000 25000 8000 4500 97500 700 700 98200

o Select a cell. o Go to Data tab, Data Tools group and click Data Validation. o Select Data Validation from the list. Fill the requirements in the dialog box.

o Go to Input Message tab and enter some message.


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Data Validation-Example
o Select a cell. o Go to Data tab, Data Tools group and click Data Validation. o Select Data Validation from the list. Fill the requirements in the dialog box.

o Go to Input Message tab and enter some message.

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Iteration Functions Goal Seek Goal Seek works on the terms of cause and effect scenarios. It helps a user to see the effect on one item in the formula on the other. This can be used when you know the outcome of a formula but dont know one input in the formula.

Location of Goal Seek


o Go to Data tab, Data Tools group and click What-if Analysis. o Select Goal Seek from the list.

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Iteration Functions Goal Seek


o On selecting Goal Seek, a dialog box similar to one shown in right appears on the screen. o In Set cell box we have to fill cell whose value we know and value of the cell has to filled in next box i.e. To Value. o By changing cell should be the cell reference that changes to bring the desired output. o Follow the example for better understanding.

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Goal Seek-Exercise Calculate the EMI to be paid on a loan of Rs.1200 @ 2%/month for 6 months.

Formula: =PMT(B3,B5,-B2,0,0)

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Goal Seek-Exercise Final Outcome of the exercise.

Note: End of Period balance becomes zero. 40

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Iteration Functions Scenario Manager A scenario is a named combination of values that is assigned to one or more variable cells in a what-if model. Scenarios to forecast the outcome of a worksheet model.
Location of Scenario Manager
o Go to Data tab, Data Tools group and click What-if Analysis. o Select Scenario Manager from the list. o On selecting Scenario Manager, a dialog box similar to one shown in right appears on the screen. o Follow the Example for better understanding

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Scenario - Exercise The exercise is to see the effect of changes in Retail Price, COGS and/or Unit Seles Growth Factor on the profit of the company.

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Scenario Manager-Exercise Steps: o Click Add button on the dialog. o In the Add Scenario dialog box (Shown in image), fill any Scenario name. o In Changing cells box, write, B3:B3,B10. o Press Ok.

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Data Table Exercise Steps: 1. Row input cell (=N8) 2. Column input cell (=10) 3. Press OK button. Final Output of Data Table:

Check: For Revenue % Growth of 15% and Cost Margin of 70%, the Gross profit is 345.
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Data Summarization Pivot Table It is a data summarization tool. It makes easier to arrange and summarize complex data for better analysis. Location of Pivot Table
o Go to Insert tab, Tables group and click Pivot Table. o Select PivotTable from the list. o On selecting Pivot Table, a dialog box similar to one shown in right appears on the screen. o Follow the Example for better understanding

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Pivot Table - Exercise Prepare Pivot Table for the analysis of the following data:

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Pivot Table - Exercise Steps:


6. Drag and drop the field from list to areas as shown in the image in the right. 7. Gives the following output in the Pivot Area as shown below.

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Pivot Table - Exercise Steps:


8. Color can be changed as per requirement. The final output of the pivot table which shows the year wise sale of products geographically.

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