Constructing Basic Financial Model

Quick reference

• 00:05 We move on.
• 00:06 I'm looking at constructing the model, and particularly looking at the financial
• 00:10 statement outputs as my first thoughts before we think about it in more detail.
• 00:16 Just for a change I thought I'd put this slide up, because I was getting withdrawal
• 00:19 symptoms having not looked at it for at least three minutes.
• 00:22 We've already considered some elements in these key points.
• 00:25 We've considered the three financial statement times.
• 00:28 We've looked at what "three-way integrated" means.
• 00:31 And during that discussion,
• 00:32 we considered that not all financial statements are born equal.
• 00:36 Some consider more elements than others.
• 00:39 The income statement, for example, only looks at net operating profit after tax,
• 00:43 whereas the cash flow statement is conceptually larger.
• 00:46 Was also looking at the operating elements, it's also looks at investing and
• 00:49 financing cash flows, too.
• 00:51 The balance sheet is larger than both of them because it encapsulates them both.
• 00:55 They both link in.
• 00:56 But then it provides other detail as well.
• 00:58 We look at the transfer between non current to current, or vice versa.
• 01:02 We look at reserves and movements there.
• 01:04 There are things that don't get picked up by any other financial statements, so
• 01:07 we have a hierarchy.
• 01:08 And that's what we need to consider when constructing the basic model and
• 01:11 the financial statements first.
• 01:13 Once we've got a grasp, we can then consider the overall question the graphic
• 01:17 begs, which is how do you eat an elephant?
• 01:19 It's an overwhelming task, building a financial model.
• 01:23 But what you have to think is you eat one piece at a time.
• 01:26 So conceptually what's the order we should put it in?
• 01:28 More on that next time.
• 01:30 Let's first of all put the key ideas about constructing this basic model first.
• 01:36 As I said before there were three financial statements.
• 01:38 The income Income statement, the summary of revenues, cost of goods sold, and
• 01:41 expenses.
• 01:42 The balance sheet, showing net worth, the status of assets, liabilities and
• 01:46 equity at a point in time.
• 01:47 And the cash flow statement, summarizing cash is cash is cash,
• 01:50 looking at operating, investing and financing activities.
• 01:54 We have to consider modeling them all.
• 01:56 And in the order of hierarchy, it will be income statement first,
• 01:59 cash flow statement second, balance sheet bringing up the rear.
• 02:04 Technically then, through the constructing the financial statements,
• 02:07 which is what I'll want to look at this particular time.
• 02:09 It's a very simple process.
• 02:11 You actually build the first one up, you repeat for
• 02:13 the second smallest financial statement afterwards.
• 02:15 And you build the financial statements from the chart of accounts as you go.
• 02:19 So you put in the actual line items.
• 02:22 So the chart of accounts will be provided to you by an accountant.
• 02:24 It might be provided from a management information system.
• 02:27 You might get it from reported accounts.
• 02:29 You need to produce all that.
• 02:30 You put all the line items in, put in the subtitles where you need to,
• 02:34 build the formulas, and
• 02:35 make sure that the opening balance sheet that you're given will actually balance.
• 02:39 Once you put in your subtitles, and you put the links between the statements,
• 02:42 we can build our checks to make sure the balance sheet always balances.
• 02:47 We start with the smallest financial statement conceptually and
• 02:50 then we put in any calculations that are missing.
• 02:53 We're going to build control accounts as we go.
• 02:55 We just don't know the order.
• 02:57 We can't move on from one line item to the next until we make sure that the balance
• 03:00 sheet balances.
• 03:01 It brings up a question well, what's the order of doing anything?
• 03:05 I could just pick anything.
• 03:06 Do I start with interest, or do I start with depreciation?
• 03:08 What's the first item?
• 03:10 And this brings us to that question about how do you eat an elephant.
• 03:14 Yes it's one piece at a time, but which piece is first?
• 03:17 So let's consider that question now in more detail.

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