Input parameters of the financial model and the principles...

Input parameters of the financial model and the principles of their formation

When forming the input parameters of a financial model, analysts follow certain rules. Consider them.

1. Analysis step. The choice of the time step for building an analytical model is linked to the analysis objectives (rapid assessment or feasibility study of the business plan that is formed to attract capital). For express analysis, the time step can be selected in a year. For more detailed analysis, monthly or quarterly steps are often chosen.

2. The currency of analysis (construction of cash flows). The choice of the analysis currency can be dictated both by simplification of procedures for forecasting price changes (for example, the forecast in the currency of the country with no inflation or its low value), and actual receipts and outflows (for example , if the project is oriented to the external market or if a significant share in the costs is occupied by imported components).

3. Cash flow forecasting. Cash flows ( cash flow), should be predicted and not profit on fixed time intervals (steps). The main principle underlying this rule is "live" money, not "paper"; profit. Therefore, it is necessary to take into account the effects of freezing profits in stocks, accounts receivable. In case of problems in VAT offset, this influence on cash flows and the need for additional capital raising should also be taken into account. In cash flows, it is advisable to allocate: operational, investment (associated with the formation of assets) and financial (related to the attraction of capital and settlements with investors). Net cash flow ( net cash flow, NCF) is the difference between the receipt of money for the period from operating activities and outflows, i.e. it is equal to the operating cash flow ( OCF). The investment project analyst rarely uses free cash flow (FCF), , which is very popular in valuation activities and in value terms analysis of the company. The reason is a more attentive attitude to risk and introduction of various discount rates for operating and investment flows. FCF - the difference between OCF and investment outflows. Often the forecast of operating cash flow is based on the forecast operating profit. The analytical indicator, close to the operating profit (profit on sales) by financial reporting standards, is EBIT (earning before interest and tax).

Operating cash flow for the year = Operating profit for the year - Income tax + Amortization for the year - Growth for the year of accounts receivable - Growth for the year of inventories and three articles + Growth of accounts payable.

Analytical indicator EBITDA = Operating profit + Amortization.

If for the period under consideration, for example, a year, not growth is assumed but a decrease in the receivables, then in the calculation of the operating cash flow ( OCF) the element of the receivable creates a positive effect (i.e. amount of decrease). The more a company or project within its framework allows to increase accounts payable without increasing the risk (due to flexible relationships with suppliers), the higher the cash flow and the higher the project estimate. Thus, the financial model allows to take into account not only the actual production effects from the investment decision, but also changes in the relationships with counterparties, i.e. reflect the impact of the project on the business.

4. Accounting for the interests of financial stakeholders. The adopted algorithm for the analysis of investment proposals - two-stage. At the first stage, the analyst abstracts from sources of financing investment outflows and simulates input parameters, and also evaluates the project "by itself". The output result is the evaluation of the commercial efficiency of the project. At the second stage, the possibility of creating an additional cost or improving the financial sustainability of the project by various financial schemes is considered. the participation in the project of the creditor and other co-investors is modeled.

5. Initial investment. It is necessary to consider all the requirements for initial investment. It is necessary to take into account investments both in the creation of fixed capital (long-term assets) and in working capital.

The emphasis in working capital analytics should be made on the needs for creating stocks (raw materials, materials, finished products), the duration of the production cycle, the need to grant a deferred payment (creating a receivable) and the ability to work on commodity loans (accounts payable).

6. Correct accounting of costs incurred is required. Analysts allocate so-called irrecoverable costs ( sunk costs), which should not be included in the financial model, although they may amount to a significant amount . The most striking example is the cost of the pre-investment phase of considering business proposals for the creation of new assets or the purchase of existing ones. The criterion for allocating non-recurring costs is the lack of connection with the projected operational flows of the project. Irreversible flows are not relevant to the expected project flows. As a rule, these are flows related to projects with other objectives (studying the environment, choosing investment directions).

The rule of allocating irreplaceable costs : these are the costs that occurred earlier and do not affect the current solution.

Example 1

The research division of the pharmaceutical company has been working for three years to create a new drug for infertility. At the beginning of the work it was assumed that it would be possible to complete the studies for a year and a half and the budget would not exceed 0.8 million dollars. Taking into account the potential of the market for consumption of the new drug and the projected investment costs of the project, the project was estimated at $ 2 million. However, at the moment, $ 2 million has already been spent, and although a number of possible chemical compounds have been rejected because of the negative impact on the body, developers have an interesting solution to the problem in their stocks. The subdivision submits a project for which $ 1.3 million is required to be invested, and within a year it will be possible to begin experimental testing of samples, and within two years to begin mass production. The present value of benefits is estimated at $ 3 million. Should we finance the work for another year?

If you consider all previously incurred costs as investment, then the project is ineffective. However, from the point of view of investment analytics this decision is not true. At the current moment, it is possible, having spent $ 1.3 million, to get a given estimate of the benefits of $ 3 million, which is an investment-attractive option for investing money. Development should be profited.

7. Accounting for lost profits.

Example 2

The company has an already constructed building that can be used in the project. The total result (reduced revenue) for the project is 1000 den. units, and the cost is 600 den. units (without taking into account the cost of the building, but with the inclusion of costs for its maintenance). Suppose that you can rent a building (or sell), receiving 500 den. units If the project provides for the use of the building, then the opportunity cost, or the lost opportunity (opportunity cost), should be valued at 500 den. units Calculation of the effect of the project should be carried out as follows:

1000 - 600 - 500 = -100 (den units) & lt; 0.

Note that within the accounting model of analysis, accounting profit is 1000 - 600 = 400 (den. units) & gt; 0. From an accounting point of view, the project is effective, and from the point of view of cost analysis - not effective and should be rejected.

If the alternative costs were only 100 den. units, the project would be effective and it should be accepted. With a lost profit of 400 den. units, the economic effect of the project would be 1000 - - 600 - 400 = 0. Analytics would show that the adoption of the project is not the worst option than the rejection of it.

8. Accounting for incremental effects. Many companies implement projects that allow using existing reserves (areas, labor, heat, energy, etc.). In the financial model, it is important to allocate investment outflows going specifically to the project in question and the operational benefits and costs directly associated with the project.

9. Accounting for external effects ( externalities ). Many projects implemented by companies affect the operating cash flows of current activities, even directly not related to the project in question. A new product brought to the market can reduce the demand for pre-existing products of the company or, on the contrary, attract attention to them and increase demand. Such effects should be properly taken into account when building a financial model of the project.

10. Accounting for the final cash flow (), which is formed in the last years of project life at the final (liquidation) phase. The accounting of investment outflows in connection with legal, environmental and tax requirements at the completion of the project is mandatory. For a number of projects (extraction and processing of natural resources, pharmaceuticals), investment outflows can be significant. Do not also forget about the cash flows generated from the sale of fixed and current assets under the project and related tax effects (if non-current assets are sold at a price above or below the book value). In a simplified form, the final cash flow is calculated as follows:

Final cash flow = Projected flow by operating activity of the project + Income from the sale of assets +/- Profit tax (loss) on the sale of assets + Return on invested working capital.

11. Compliance with monetary results and profitability thresholds reflecting investment alternatives. When forming the parameters of a financial model, it is important to adhere to the rule of compliance of the forecast macro and industry parameters and the required return on investment. Matching Rule : projections of operating cash flows at the prices of the corresponding year (nominal flows) should be accompanied by an estimate of capital costs in nominal terms. Real cash flows (predicted in basis prices) should correspond to real rates, i. cleared of inflationary expectations. Compliance should also be performed in terms of the currency of the forecast of cash flows, the degree of their risk.

12. The principle of imposing a project on a company. To evaluate a project, the project itself is first considered (a conditional allocation scheme is used), its economic efficiency and financial solvency are analyzed, then the company's financial plan is developed without a project, then at the level of the basic forms of financial reporting (balance sheets, profit statements, cash flows) combine the results of the current activities of the company and the project. On the basis of the combined reports received, a conclusion is made about the financial soundness of the company as a whole, taking into account the project. The problem in implementing this principle is the cumbersomeness of all the constructions, the conventionality of the project description (the project related to the modernization, the change in the technology of the existing production, will hardly yield to a separate description), and some artificiality in the process of overlapping (not all functions have additivity, for example, in terms of determining the amount of taxes).

With special caution, one should approach the formation of a financial model of investment decisions that do not directly affect the company's cash flow increase, but ensure an improvement in management quality, form a positive image of the company (for example, projects for the modernization of the company's management system (ERP- systems), updating of accounting software and analytics). Such projects with a large share of conventionality can be linked to the savings of current costs or the creation of additional cash flows. As a rule, for such projects special analytical models are being developed, the emphasis is on qualitative results.

The main point in building a financial model for expanding or modernizing functioning real assets is the correct accounting of incremental cash flows.

When calculating operational (current) costs associated with the implementation of the project, you must follow the rules listed below.

1. Allocate costs that will change in connection with the implementation of the project (element-by-element, constant). It is advisable to evaluate the change in costs on the basis of the principle "it will be - was". Note that the changes received can have different signs: plus - Increase costs, minus - cost reduction, 0 - no change in costs. Operating costs associated with the implementation of the project, it is unacceptable to identify with the cost of production for the current business. When estimating the increment of variable costs, the use of unit cost is justified (this calculation is analogous to calculations through the rate of resource consumption and its price). The change in fixed costs must be estimated for each cost item in absolute values ​​over a certain period.

Cost reduction projects are evaluated in a similar way: the reductions and/or incremental costs associated with the project implementation are considered (no increase in revenues in such projects may be observed). Reducing costs will entail an additional profit of the enterprise, which pays for the invested funds.

2. Cut costs that are not directly related to project implementation.

Example 3

The company is considering a project for the purchase of new equipment, which should significantly reduce the cost of production. In the forecasted budget of expenditure, an increase in current expenditures for advertising of products is also planned. When evaluating the effectiveness of the equipment replacement project, the increase in advertising costs should not be considered, since this growth should not affect the performance indicators of the asset renewal project. The growth of advertising costs should be taken into account in the flows in assessing the profitability of the product and the effectiveness of its preservation in the range.

However, when assessing the efficiency of modernization of any part of the production process, changes in the costs of the particular facility are often considered. Often additional profit and cash flows arise not on a specific site, but on the company as a whole. In this case, it is correct to consider effects on a number of objects. It is important only to make sure that the effects really arose from the implementation of investment outflows.

3. Reflect the tax shield by depreciation. Amortization in the financial model is treated as a "non-cash outflow", so it is not taken into account. But, as a rule, investment projects lead to an increase in depreciable assets. On the one hand, this generates an increase in the property tax, and on the other hand - gives the organization the opportunity to reduce the profit tax, i.е. to realize the effect of the "tax shield". Additional savings on the profit tax in equipment replacement projects can be calculated using the formula

Annual tax bill from the project implementation = (Depreciation charges for new project assets - Depreciation deductions for the retired assets of the project) x Income tax rate.

Tax savings are monetary benefits and should be taken into account in the financial model of the project.

Example: calculation of incremental cash flows

Stock Vector-M uses as a target capital structure a financial lever (FC/SC), equal to one. The company's shares are quoted on the exchange, and the beta-factor estimated by analysts is 1.1. The company is considering an investment project related to the modification of the company's traditional products - targeting it to new sales markets and meeting new needs. Marketers expect the preservation of competitive advantages for the project for a period of at least five years.

The prevailing market characteristics: risk-free profitability k ( - 8%, premium for market risk - 10%.) The industry beta coefficient of manufacturers of new (modified) products is 1, 3.

The investment project of the company will make changes in cash flows. So, according to forecasts of planning department and marketing department, revenue will increase by 40 million rubles.

Sales and production costs will decrease by 4 million rubles. Administrative costs will increase by 1 million rubles.

Stocks of raw materials will increase by 10 million rubles.

Accounts receivable will increase by 18 million rubles.

Accounts payable to suppliers will increase by 10 million rubles. Information about the project:

■ the cost of equipment - 100 million rubles.

■ The tax rate of depreciation for this equipment is 20% (equipment life is five years)

■ the expected liquidation value of the equipment - 10 million rubles.

■ costs for the delivery of equipment - 5 million rubles., installation will cost another 5 million rubles.

■ amortization is uniform. The rate of income tax is 24%.

The company uses borrowed funds, attracted at 18% per annum. Interest payments completely reduce the taxable base.

Should I accept the project?

Sieve (all estimates in million rubles).

It is important to show investments in the main and negotiable captain.

Investments in the OS - 110.

Investments in NWC = 18 + 10 - 10 = 18.

The project review period is five years.

Incremental cash flow of each year = (40 + 4-1) (1- tax rate) + Taxation board for depreciation = (40 + 3) (1 - 0.24) + Annual depreciation • 0.24 = 37, 96.

Annual depreciation = 110/5 = 22.

We are not interested in liquidation or residual value here, as attention is focused on tax depreciation.

In the fifth year there will be additional flows for the sale of equipment for 10 million rubles. and the tax on this income and the return of working capital, i.e.

CF 5 = (40 + 3) (1 - 0.24) + 22 • 0.24 + 10 (1- 0.24) + 18 = 63.56.













WACC = 0.5 • 18% (1 - 0.24) + 0.5 (8% +1.3 • 10%) = 17.34%

Such a calculation does not take into account the portfolio effect of the project. The project of new products is more risky, and it meets the increased required profitability.

NPV = -128 + PV projected project flows = +4.

You can accept the project.

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