Eating an Elephant

Quick reference

• 00:04 I talk about eating an elephant.
• 00:05 What on earth am I going on about?
• 00:09 Well there's a wise old Indian proverb that says, how do you eat an elephant?
• 00:14 And the answer is, one piece at a time.
• 00:16 And I use this analogy for financial modeling, pretty much when people start
• 00:21 building financial models, they never actual get any tuition to begin with.
• 00:27 And it's a bit overwhelming, they don't know where to start.
• 00:30 And the way I say is, just think of it one piece at a time and
• 00:33 then it will all come together.
• 00:37 So what do I mean about eating an elephant?
• 00:40 Well let's consider a blank slate, literally.
• 00:45 One blank slate coming up.
• 00:49 Now, whenever you build a financial model, it's always gonna be different.
• 00:52 It's going to have different elements in it, and
• 00:54 it doesn't matter what model I build, it's never going to be what you build.
• 00:58 So let's put up some of the basic elements of a financial model you'd expect to see.
• 01:03 The building block in no particular order, and when I mean a particular order,
• 01:07 I mean exactly that.
• 01:08 Let's say we'll consider interest, we'll consider depreciation,
• 01:15 tax, revenue, cost of goods sold, operating expenditure,
• 01:20 capital expenditure, equity, debt, dividends,
• 01:25 debtors, creditors, amortization just a few.
• 01:30 Now look, I could have put in provisions, I could have put in inventory,
• 01:34 I could have put in bad debts, I have a lots of other things I could put in,
• 01:37 I've got to stop somewhere.
• 01:39 And the aim of this course is to try come up with idea of concepts and
• 01:42 how to allow for them.
• 01:44 And this is what have started to actually use, so
• 01:46 I just brainstorm these are things that I would put in there, so
• 01:50 the next thing I need to do is consider my financial model.
• 01:53 Okay, how it's actually looking?
• 01:55 Well I need, a boundary, one boundary.
• 02:00 Everything inside that green box has been in my model, and
• 02:04 everything that's not is not part of my model structure.
• 02:07 First thing I do after that then, is I put another boundary around it.
• 02:12 This is where I'll put in my checks infrastructure that I explained in
• 02:17 part one of the course.
• 02:19 Now when I'm building a model, it doesn't matter how complicated,
• 02:23 how sophisticated it might be,
• 02:25 you can break up a financial model essentially into eight consituate parts.
• 02:29 Now checks is one of them already, but then we've got the operational section.
• 02:34 We've got working capital adjustments, assets, financing,
• 02:39 tax wouldn't it be good if we can get ride of that one,
• 02:43 financial statements, and other outputs.
• 02:46 That's a total of eight different areas.
• 02:50 Now the thing really next to do is, okay, in my list on the left hand side,
• 02:54 where do they go in this model?
• 02:56 So I can start to mind map what's going on here.
• 03:00 And what order would I build it in?
• 03:01 Well, if I'm looking from that list, to be honest, the first thing you that you
• 03:06 should be thinking of building here probably, is not going to be depreciation.
• 03:11 It's probably going to be revenue, so let's take it out of the list.
• 03:16 Bang, thank you.
• 03:17 And we will actually put it into the model, and
• 03:19 that will go into the operational section.
• 03:22 So I would put in that, that's my revenue.
• 03:25 The thing that would then be dependent on this is probably cost of goods sold.
• 03:29 So again, I'll remove it from the list, and
• 03:32 I'll put it into my operational section.
• 03:35 Can you guess where I'm going next?
• 03:36 It's gonna get easier and easier, isn't it?
• 03:38 Next up, goodbye opex, and hello again in the operational section.
• 03:44 And finally, of the things that end in x,
• 03:46 I'm going to take out capex and put it into the operational section.
• 03:50 And the aim is with items,
• 03:52 is eventually I'll be able to report them in the financial statements.
• 03:56 That is the income statement, the balance sheet, and the cash flow statement.
• 04:01 So you can see where I'm trying to get you to.
• 04:03 Now when we model we say okay,
• 04:05 I'm going to sell a million widgets at a dollar each, that's a million dollars.
• 04:10 And that will be my revenue, start with my income statement.
• 04:13 But is it going to be my cash flow number?
• 04:16 Probably not is the answer.
• 04:18 Because what's actually going to happen is it will come in over the whole period,
• 04:22 my money, and some of it may not actually be received by the end of the period.
• 04:26 Indeed, some money from the previous period might come in, and
• 04:29 some money might never come in because people just don't pay.
• 04:33 So need working capital adjustments,
• 04:35 those which affect my actual money coming in, my receivables are known as debtors.
• 04:40 So take that out, put it in working capital adjustment section, and
• 04:43 those where I have to pay bills, they're my creditors, my payables.
• 04:47 So take that out and put that in as well.
• 04:50 So I can take my revenue,
• 04:52 I can make my adjustments with debtors to get cash receipts,
• 04:55 that will give me my income statement and my cash flow statement number.
• 04:59 Cost of goods sold and opex?
• 05:00 I can actually make credited adjustments here and
• 05:02 put those through my financial statements, fine.
• 05:05 But it doesn't work for capex, because capex is all about making adjustments.
• 05:09 And it's a tangible asset to depreciation, and if it's intangible,
• 05:14 what we call amortization.
• 05:15 Where we actually split the cost over more than one period,
• 05:19 because it relates to the benefits of more than one period, more on that later.
• 05:23 So let's put those two items depreciation, take it out, put it in assets.
• 05:28 And similarly amortization, take that out, and put it into the assets block as well.
• 05:33 Now all this is going to need funding, so I'm going to have to debt and equity,
• 05:38 so that's putting debt first.
• 05:39 So goodbye debt, put it in financing, and the servicing of that is going to be
• 05:44 interest, take that out of the list and put it in.
• 05:47 Similar equity for the shareholders, they'll need to put money in, so
• 05:50 we'll take that out and put it in the box.
• 05:52 And when we actually service that equity, we'll be paying out dividends, so
• 05:56 we move that, and out it goes.
• 05:59 It's a taxing question next, but what's left?
• 06:02 That's it, bye tax, and tax goes in here.
• 06:07 So this is how we build a model, we start off with the operational section,
• 06:10 having built the checks already.
• 06:11 We're building our revenue, our COGS, our capex and our opex.
• 06:15 We put through our working capital adjustments, debtors, creditors,
• 06:19 and our non-current asset adjustments for depreciation amortization.
• 06:23 So it can all feed into financial statements,
• 06:25 namely the income statement, the balance sheet, and the cash flow statements.
• 06:28 That's what got to be financed by debt and equity, and it's servicing of that
• 06:32 interest and dividends, that's what got tax consequences.
• 06:34 But we may have other outputs,
• 06:36 this is really from part three of our course all together.
• 06:39 Not going to be considered this time, but other outputs might include
• 06:43 putting in charts, creating a dashboard, having a ratio analysis,
• 06:48 putting in scenario analysis, sensitivities, and even doing evaluation.
• 06:53 That's what we're talking about here.
• 06:55 And the way we actually show this complicated chart throughout this course,
• 07:00 is we actually use this slide.
• 07:02 So in an integrated model,
• 07:04 we think of a model breaking down to its constituent parts.
• 07:08 So the aim is to get from a to b, streamlined, so there's my arrow.
• 07:13 First thing we do is build in checks, we then put in the operational section.
• 07:19 We have to put through working capital adjustments, and our asset adjustment,
• 07:23 that's going to have to be serviced by financing, we'll have to pay tax on it.
• 07:27 All that will be reported on our financial statements,
• 07:30 and after we've done all that, we might create other key outputs too.
• 07:35 So back to the chart,
• 07:37 just before we finish it off, this is something that is really useful.
• 07:40 I think this is my mind map of how a model works,
• 07:42 just remember this links into the income statement, the balance sheet, and
• 07:45 the cash flow statement, so let's just bring those up again, please.
• 07:49 One income statement, one cash flow statement, and
• 07:52 one balance sheet, we need to remember to link them.
• 07:55 We need to make sure that the net profit after tax in the income statement,
• 07:59 leads into the retained earnings section of the balance sheet.
• 08:02 And similarly cash from the cash flow statement also feeds into
• 08:05 the balance sheet.
• 08:07 Great, we're getting there!

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