Introduction
Excel graphs are vital tools in creating understandable, influential reports. There are different types of charts through which you can turn raw data into comprehensible visuals that truly highlight the trends and comparisons. By following the steps outlined in this report, you will be able to create effective Excel graphs for professionals to present data
What is Financial Modeling?
Financial modeling is the development of a mathematical representation of a company’s financial situation. It encompasses the process of developing an entire set of projections about future performance while taking historical data and assumptions into account. A financial model can be considered dynamic in the sense that it helps businesses make better decisions by providing a critical view of the financial outcomes for different scenarios under study.
Discounted Cash Flow (DCF) Valuation Model
The company’s present value of cash flow is calculated using its Discounted Cash Flow ( DCF ) valuation model, which adjusts the future cash flows regarding the time value of money. This DCF calculates the current fair value of projects, companies , or assets by considering other factors such as inflation risk and the cost of capital , based on further analysis of the forecasted future performance of the company. The DCF valuation model applies the discounted free cash flows estimated for a given company and subsequently discounts them back to derive a present value estimate, which can serve as a basis for making an actual investment today.
How to build a DCF Model
The DCF model presumes that the business ‘s value is solely a function of the cash flows the business generates in the future. Thus, defining the cash flows generated by any business and their accurate estimation constitutes the first challenge faced by a person building a DCF model.
There are two possible ways to estimate cash flow generation by a business:
Unlevered DCF methodology
Calculate and discount the cash flows of operations. You then take this present value and add in any non-operating assets like cash and subtract out any financing-related liabilities like debt.
Levered DCF Approach
Give forecast and discount cash flows remaining available for distribution to the equity shareholder after cash flows to all other non-equity claims or debt have been reduced.
Ideally, both methods should yield the same amount; however, in reality, it is relatively difficult to achieve this . The most common method for estimating value is the unlevered DCF method; therefore, I will describe this particular approach further . It includes the following steps:
Step 1: Forecasting unlevered free cash flows
First Step is to predict the cash flows a business derives from its core operations after deducting all operating expenses and investments.
These cash flows are termed as “unlevered free cash flows”.
Step 2: Calculating the terminal value
You cannot project cash flows out to infinity. Somewhere along the line, you need to make some higher-level assumptions about cash flows beyond the last year for which an explicit forecast is made by estimating a single lump sum of the business after the end of the explicit forecast period.
That amount is termed as the “terminal value.”.
Step 3: Discounting the cash flows to the present at the WACC
– The weighted average cost of capital is the discount rate that reflects the riskiness of unlevered free cash flows.
– Since all operating cash flows constitute unlevered free cash flows, they therefore “belong” to the firm’s owners as well as lenders.
– Thus, the cost of both providers of capital-debt versus equity-needs to be captured using appropriate capital structure weights, hence the term “weighted average” cost of capital.
– The enterprise value is therefore the present value of all unlevered free cash flows.
Step 4: Add the value of non-operating assets to the present value of unlevered free cash flows
If the business has any non-operating assets, for example cash or other investments that lie on the balance sheet doing nothing to make money then we add those to present value of unlevered free cash flows.
Step 5: Subtract debt and other non-equity claims
– The bottom-line objective of the DCF is to determine what constitutes equity owners’ ownership-equipment value.
– This means therefore if a firm has some lenders (or other non-equity claims to a firm) we have subtract this in the present value.
– The remainder will be owned by the equity owners.
Step 6: Divide the equity value by the share outstanding
It says something about total value to the owners but tells how much any share would be. And to compute this we’ll take this equity value, divide that by a firm’s outstanding diluted shares.
Computing Unlevered Free Cash Flows
The unlevered free cash flow formula looks as follows:
“FCF = EBIT x (1- tax rate) + D&A + NWC – Capital expenditures”
EBIT = Earnings before interest and taxes. It is the company’s operating profit calculated on GAAP.
Tax rate = Tax rate that the company may incur. While estimating the taxes, we normally look at a company’s past effective tax rate.
D&A = Depreciation and amortization.
NWC = Change in net working capital year over year. An increase in NWC will be a cash outlay while a decrease will be a cash inflow.
The required capital expenditures are the cash investments the company must make to sustain the forecasted growth of the business. If the cost of reinvestment into the business were not factored in, the value of the company would be overstated, giving the company credit for EBIT growth without accounting for investments required to achieve it.
Conclusion
This approach enhances the report ‘s clarity and impact. It selects the appropriate graph style, as well as other styles , to fit the report for improved readability, which , in turn , supports data-based decisions.