Analyzing Value with Models
Strategics, financials, and entrepreneurs undertake investment with the expectation of NPV & IRR. They accept projects that have positive NPV and IRR higher than the cost of capital. They actively find and structure positive NPV projects and then match financial products to them.
The positive NPV project is ideally a perpetuity with the value of the business being the perpetuity value:
Perpetuity value = CF / Discount rate
Calculating NPV & IRR is the main analytical work of finance.
*Growth statistic CAGR (Compound Annual Growth Rate) is yearly IRR
From Accounts to Models
To go from accounts (accounting) to a finance number we use models. We only use Free Cash Flow to determine valuation for major transactions in a capitalist economy including restructuring, growth, M&A, and capital raising.
To go from account filings to models, we need to “clean the numbers”, “scrub the financials”, “normalize the financials”. This amounts to recasting accounts to get to a finance number. We try to get to a finance number to get to a valuation. We get to a valuation to then take actions in a capitalist economy.
*We want more add backs to get to a higher valuation
After getting valuation, we can then model the different actions we can take in a capitalist economy to increase the valuation of the strategic, financial or entrepreneurial firm.
Modeling in Excel
Just like our account statements, our models are built and exist in Excel
Analysis of Account Statements
Analysis of account statements (ratio of analysis) has various uses including from a liquidity perspective, commercial bank perspective, activity perspective, profitability perspective, and growth perspective.
Ex. 4x-7x debt multiple for lending purposes