Efficiently manage financial risk with best practice financial models. Risk management with best practice financial models

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2 Efficiently manage financial risk with best practice financial models 2

3 Presenter Tim Heng Tim Heng Associate / Trainer BAppFin (Hons), MCom (Actuarial) tim.heng@corality.com Expert in financial modelling and audit with a wealth of experience across many asset classes in both transaction and operation Experience includes the construction of project and operational models and audit of financial models for a wide range of industries including mining, infrastructure, energy sectors as well as corporate planning and budgeting models Extensive experience delivering public and in-house tailored financial modelling training 3

4 Content Session Part 1 - Theory Risk management framework Best practice modelling Financial model layout Session Part 2 Financial modelling Implementing scenario manager Sensitivity and data tables Tornado charts Management reporting Tea break 10:30 11:00 4

5 Risk management is: The process of identifying business risks (e.g., detecting possible adverse events of significance) AND Mitigating these risks with an appropriate risk management framework 5

6 Why worry about risk management? Essential to achieve strategic objectives and manage the increase in volatility and complexity Crucial to ensure long-term growth of business 6

7 Risk management framework Identify key risk factors for the business Develop risk management framework Implement risk management program and strategies Forecast and risk analysis/scenarios Identify and develop risk mitigation 7

8 Identify key risk factors for the business Market risk Counterparty risk Timing Taxation risk Business Operating costs Financing risk CapEx risk 8

9 Develop risk management framework Develop risk management policy and procedures manual Implement risk management policy Regular monitoring and reporting of identified key risk factors Continuous review and update of risk management policy and procedures manual Develop risk mitigation framework Proactive approach Reactive approach Preventive 9

10 Risk mitigation Reactive Proactive Managing risk events which have been occurred ineffective, impulsive and costly Preventing and managing emerging risks that may effect the success of the business Predictive Establishing tools, techniques and processes to predict risk and their business impacts 10

11 Forecast and risk analysis/scenarios Create infrastructure to forecast risk factors Efficient way of impact analysis Development of a financial model 11

12 Snapshot of a typical financial model 12

13 and its issues Hidden rows Inconsistent formatting 13

14 Best practice modelling 14

15 Best practice financial modelling methodology - SMART SMART will: Increase user and management confidence Reduce model risk Increase modelling productivity Ensure the development of consistent, well presented financial models Ensure cost effective model audits Read more about SMART: 15

16 Best practice financial modelling methodology - SMART Transparency A transparent spreadsheet means nothing is hidden and that the spreadsheet is easy to use. All assumptions, formula and calculations can be traced and reviewed easily. This makes the model user friendly, reduces modelling risk and increases stakeholder confidence as all users can check how the model has been set up and question its assumptions. Flexibility A flexible spreadsheet allows you to change inputs easily which will increase modelling productivity and efficiency. A flexible model should also provide powerful scenario and what-if analysis so that model users quickly and easily can run scenarios and analyse key business drivers ultimately resulting in tactical decision making. Presentation Financial models are business communication tools and should therefore professionally present model outputs and financial analysis to stakeholders. A well-presented model will instil confidence in stakeholders as it signals that care has been taken during model development and key insights can be communicated quickly and easily. 16

17 Properties of a good financial model Fit for purpose Well presented Easy to check and update 17

18 Best practice methodology Best practice methodology is not an ideology - it is the rules that guide the construction and modification of a financial model The challenge is to work according to a system that is easy to apply and remember We will show you a simple set of rules 18

19 Globally accepted modelling practices Timing goes from left to right, not down the page Break up long or complex calculations Separate inputs and calculations Strictly avoid circular references Use consistent formulae across rows Use a consistent sheet structure Use flexible coding to allow for rapid analysis Clearly present units on every row/assumption Use consistent formatting to increase readability Avoid VBA for calculations (great for presentation) Include integrity checks where possible Present key outputs in a summary sheet 19

20 Best practice modelling covers three main categories Model infrastructure Formatting and presentation Formula structure 20

21 Model infrastructure Good design is the foundation of a good model Inputs, calculations and outputs are separate Clearly define each assumption and group assumptions together Worksheet tabs labelled, grouped, coloured and ordered Scenarios are applied without overriding the base case Time runs from left to right (across sheets) 21

22 Model infrastructure Timing Inputs Revenue Costs Finance Financials Executive summary & plots Depreciation Taxation Equity 22

23 Model infrastructure Workbook tab structure Technical sheets Input sheets Output sheets Calculation sheets Order with output sheets on left as it is most prominent when open Colour coded Group by categories 23

24 Consistent sheet structure 24

25 Formatting and presentation How it shouldn t look like it 25

26 Formatting and presentation Best practice modelling 26

27 Formula structure The rules are simple Keep formulae simple Break down calculations into bite-size pieces Apply one formula per row Do not use hard-coding Address circular logic and references 27

28 Formula structure Keep formulae simple No more than one or two IF statements within a formula Avoid excessive use of Excel formulae Avoid formulae that are difficult to understand such as INDIRECT, OFFSET, INDEX, MATCH, VLOOKUP, HLOOKUP Avoid using too many named ranges The avoidance of mega formulae (see example below) is key for keeping audit costs down and avoiding errors 28

29 Formula structure Address circular logic and references Circular models are generally not accepted as an industry standard Iterations' feature may not produce the same results for the same inputs Most banks will not accept iterative models The cost of reviewing circular models is a lot higher than that for models which are not circular Some problems can be solved algebraically Use simple VBA to break circular logics as the last option 29

30 Best practice modelling Excel styles Cell styles Custom number formats Conditional formatting 30

31 Cell Styles Select New Cell Style in the Cell Styles toolbar shortcut Create new style name and format Check the Dialog box to apply that property to the underlying cell Based on the which boxes are ticked, Styles can be overlayed 31

32 Custom number formats Cell formatting Format Cells Number formatting Custom Ctrl + 1 Can format numbers when it is positive/ negative/ zero (separated by ; ) - this is useful for checks, binary flags, switches Allows for text alongside numbers Cons Qtr 0 32

33 Conditional formatting Format depending on cell value Home Styles Conditional Formatting Conditional formatting for flags Use different colours for Cons and Ops Alt+O + D More care is required (be row or column specific by using anchoring) Avoid copying conditional formatting from multiple rows 33

34 Sequence of building a model Inputs Scenarios Assumptions Timing Construction Main body of calculations Operations Debt Depreciation & tax Cashflow waterfall P&L Balance sheet Outputs Returns Summary Source: Corality Financial Group 34

35 Risk management focus Inputs Scenarios Assumptions Timing Construction Main body of calculations Operations Debt Depreciation & tax Cashflow waterfall P&L Balance sheet Outputs Returns Summary Source: Corality Financial Group 35

36 Risk scenario analysis using scenario manager 36

37 Scenario sensitivity tables 37

38 Risk scenario analysis NPV impact analysis using a tornado chart (AUD million) BBSW +2%/-2% USD/AUD +10%/-10% Gearing 40/65 Contract extension no/yes Price low/high Opex +20%/-10% Capex +30%/-10% Tax +5%/-5% Timing + 1 year

39 Management reporting Develop powerful end-user orientated summary sheet Usually between 2-3 pages Summarising key metrics of business such as revenue and operating costs 39

40 Management reporting Summary usually includes funding, return, and scenario section 40

41 Management reporting Create charts for most important key metrics Visualisation is a simple tool to communicate important results and outcomes 41

42 Web resources Spent your training budget? Keep learning for free Over the years we have worked hard to bring you a comprehensive and accessible financial modelling and analytics site. After training use it to refresh your memory, stay up to date and prepare for the next course. Nick Crawley, Chairman, Corality Useful tips and tricks on Excel and financial modelling Comprehensive library of learning materials including free self-study tutorials Excel workbooks industry blogs We support fimodo.com financial modelling experts sharing their knowledge 42

43 Corality Training Academy Corality Training Academy s comprehensive suite of courses offers something for anyone interested in Excel, financial modelling and project finance. Our courses will help you build your capabilities throughout your career and gain the tools you need to succeed in your field. Brooke Cashman Training Coordinator brooke.cashman@corality.com Contact us Contact our team contact@corality.com Visit our website Subscribe to our newsletter Fast track your career through hands-on coaching from our industry specialists Work faster and with improved quality Benefit from on-going education through our extensive library of tutorials and industry blogs 43