For a PDF version of this content that includes BAV Model screenshots, visit: http://www.hbs.edu/it/pdf/bav_help.pdf Overview: The purpose of the Business Analysis and Valuation Model (hereafter, the BAV Model ) is to aid users in analyzing and valuing any company with at least two years of historical financial statement data. Table 1 below provides a brief overview of the 14 worksheets that comprise the BAV Model. A detailed review of each worksheet and accompanying instructions follow in the Worksheet Instructions section. Table 1. BAV Model Worksheets Worksheet Title Function Overview and Instructions Imported Income Statement Imported Balance Sheet Imported Statement of Cash Flows Classification Lookup Standardized Financial Statements Accounting Adjustments BAV Identities Condensed Financial Statements Ratio Analysis To provide an overview of the structure and functionality of the BAV Model, as well as specific worksheet instructions. Because firms use different nomenclature and reporting structures in their financial statements, it is necessary to standardize a firm s historical financial statements. This is achieved by importing the historical financial statements into the BAV Model, and completing a financial statement line-item classification process. Provides help in the line-item classification process using examples of financial statement line-items that are commonly found under a given classification heading. Standardized financial statements are the result of the line-item classification process and serve as the foundation for subsequent accounting and financial statement analysis. Accounting adjustments allow you to tailor a firm s standardized financial statements to reflect any adjustments that are warranted. The BAV Identities worksheet defines the income statement and balance sheet identities that comprise the Condensed Financial Statements. The Condensed Financial Statements serve as the foundation for the pro forma financial statements. The Ratio Analysis worksheet provides a detailed breakdown of ratios used in evaluating profitability and operating, investment, and financial management. Ratio analysis can aid in both better understanding the historical performance of the firm and in evaluating the reasonableness of your Key Assumption inputs. Page 1 of 28
Key Assumptions Performance Charts Pro Formas & Valuation Valuation Summary The Key Assumptions worksheet allows you to set forth your expectations for the firm s performance throughout the forecast horizon. The Performance Charts worksheet provides a visual reference for comparing the firm s projected performance to both its historical performance and to the historical performance for comparable U.S. firms. The Pro Formas & Valuation worksheet provides forecasted financial statements (based on the Condensed Financial Statements and your Key Assumption inputs) and demonstrates valuation under the Discounted Cash Flows, Abnormal Earnings, and Abnormal Returns valuation approaches. The Valuation Summary worksheet reports the valuation results, the net effect of selected accounting adjustments, and restates the key assumptions underlying the valuation results. Important Technical Reminders 1. File Saving Protocol The BAV Model is distributed as an Excel template, denoted by the.xlt file name extension. When a template file is first opened, Excel automatically modifies the template file s name and replaces the.xlt extension with the standard.xls extension (e.g., a template named BAV Model.xlt when opened would be named BAV Model.xls automatically). This preserves the template in its original condition. Once the template is opened, you can re-name the file (select File Save As (new name)), and save it to a desired location on your computer. Given Excel s default handling of template files, the original version of the BAV Model will always be available under the distributed template file name. 2. Use of Macros and Excel Security Level Settings The BAV Model makes extensive use of macros. For these macros to be operational, your Excel security level must be set to medium, and you must select the enable macros button when the workbook is first opened. To check/adjust your security level, select Tools>Macros>Security> Medium (level). If your security level is set to high, the workbook will not operate correctly. 3. Opening Multiple Copies of the Model Simultaneously In order to open multiple copies of the model at the same time, each copy must be opened in a separate instance of Microsoft Excel (i.e., start Excel from the Start menu, then use File>Open to open each copy of the model). Excel allocates a fixed amount of memory for each instance and multiple copies of the model can easily require more memory than allocated by a single Excel instance, resulting in Out of System Resources errors. Page 2 of 28
4. Providing Feedback in the Event of a Technical Error In the event that you encounter a technical error in the process of using the BAV Model, please let us know by visiting this website for support information: http://www.hbs.edu/it/bav/. Please include a brief description of the error, and specify the operating system (e.g., Windows 2000, Windows XP), version of Excel (e.g., 2000, XP, 2003), and BAV Model version number you are working with (e.g., BAV Model v.4.0). To identify your BAV version, go to the BAV Navigator menu and select About BAV Model. Basic Steps in Using the BAV Model There are five primary steps in using the BAV Model: Step 1: Complete the Initial Setup. Step 2: Import historical income statement, balance sheet, and statement of cash flow data for the company you wish to value into the worksheets titled Imported Income Statement, Imported Balance Sheet, and Imported Statement of Cash Flows, respectively. Step 3: Recast the imported data from step 1 into a standardized format shown in the Standardized Financial Statements worksheet. This is accomplished by completing the line-item classification process (described below) for each of the imported financial statements. Step 4: Make any accounting adjustments that are warranted. Step 5: Input assumptions regarding the company s future performance in the Key Assumptions worksheet. Note: In version 4.0 of the BAV Model, the availability of the Compustat WRDS download feature automatically completes Steps 1-3 for authorized Compustat WRDS users. Sources of Guidance and Instructions The BAV Model provides you with a number of guides to help navigate your way through each of the required steps. Guidance may be obtained from any of the following sources: 1. Instructions A complete set of instructions are provided in this document and can be printed in the usual manner. Page 3 of 28
2. BAV Dashboard Worksheet The BAV Dashboard is a useful guide for new users of the BAV Model. As Exhibit 1 shows, the BAV Dashboard is comprised of 8 ordered steps which, when followed in sequence, guide the user through the basic steps of using the BAV model. To begin, select Step 1 by clicking on the first orb and you will be taken to the Imported Income Statement worksheet where the process begins. After completing the required steps on the imported financial statement worksheets (e.g., the Imported Income Statement, Imported Balance Sheet, and the Imported Statement of Cash Flows), selecting the Return to BAV Dashboard hyperlink in the upper left corner of any of the worksheets will take you back to the Dashboard, where you can proceed to the next step. After selecting one of the eight Dashboard steps and visiting the associated model worksheet(s), upon returning to the Dashboard, the step selected will automatically contain a check mark in the box at the bottom of each of the orb, indicating that you have previously visited the related worksheet(s). These check marks help you to keep track of the steps taken and those that remain. Please note that use of the BAV Dashboard is optional, and as a basic guide, it does not represent the full functionality of the BAV Model. Once you are familiar with the BAV Model worksheets, you may prefer to use the BAV-Navigator menu, which not only provides links to all of the model worksheets, but also contains a host of additional features that are described below. Exhibit 1. BAV Dashboard Page 4 of 28
3. Worksheet Overview and Instructions Hyperlinks Each worksheet that requires user input includes an Overview and Instructions hyperlink in the upper left corner that takes you to the specific portion of the instructions that pertain to that worksheet. Exhibit 2. Worksheet Overview and Instruction Hyperlinks 4. Cell Comment Flags Comment flags, denoted by a red triangle in the upper right-hand corner of a cell, provide further instruction, in the form of either general guidance or definitions of specific cells. To view the contents of a comment box, place the cursor over the red triangle and the comments will appear. Exhibit 3. Cell Comment Flags 5. Color-coding The BAV Model uses yellow shading to identify each cell requiring user input. Such input cells either require you to enter text or a numeric value, or they contain a drop-down menu from which a selection is required (see Exhibit 4). Yellow-shaded input cells must not be left blank. * If the value for a yellow-shaded cell is zero, enter 0 in that cell. *With the exception of select cells in the Accounting Adjustments worksheet -- Step 4 below -- all yellow-shaded cells require user input. On the Key Assumptions worksheet, yellow-shaded input cells may be located adjacent to gray-shaded cells. In contrast to yellow-shaded cells which require you to enter an input, gray-shaded cells indicate that additional inputs are possible, but they are not required in all instances. Cells without shading are output cells (containing either calculated or posted numbers) and are write-protected; any attempt to overwrite these cells will prompt an error message. Exhibit 4. BAV Model Cell-Shading (input cell and drop-down menu cell) 6. BAV Workbook Navigation Menu The BAV Workbook Navigation Menu (hereafter, the BAV-Navigator ) is located at the top of each worksheet and contains a drop-down menu with selections that allow you to jump to any worksheet within the Page 5 of 28
workbook (see Exhibit 5(a)). As shown in Exhibits 5(b), 5(c), 5(d), and 5(e), the BAV-Navigator menu also includes a Custom Report Generator, which allows you to select desired worksheets for printing, a Clear Selected Sheets menu, which provides options for clearing entire sections of the workbook, and Scenario Management tools (described below). Exhibit 5(a). BAV Workbook Navigation Menu - BAV-Navigator Exhibit 5(b). BAV-Navigator - Printing using the Custom Report Generator Page 6 of 28
Exhibit 5(c). BAV-Navigator - Clearing Selected Worksheets A Note About Scenario Manager Through the BAV-Navigator menu, you can access a scenario manager tool that allows you to name, save, and review up to five different scenarios for the company being analyzed. In order to save your current work into a scenario, first select the Save Scenario option from the BAV-Navigator menu (see Exhibit 5(a) above). As shown in Exhibit 5(d), the Store Scenario window asks you to select a scenario from the drop-down menu (scenario 1-5) and to provide a description for that scenario. After doing so and selecting OK, the named scenario will be stored and can be retrieved at any time by selecting the Review Scenario option from the BAV- Navigator menu (see Exhibit 5(a) above). As shown in Exhibit 5(e), the Review Scenario window identifies the existing saved scenarios and allows you to revert to a previously saved scenario if desired. While scenario manager treats the imported financial statements and their line item classifications as fixed, within each scenario you can vary all of your Key Assumption inputs, including the forecast horizon, as well as all of the Accounting Adjustments, allowing the user to perform a sensitivity analysis based on multiple inputs. Finally, if you save multiple scenarios, Table 4 on the Valuation Summary worksheet displays the valuation results under each of the named scenarios. Page 7 of 28
Exhibit 5(d). Scenario Manager - Name and Save Scenarios 1-5 Exhibit 5(e). Scenario Manager - Review Scenarios 1-5 BAV Model - Worksheet Instructions: Version 4.0 of the BAV Model has a new auto download feature that retrieves company financial statements from the Compustat North American database for authorized Compustat WRDS users. To request a Compustat WRDS account, see http://wrds.wharton.upenn.edu/. The instructions that follow are divided into sections that pertain to Compustat WRDS users and those that pertain to non-compustat WRDS users. Non-Compustat WRDS users, please skip the following section and proceed to directly to Step 1. Initial Setup. WRDS users, please review the following section Step 1. Downloading Company Financial Statements from Compustat WRDS, then proceed directly to Step 3. Output - Standardized Financial Statements. WRDS users, please note that in the event that a given company s financial statements are not available in the Compustat WRDS database, these financial statements will need to be manually imported from an alternative source. The Page 8 of 28
instructions for manually importing financial statements are the same as those that pertain to non-compustat WRDS users and begin in the section titled Step 1. Initial Setup. Click here to skip the WRDS instructions and go directly to Step 1. Initial Setup Step 1. Downloading Company Financial Statements from Compustat WRDS For authorized WRDS users, the first step in using the BAV Model is to download the desired company s financial statements from the Compustat WRDS database. To initiate a download request, navigate to the Imported Income Statement worksheet, and select the Download Company Financials from Compustat WRDS button located in the Initial Setup section at the top of the page. Exhibit 6. Initiating a Download Request from Compustat WRDS Selecting the Download Company Financials from Compustat WRDS button will prompt the WRDS Download Details form. Where indicated, enter the company s ticker symbol (e.g., AMZN for Amazon.com), the starting and ending years corresponding to the financial statements you desire (e.g., 1997 and 1999, respectively), and your WRDS username and password. Please note that if you initiate a subsequent download request, your username will be retained, however, you will need to reenter your password for protection purposes. Also note that if you are unsure of the company s ticker symbol, you can select the Ticker Look Up button, which will allow you to perform a search by company name or ticker symbol. Once you have completed the download details form, select the Download button at the bottom of the form to initiate the download request. Please note that the download process can take up to 30 seconds. For best results, do not activate other programs during the download process. Page 9 of 28
Exhibit 7. Completing the WRDS Download Details Form As soon as the download process is finished, you will be notified that the process was completed successfully. At this point, the yellow cells in Step 1 of the Initial Setup will have been automatically filled-in, and you will be directed to proceed to Step 2: Select Valuation Type. Page 10 of 28
Exhibit 8. WRDS Download Request Completed Successfully After selecting either Equity or Asset Valuation from the Step 2 drop-down menu, proceed directly to the Standardized Financial Statements worksheet to view the downloaded financial statements. Exhibit 9. Select Valuation Type At this stage, you are now able to verify whether the financial statements data that have been downloaded are complete and are consistent with your understanding of the firm and its business. Often, the Compustat database does not contain full details of the breakdown of net interest expense into the constituent interest Page 11 of 28
income and expense items. If you have additional details available, you can type revised figures in the appropriate cells in the imported financial statements worksheets. More generally, you can make changes, as needed, to the imported financial statements by following the instructions below pertaining to non-compustat WRDS users, in the section titled Step 1. Initial Setup. Note: The WRDS auto download feature can be used repeatedly if desired. If you initiate a subsequent download request, the newly downloaded data will overwrite the data initially retrieved. In the event that you manually imported data for a company not contained in the WRDS database (instructions for doing so follow) and subsequently decide to analyze a company that is contained in WRDS without saving the workbook and opening a new model template, you will first need to clear the imported financial statements worksheets. To do so, select the Clear Selected Sheets option from the BAV-Navigator drop-down menu located in the workbook s top menu bar and then select the clear Imported Financials option. In addition, if you identified Key Assumptions and/or performed one or more Accounting Adjustments and want to clear these inputs as well, you can do so by following the same steps (BAV-Navigator>Clear Selected Sheets> ) and select the clear Key Assumptions and/or clear All Accounting Adjustments options. Step 1. Initial Setup Note: The following instructions describe the process of manually importing company financial statements. These instructions apply to both non-compustat WRDS users and to WRDS users in instances when a company s financial statements are not available in the Compustat WRDS database. Your first step in using the BAV Model is to complete the Initial Setup at the top of the Imported Income Statement worksheet (see Exhibit 10). As detailed below, the Initial Setup consists of two basic steps: (1) identifying the name of the firm being analyzed, the years for which its historical financial data is to be inputted, as well as critical information for standardizing this data, and (2) selecting the type of valuation (firm equity or assets). Page 12 of 28
Please note that the BAV Model requires the Initial Setup to be completed before proceeding to Step 2. Exhibit 10. Initial Setup - (top portion of the Imported Income Statement worksheet) Initial Setup - Specific Steps: a) Navigate to the top of the Imported Income Statement worksheet. b) Enter the company s name in cell H4. c) Select the ordering of years on the company s imported financial statements (e.g., Ascending or Descending ) in cell H5. d) Enter the date of the latest (most recent) imported income statement year in cell H6 (e.g., 2001). e) Enter the earliest imported income statement year in cell H7 (e.g., 1997). {Note: the BAV Model can accommodate between a minimum of two years and a maximum of ten years of historical financial statement data.} f) Select the fiscal year-end month and day in cells H8 and K8. g) Select the units that the financial statements are expressed in (e.g., dollars - $, thousands - 000 s, or millions - $MM ) in cell H9. h) Select the valuation type (Equity or Asset Valuation) in cell H11, depending on whether you want to value the equity or the assets (equity plus debt). Page 13 of 28
Step 2.Importing Historical Financial Statement Data (including the income statement, beginning balance sheet, and statement of cash flows) for the company being analyzed 2.I. Imported Income Statement a) Navigate to the Imported Income Statement worksheet (see Exhibit 11 below). b) Import (copy>paste) the firm s income statement labels (e.g., Sales, Cost of Sales) in column H, beginning in cell H16. c) Import the corresponding income statement data in column I, beginning in cell I16 (this step can be combined with the previous step). At a minimum, you will need to import two years of data. d) Confirm that the imported data is correctly aligned with the column year-headings (cells I15 - R15) which are automatically generated. Please note that the imported financial data cannot be separated by blank columns. Exhibit 11. Importing Historical Financial Statements 2.2. Imported Beginning Balance Sheet Note: Both the Imported Income Statement and Imported Statement of Cash Flow worksheets call for importing the firm s historical year-end data as it is presented by the firm. In the Imported Balance Sheet, however, you are asked to present the firm s year-end account balances as the beginning account balances for the next year. The reason for this shift is due to the underlying relationship between the balance sheet and the income statement. Since businesses acquire assets (e.g., plants, raw materials, inventory, etc.) prior to generating revenues and earnings, and since the revenue and earning capacity of a firm is determined by the availability of these assets, it is useful to think of a firm s performance in a given period in relation to its beginning balance sheet for that period. To facilitate this comparison, you are asked to import the beginning balance sheet (the prior year-end Page 14 of 28
balance sheet) for the years shown in the column headings (cells I5-R5). Also note that the range of historical balance sheet years that the model can accommodate is bounded by the earliest and latest income statement dates entered in the Initial Setup in the Imported Income Statement. The minimum number of historical balance sheet years is defined as the two most recent years (e.g., the beginning balance sheet for the Latest income statement year and the ending balance sheet for the Latest income statement, which is the beginning balance sheet for the first forecast year). The maximum number of imported historical balance sheet years is the same number of years of imported income statement data. 2.2. Imported Beginning Balance Sheet - Specific steps: a) Navigate to the Imported Balance Sheet worksheet. b) Import the firm s balance sheet labels (e.g., Current Assets) in column H, beginning in cell H6. c) Import the corresponding beginning balance sheet data in column I, beginning in cell I6. At a minimum, you will need to import two years of data. d) Confirm that the imported data matches the column year-headings (cells I5 - R5). Reminder: The imported financial data cannot be separated by blank columns. 2.3. Imported Statement of Cash Flows a) Navigate to the Imported Statement of Cash Flows worksheet. b) Import the firm s Statement of Cash Flows labels (e.g., Cash Flow from Operating Activities) in column H, beginning in cell H6. c) Import the corresponding Statement of Cash Flows data in column I, beginning in cell I6. At a minimum, you will need to import two years of data. d) Confirm that the imported data matches the column year-headings (cells G5 - P5). Reminder: The imported financial data cannot be separated by blank columns. Step 3. Classifying the Imported Income Statement, Balance Sheet, and Statement of Cash Flow line-items Firms use a variety of differing labels to refer to similar items in the financial statements. You therefore need to standardize the imported financial statements into a format that will be used throughout the model. This requires the following steps for each of the imported financial statements: a) Navigate to the Imported Income Statement, Balance Sheet, or Statement of Cash Flows worksheet. b) Column D in each of the imported worksheets consists of a series of yellow-shaded cells, each containing a drop-down menu that is used to match the imported financial statement line-items to line-items using a standardized financial statement taxonomy. Click on a yellow-shaded classification cell, thereby activating the classification drop-down menu, and select the menu label that corresponds to the firm s imported label located in the adjacent cell in column H (see Exhibit 12). You must assign classification labels for each non-sub-total line-item. Drop-down menu labels also Page 15 of 28
include select sub-total headings (e.g., Net Income, Total Assets, etc.) that also must be used. If you have a question about the appropriate classification menu label to assign to a given line-item, select the Questions? button next to the Classifications heading (see cell D15 in Exhibit 12 below). Doing so will take you to the Classification Lookup worksheet in which you can select any of the classification menu labels and view a sample of financial statement line-item labels classified under that menu heading. The Return to buttons will take you back to the imported financial statement worksheet. Note: Because of the variability in reporting practices regarding the number of common shares outstanding (often reported in the income statement, other times in the balance sheet or in the footnotes to the financial statements), common shares outstanding can be classified in either the Imported Income Statement or in the Imported Balance Sheet worksheets. In the event that shares outstanding are not reported in either the income statement or the balance sheet, the number of shares outstanding must be manually entered in cell O54 of the Key Assumptions worksheet. Also note that the number of shares outstanding must be expressed in the same units that are used for the imported financial statements. Exhibit 12. Classifying Imported Financial Statement Line-Items Step 3. Contd. Reporting Variability and the Need for Changing Signs (+/-) Though revenues are uniformly presented in the income statement as positive numbers, the reporting of both expenses and other sources of income varies across firms. Some firms present expenses as positive numbers (though they are treated as negative numbers in sub-total calculations), others present expenses as negative numbers (e.g., -100 or (100)). Similarly, some firms report other sources of income as positive numbers, Page 16 of 28
while others report them as negative numbers. Given this variability, the final step in the financial statement line-item classification process is to tailor the BAV Model to conform to the firm s reporting preferences by indicating the need to change the sign (+ or -) of certain line-items. Income Statement Sign Changes Review the Imported Income Statement to determine whether the firm s expenses (including operating expenses, interest expense, and preferred dividends) are presented as negative numbers (e.g., -100 or (100)), and/or whether the Interest Income and Other Income line items are presented as negative expenses. Where either of these issues arise, use the Change Sign? drop down menu in the adjacent cell in column F to identify the affected line item with a negative sign. For example, as shown in Exhibit 13(a), Amazon.com reports the Cost of Sales expense as a negative number (see Exhibit cell I17). Identifying this reporting configuration by selecting the negative sign in cell F17 will ensure that the BAV Model treats this line item correctly. Exhibit 13(a). Income Statement Sign Changes Balance Sheet Sign Changes Firms sometimes classify assets as negative liabilities, or liabilities as negative assets. To classify these as positive assets or liabilities, you will need to use the Change Sign? drop down menu in column F to identify which balance sheet lines require changes in signs. Page 17 of 28
Statement of Cash Flow Sign Changes Firms reporting of cash flow information varies across both time and geography. All U.S. companies are required to include a statement of cash flows in their financial statements under Statement of Financial Accounts Standard No. 95 (SFAS 95). Most firms outside the U.S. (and U.S. firms prior to SFAS 95) report a funds flow statement rather than a statement of cash flows. Funds flow statements show working capital flows, rather than cash flows. Using the Change Sign? drop-down menu in column F of the Imported Statement of Cash Flows worksheet, you are able to convert a funds flow statement into a cash flow statement. The standardized cash flow statement will only be correct if the firm reports cash inflows as positive numbers, and cash outflows as negative numbers. As shown in Exhibit 13(b), if the firm you are analyzing does not use this format (e.g., it shows both cash/fund inflows and cash/fund outflows as positive numbers) you will need to use the Change Sign? drop down menu in column F to identify which rows are cash outflows and require changes in signs. Exhibit 13b. Statement of Cash Flow Sign Changes Step 3. Output - Standardized Financial Statements Standardized Financial Statements serve as the foundation for subsequent accounting and financial statement analysis and are automatically generated based on the imported financial statement line-item classification process described above. As shown in Exhibit 14, using the Expand/Collapse buttons in the left margin, the standardized balance sheet, income statement, and statement of cash flows can be viewed either separately or all at once (for the latter, you will need to scroll down to view). Looking left to right, the Standardized Financial Statements show the As Reported line-item values. As described in the Accounting Adjustments section below, upon completion of an accounting adjustment, the Page 18 of 28
Standardized Financials worksheet will also show both the net effect of all accounting adjustments, and the Adjusted Balance (i.e., the As Reported values plus the net effect of all accounting adjustments) for each line-item. Exhibit 14. Standardized Financial Statements Step 4. Accounting Adjustments Accounting analysis is a central component in the business valuation process. Financial statements prepared by the firm and verified by independent auditors, in part, reflect management s view about the firm s expected future performance. This view (or forecast) may not correspond with that of the analyst interested in valuing the company. Where existing accounting practices are questioned, one or more accounting adjustments may be needed to both supplant management s view with the analyst s view and to accurately portray the firm s financial statements. As shown in the top portion of Exhibit 15, instructions for completing accounting adjustments are shown at the top of the Accounting Adjustments worksheet. To make one or more accounting adjustments, first navigate to the Accounting Adjustments worksheet using either the Adjust? buttons located in column A of the Standardized Financial Statements worksheet, the BAV-Navigator, or simply select the Accounting Adjustments worksheet tab at the bottom of the screen. Page 19 of 28
Begin by entering the company s marginal tax rate in cell D4. Next, with the desired adjustment in mind, review the accounting adjustment category headings in the Menu of Financial Statement Adjustments to identify the appropriate adjustment category. Using the Expand/Collapse buttons in the left margin, select the desired adjustment category. Once the accounting adjustment category is selected, a sub-menu of specific accounting adjustments will appear. Select specific adjustments by placing a check-mark (left-click) in the corresponding box(es). As each box is checked, a template for the selected adjustment will appear below the adjustments menu (you will need to scroll down the worksheet or click the Go to Entry Form link to view). Specific instructions for each adjustment template are revealed (or hidden) by selecting the Show Instructions/Hide Instructions button at the top of each template. Exhibit 15. Selecting Accounting Adjustments Accounting Adjustment Note 1: As is the case throughout the BAV Model, input cells are shaded yellow and output cells are shaded white. However, unlike other areas within the workbook, not all yellow-shaded cells require inputs (that is, you may be presented with a choice of several financial statement accounts to adjust, and need only select one). Accounting Adjustment Note 2: If you are unable to locate the desired accounting adjustment template in the menu of adjustments presented, accounting adjustment V.3, Other Adjustments - Other shown above in Exhibit 15, can be used to modify the firm s balance sheet and income statement to reflect the desired adjustment. Also note that Other adjustments Page 20 of 28
contain a reconciliation check to make sure that the adjustment inputs reconcile. If a reconciliation error exists, the amount of the imbalance will appear in bold red font at the bottom of the adjustment template. Step 5. Identifying Key Assumptions Prospective analysis includes two tasks - forecasting and valuation. Forecasting is a way of summarizing what has been learned through business strategy analysis, accounting analysis, and financial analysis. Accordingly, a forecast can be no better than the business strategy analysis, accounting analysis, and financial analysis underlying it. In identifying key assumptions, you are defining your expectation for the firm s performance throughout the forecast horizon. Though a wide range of factors are considered in determining forecast assumptions, the Key Assumptions worksheet only requires input for a select group of ratios. The components that comprise the Key Assumption ratios are defined on the BAV Identities worksheet (see Exhibit 16). These identities, in turn, collectively form the firm s condensed income statement and balance sheet shown in the Condensed Financial Statements worksheet (see Exhibit 17). Exhibit 16. BAV Identities worksheet Page 21 of 28
Exhibit 17. Condensed Financial Statements worksheet Assessing the Plausibility of Forecast Assumptions As you decide upon the key assumptions that will determine the future performance of the firm, it is often useful to consider how these projections compare to both the firm s historic performance and to the historic performance of comparable firms. Together, the Ratio Analysis and Performance Charts worksheets can assist you in making such comparisons. Ratio Analysis worksheet The Ratio Analysis worksheet is divided into four sections containing ratios for evaluating profitability and operating, investment, and financial management (see Exhibit 18). Sections may be viewed separately or all at once by toggling the Expand/Collapse buttons in column A. Using the drop-down menu in Exhibit cell D6, you can select balance sheet ratio calculations based on beginning, ending, or average balance sheet values. Page 22 of 28
Exhibit 18. Ratio Analysis worksheet Performance Charts worksheet The Performance Charts worksheet can be accessed through either the BAV-Navigator Menu or by using the View Charts button located at the top of the Key Assumptions worksheet (see cell L2 in Exhibit 21 below). The Performance Charts worksheet shows the firm s historic and pro forma sales growth, net operating profit after tax (NOPAT) margin, net asset turnover, operating return-on-assets (ROA), and return-on-equity (ROE). As shown in Exhibits 19(a) and 19(b), each firm-specific chart is paired with a related chart showing the performance for comparable U.S. firms in the period 1984-2001. The drop-down menu located above each firm chart can be used to adjust the scale of the y-axis to match that of either the related U.S. Historic Comparables chart (the default setting) or to the firm s historical performance. Page 23 of 28
Exhibit 19(a). Performance Charts worksheet - scaled to U.S. Comparables Exhibit 19(b). Performance Charts worksheet - scaled to the firm s historical performance The forecasting process should be embedded in an understanding of how various financial statistics behave on average. Absent detailed information to the contrary, one would expect sales and earnings numbers to persist at their current levels, adjusted for overall trends of recent years. However, rates of return on investment (ROA and ROE) tend, over several years, to revert close to the Weighted Average Cost of Capital and to the Cost of Equity Capital, respectively. Profit margins also tend to revert to a normal level that varies widely across firms and industries, depending on levels of asset turnover and leverage. Some firms are capable of creating barriers to entry that enable them to fight these tendencies toward normal returns, even for many years, but such firms are the unusual cases. Step 5. Contd. - Inputting Key Assumptions The following steps are required to input your assumptions: a) Navigate to the Key Assumptions worksheet. Page 24 of 28
b) In the Forecast Horizon text box (shown below), enter the number of years for the firm s forecast horizon. The forecast horizon can be thought of as the number of years that you expect it will take for the firm to reach a steady-state operating performance level. The minimum forecast horizon is two years and the maximum is 15 years. Exhibit 20. Key Assumptions - Forecast Horizon c) Enter growth rate, profit margin, and productivity-related assumptions for the desired number of forecast years in rows 12-15 (see Exhibit 21). Note: For firms with four to ten years of imported historical financial data, the Show Early Years button in Exhibit cell D2 can be used to view the trend line performance of the firm along these dimensions throughout the period. d) Enter assumptions for the same line-items for the terminal forecast period in cells O19-O22. The terminal period begins in the year following the selected forecast horizon. Exhibit 21. Identifying Key Assumptions (steps c and d) Step 5. Identifying Key Assumptions (Cont.) e) Enter Market Value Leverage and Cost of Capital parameters for the first forecast year in cells O33-O34 and O40-O48, respectively (see Exhibit 22). Market leverage ratio entry raises a tricky issue. If we are trying to value the firm, how do we know the market leverage? To avoid circularity, you can use the market leverage ratio for other firms in the same industry. Alternatively, you can enter a starting estimate; then Page 25 of 28
when you have valued the firm you can re-estimate its market leverage and enter revised ratios. After doing this several times, the forecasted market leverage ratios should be consistent with your valuation. f) Confirm that the number of common shares outstanding is reported in cell O54. If not, enter the number of shares outstanding, using the same units used for the financial statements. Exhibit 22. Identifying Key Assumptions (steps e and f) Step 5. Contd. - Identifying Key Assumptions Capital Structure Assumptions: Book and Market Leverage, and the Cost of Capital The beginning book value leverage for the first forecast year is already determined based on the firm s last reported balance sheet. However, you can modify the firm s capital structure in forecast year 2 by changing (gray-shaded) book value leverage cells P26 and P27 (see Exhibit 22 above). You may make further adjustments to book leverage in years 3 and on by continuing to enter values in the adjacent cells in rows 26 and 27. Once you reach the point that book leverage is stable in future years, you can stop entering new leverage forecasts. The model will then repeat the last entered forecasts throughout the remaining forecast horizon. Note that if in a given year you change the firm s book leverage (or carry forward the prior year s values in anticipation of making changes in future periods), you must also change (or carry forward) the firm s market leverage and cost of capital parameters in that year. Based on these estimates, the model shows imputed betas for debt, preferred stock, and common equity, assuming that the firm s asset beta remains fixed. Adjustments to the firm s asset beta are permitted in forecast year 2 and beyond. Note that the asset beta will change only if the firm s business changes. Page 26 of 28
Valuation Worksheets: Pro Formas & Valuation worksheet The Condensed Financial Statements and your Key Assumption inputs collectively determine the firm s pro forma financial performance during the forecast horizon. The Pro Formas & Valuation worksheet consists of four panels showing the Pro Forma Financial Statements (shown in Exhibit 23 below), followed by valuations under the Discounted Cash Flow, Abnormal Earnings, and Abnormal Returns valuation methods, respectively. To aid in navigating the Pro Formas & Valuation worksheet, a Display Control box (shown in Exhibit 23) provides several display options. As the names imply, Pro Forma Only shows just the Pro Forma, while Show All shows the Pro Forma and all three valuation panels. You can also choose to look at the pro forma along with any of the three valuation panels. Exhibit 23. Pro Forma Financial Statements Note: That while reviewing the Pro Formas and Valuation worksheet, the Auditing Toolbar shown in Exhibit 24 (go to Tools Auditing Show Auditing Toolbar) can be used to show the relations between various cells in the worksheet. Page 27 of 28
Exhibit 24. Pro Forma Financial Statements and the Auditing Toolbar Valuation Summary worksheet The Valuation Summary is the final output worksheet and consists of four tables. The first table reports the valuation estimates for the firm s assets or common equity (based on your Initial Setup selection) under each of the three valuation methods. The second table provides the name of each of the selected accounting adjustments (if any) and a summary of the net effect of these adjustments on net income to common, beginning book value of common shareholders equity, and return-on-equity in the latest statement year. The third table shows the key assumptions underlying the valuation estimates. Pro forma return-on-assets and return-on-equity are also shown for comparison to the firm s weighted-average cost of capital (WACC) and to the cost of common equity. If multiple scenarios are saved during the analysis process, the valuation estimates for the firm s assets or equity (based on your Initial Setup selection) under each of the five possible saved scenarios are reported in the fourth table. In addition to the tables mentioned above, if any errors occur in the initial financial statement line-item classification process, a message will appear indicating whether the classification error(s) relate to the balance sheet or to the income statement classifications. Page 28 of 28