There are numerous ways to value a company. Each method has its pros and cons and are usually used in combination to triangulate a value. Of course, the value is ultimately set by the buyer.
This post will give an example of public comparables methodology. A public compset is a select set of publicly traded companies where price metrics and operating metrics are laid out in a table for comparison with the target company. The example below is a quick compset I threw together of internet companies with Apple and RIMM thrown in for comparison.
What companies to include
Ideally, there are direct competitors and pure plays, meaning they only focus on that one product/service. You can also include companies that offer similar services. In our example compset below, most are internet/tech companies. But there is a sub-segment of pure internet companies if you remove Apple and RIMM.
You can also segment the list based on size or other outliers.
In my experience, the ideal list size is 7-10 companies.
Continue reading “Valuation Methods – Public Comparables”
Capital Expenditures aka CapEx is the spending of money to buy or fix assets. CapEx is typically related to buildings, property, equipment. Many financial models are built to help determine growth and expansion plans that require spending money on equipment and other assets. Understanding the relationship between CapEx, deprecation, and the financial statement is a very important aspect of financial modeling.
In the current sample financial model, deprecation and CapEx are not forecasted to change. However as the business grows, additional equipment is needed.
In the new model, we CapEx spending in Years 5,6 and 8.
Days Sales Outstanding (DSO), Days Payable Outstanding (DPO), and Inventory Turns are some key metrics for company analysis. While they are just some simple calculations, they tell are story about how a company is doing.
In the balance sheet assumptions section of the model, see below, we calculate each metric and then make assumptions about the forecast values.
Continue reading “Days Sales Outstanding, Days Payable Outstanding, and Days Sales Inventory”
What is a circular reference?
A circular reference is when a cell refers to itself directly or indirectly.
Are circular references bad?
In most cases, a circular reference should and can be avoided with some planning. However, in a complex financial, I found it easier to just use circular references in certain areas.
Circular References in Financial Models
Circular references are used to help calculate cash balances. Let’s walk through two typical cases.
The cash sitting in the bank generates interest. The interest income is taxed and lowers the net income. More cash -> more interest -> more tax -> lowers net income -> effects cash.
See the example below. To determine the amount of interst, we use an average of the forecasted beginning and ending cash balances. It’s not fair to use just the beginning or the ending cash balances to calculate interest because over the time period that balance will change. Continue reading “Circular References in Financial Models”
One of the hardest parts of building a financial model is getting the balance sheet to balance, meaning the basic equation of Assets = Liabilities + Shareholder’s Equity is true.
The balance sheet itself is not the problem, it is usually the cash flow statement that introduces the error.
Here are some tips to make sure your cash flow statement is correct to ensure you calculate the correct ending cash balance.
For a working model, start with the basic financial model.
Make sure you rebuild the historical cash flow statement with formulas, that’s the only way to ensure you’ve accounted for all numbers and everything will flow going forward.
All line items on the balance sheet must be used in the cash flow statement. Continue reading “How to Balance Your Balance Sheet”
Forecasting the income statement is the first step to building
Rebuild the historicals
To forecast the income statement, you have to understand the historicals. So start by rebuilding the financial statements. This means taking the given values and adding formulas where necessary.
If you want to give it a shot (highly recommended), you can download the values only version and rebuild the financial statements by adding in formulas for all three financial statements. Continue reading “How To Forecast The Income Statement”