Miguel Patomiguelpato@arnet.com.ar

Modelos

In the Beginning….

….was the Word.

The Black Box

Inputs OutputsProcess

Modelling Best Practice

Introduction Historic data entry Forecasting Scenario Modelling Risk Analysis

Introduction

Introduction - What are we doing?

Problem Identification

Solution Generation

Financial Validation

Stakeholder Negotiation

Implementation

Introduction - Why use a financial model?

Facilitate diagnosis of historic performance..

...in order to identify areas for improvement and..

...evaluate the impact of new strategies...

...upon the cash requirements going forward

Introduction - Using Financial Models

ProblemIdentification

FinancialValidation

SolutionGenerationImplementation

FinancialModel

StakeholderNegotiation

Historic Data Entry

Historic Data Entry3 years historic data

spothistorictrends..

Current year

..understandwhere weare..

3 years forecast data

..and planfor the future

Problem Identification Solution Generation

Historic Data Entry

Must be consistent and credible….

… hence must reconcile to audited accounts

Audited Accounts

Trial Balance

Model - historic data

Historic Data Entry

Must be consistent with internal budgetting process...

…. hence must reconcile to management accounts.

Audited Accounts

Trial Balance

Management Accounts

Model - historic data

Historic Data Entry

Must distinguish between operating activity...

Profit & Loss Balance Sheet Cash flow

Turnover

Earnings BeforeInterest & Tax

Net OperatingAssets

Net FreeCash Flow

…and financial activity

Interest & Quasiinterest

Net Financialdebt/quasi debt

Interest & Capitalmovements

Historic Data Entry

Must allow (de)consolidation of Business Units (SBUs)

CoreBusiness

AerosolsCosmetics +

Swallowfield

Belgium(SCPSA)

BusinessTransferred

Journaladjustments

Historic Data Entry

Must identify cash flow between (SBUs)

Profit & Loss Balance Sheet Cash flow

Turnover

Earnings BeforeInterest & Tax

Net OperatingAssets

Net FreeCash Flow

Interest & Quasi

interest

Net Financialdebt/quasi debt

Interest & Capital

movements

Inter-SBUtrading/interest

Inter-SBU loans/balances

Inter SBUfunding

Historic Data Entry Must reflect our knowledge of the business!

EconomicTe

chno

PhysicalPo

litic

/lega

lSocio/culturalDemographic

Competitors

Supp

liers

Custom

ers

Public

Dis

trib

utor

s

SBUC

ompa

ny

Historic Data Entry Understanding market means understanding PLC

CumulativeRevenue

Time

New Users,NewMarkets

NewProducts

DevelopNew Markets

IncreaseUsage

WinCompetitorsCustomers

Compete inExistingMarket

Increasevolume

ImproveSales Mix

IncreasePrices

IncreaseMargins

VariableCosts

FixedCosts

ReduceCosts

ImproveProductivity

Long TermProfit

Improvement

Forecasting

Forecasting Identify and quantify corporate strategy

Stakeholderexpectations

Cos+ Plc AIL

FirmValue

Creation

Identify drivers ofperformance

Ensure measures areinternally consistent

Align the firm’s goals and decisionprocesses with corporate strategyand sources of value

External StakeholdersUnderstand how externalstakeholders perceive thevalue of the firm

What drivers?

What measures?

What measures?

Forecasting Identify performance drivers/measurement criteria

Performance Driver Measurement Criteria

Operating PerformanceProjections

Revenue growth,Margins & Earnings

Working CapitalPerformance Objectives

Debtor & Creditor DaysStock Turnover

Capital ExpenditureRequirements

% EBDIT reinvested,% opening assets

Financial ResourceRequirements

Cash Generation, Head Room &

Bank Relationship

Forecasting Encourage appropriate ownership

Operating PerformanceProjections

Revenues Margins Overheads

Sales & marketing

OperationalDept/ Heads

HR, FinanceDept. heads

Forecasting

Assumptions

Proforma

Revenue

SALES & MARKETING ASSUMPTIONS

Volume

Price

1999 2000 2001

Absolute

100

£20

£2,000

Sales = VxP

Do not become slave to an assumption

Forecasting Consider the best modelling approach …. ...and base future assumptions on historic performance

Example Plc Capital Expenditure Assumptions

1995 1996 1997 1998 1999 2000 2001 2002 2003

Capital ExpenditureLand & Buildings Capex 6 164 351 200 50 50 50 50 50Plant & Machinery Capex 777 581 704 500 408 408 408 408 408Finance Lease Capex 783 745 1,055 0 0 0 0 0 0

DepreciationLand & Buildings Dep'n - % of opening cost -3.94% -4.32% -4.28% -5.43% -5.00% -5.00% -5.00% -5.00%Plant & Machinery Dep'n - % of opening cost -8.00% -7.70% -8.18% -7.60% -6.50% -6.50% -6.50% -6.50%Finance Lease - % of opening cost -28.24% -23.96% -15.72% -7.76% -7.09% -7.09% -7.09% -7.09% -7.09%

Forecasting Model cash at bank as the balancing figure

BALANCE SHEET £ £

Net Assets 100 100

Cash 0 (6)Overdraft (30) (30)Loans (30) (30)Net Debt (60) (66)

Share Capital (20) (20)Reserves (25) (20)P&L 5 6Capital & Reserves (40) (34)

PROFIT & LOSS £

EBDIT 10Depreciation (10)

EBIT 0Interest (6)

EBT (6)Tax 0

Profit f/y (6)

Avg debt x r%

Net Assets - Capital & Reserves

Scenario Modelling

Scenario Modelling Simple forecasting doesn’t fit all business decisions

years

Revenue

SingleScenario forecastingMulti-scenario

ModellingMulti-scenarioModelling with risk

Scenario Modelling

Investment in model depends upon strategic impact

StrategicImpact

Level of uncertainty

Sensitivity Analysis

Scenario modelling

Scenarios with risk

Scenario Modelling Mapping Swallowfield’s decision process

NPV (future losses)

BENEFIT

WINDDOWN

WALKAWAY

COST BACKLASH UPSIDE

Scenario Modelling Benefit

NPV (Future cash losses) = Avg (op.cash deficit 1996-1998) x(1+g)(r-g)

= £1 million x 12.1 = £12.1 million

Scenario Modelling Cost

Swallowfield C.P. SA- £UKWind Down P/(L)

12/31/98 Break-up Additional Break up Working cap on secured Debt Termination Items Net Assets reval Obligations Provision Net Assets Wind Down asset Substitution liabilities Retained

Fixed Assets 1,566 (711) 855 (855) 0Stock 1,330 (676) 654 654Other debtors 302 (262) 40 (40) 0Debtors 1,040 (313) 727 (727) 0

Creditors (1,165) (1,165) 1,165 0Other Creditors (364) 232 (132) 132 0O/D 0 0 0 0Leases (6) (6) 6 0BBL (977) (977) 977 0Lloyds (364) (364) 364 0

Employee Termination (1,202) (1,202) 1,202 0Contract Termination (76) (76) 76 0Ernst & Young Provision (455) (455) 455 0

NET ASSETS 1,362 (2,101) 654Asset impairment (1,730)

Additional Obligations (1,278)(455)

Working Cap wind down (530)P/(L) on secured asset (129)

Debt Substitution (364)Termination payments(1,732)

P/L Effect (3,463)

Cash Effect of Wind Down (2,755)

Scenario Modelling UpsideSwallowfield - New Business M&S Hema Other Existing UK

Hema Total

£'000 £'000 £'000 £'000 £'000Benefits of Controlled Wind Down - YEAR 2 OnwardsPotential New Business (Net of Discounts) 770 1,989 1,115 500 4,374 Direct Costs % 60% 62% 51% 58%Gross Profit on Potential New Business 308 753 551 210 1,822

Probability of Business Transferred/(Lost) - Controlled Wind Down 95% 70% 40% 0% 2,570£ Probability of Business Transferred/(Lost) - Walk Away 95% 0% 0% (20%) 632£ Increased Probability of Securing Business 0% 70% 40% 20% 1,938£

Expected Gross Profit - Controlled Wind Down 293 527 220 0 1,041Expected Gross Profit - Walk Away 293 0 0 (42) 251Expected Additional Gross Profit per annum 0 527 220 42 790

Indirect Costs - Controlled Wind Down 125Indirect Costs - Walk Away 106Expected Additional Costs per annum 19

Expected EBIT per annum - Controlled Wind Down 916Expected EBIT per annum - Walk Away 145Expected Additional EBIT per annum 771

Costs To Achieve Controlled Wind DownCapital Expenditure 50 50 100Set up Production Line (Moulds) 50 50 100Incremental Costs of Controlled Wind Down 1,239

1,439

Expected Payback Period 1.8

Incremental Costs of Controlled Wind Down£'000

Controlled Wind Down 2,916 Walk Away 1,677 Difference 1,239

Risk Analysis

Risk Analysis How can we assess the risk in the funnels?

NPV (future losses)

BENEFIT

WINDDOWN

WALKAWAY

COST BACKLASH UPSIDE

Risk Analysis

cbdemo.exe

Real Options

Real Options

Are all decisionsreally

irreversible?

Real Options Early decisions

NPV (future losses)

BENEFIT

WINDDOWN

WALKAWAY

COST BACKLASH UPSIDE

Real Options

Treating Investment Opportunities as a Call Option

Real Options

Mapping Black & Scholes to an investment decision

PV (OP. ASSETS)

COST OF ASSETS

DEFERRAL PERIOD

EXERCISE PRICE

TIME TO EXPIRY

STOCK PRICE

RISK FREE RETURN

STD DEV. OF RETURNS

TIME VALUE OF MONEY

RISKINESS OF PROJECT