First of all let’s discuss the meaning of the topic that you’re diving into. So let’s start with understanding the basics. My first question will be like, what are and why the fundamentals/basics of corporate finance matter to me and you? Yes you are absolutely right; No one can, run a business without corporate finance. Each and every business and corporation out there will get involved with corporate finance because it’s all about the diverse financial actions a company needs to take for working. Firms need corporate finance to function and more specifically to create value.
Whether your business is small or large, you most likely have a dedicated person or even a team to manage the financial activities, to look after the corporate finance of the organization and make sure the company is not falling apart due to its financial management. What kind of issues or questions does a corporate finance deal with? Some of the issues and questions are:
- A firm should or should not invest in the projected venture?
- Should the dividends be given to shareholders for their investment in the company or not?
- How should the company make payments with debt or equity, or a little from both?
For example let’s take the dividend part as it is very crucial part of corporate finance, which deals with shareholders and the value to be given. The proceedings and actions of corporate finance are without a doubt focused on maximizing shareholder value, either through a short term or a long term financial activities.
The main concepts of corporate finance can be divided into 2 main categories:
1) Capital budgeting or Investment analysis: Investment analysis is solely dedicated in adding value to the long term corporate finance ventures. These ventures are related to the investments that are funded through capital structure.
2) Working capital management: Is about the day to day methods of running the business and hence is more focused on the short term growth of the business. Basically the capital budgeting is dedicated to the long term investment and growth whereas capital management manages the relationship of short term liabilities and assets.
What is Financial Modeling?
Let’s start the topic by introduction of “Financial Modeling” and rest will be easy to follow. A well laid financial model is the most important element of the strategic plan for a corporate business, whether it plans to expand physically, by means of acquirements, or/by looking for external funding’. A good financial model forms a path for the future, in a transparent and credible way, with bendable actions that can be worked on and easily be altered for approaching risks facing your business and by working on opportunities.
Financial modeling is the process, a way to put together a financial representation of a business or we can say that it’s creating a summary of business operations. This task of building a mathematical model helps financial analysts to foretell likely performance and earnings of the company in future. Studying these financial models/representations the analysts use numerous projection formulas, valuations and theories to recreate business operations, once these financial models are completed it demonstrates a numerical description of the business procedures which then is used for future business predictions.
Some of the important objectives of creating financial models are:
- Raising capital
- Valuing a business
- Making acquisitions
- Growing the business
- Capital allocation
- Selling or divesting assets and business units
- Budgeting and forecasting
How is Corporate Finance Related to Financial Modeling?
A finance team might build models as they generate or modify their financial forecasts, which explains the frequent confusion between the two functions. But Financial models serve other principles, as well, to analyze both current operations and for long-term forecasting. Models can also help find out the impact of decreasing or increasing prices for various services or products.
The financial models are also integrated by organizations to assess their finances and undertakings. It is henceforth a contribution to making subsidizing plans for corporate undertakings hence, Corporate finance tend to be related with transactions in which existing capital is utilized and new capital is raised in order to create, develop and grow new ventures and projects, and to acquire other businesses. Corporate finance is often connected with corporate dealings that lead to the formation of new capital structures or change of ownerships. Corporate finance provides support for:
- Target research, approach and selection
- Feasibility analysis
- Preparation of business plans
- Sourcing support and funding advice
- Tax structuring, funding and deals
- Project management
- Terms of negotiation
Corporate Valuation Methods in Financial Models:
When valuing a company there are three main valuation methods used by corporate valuation practitioners:
- DCF analysis (Discounted Cash Flow)
- Comparable company analysis (“Comps”)
- Precedent transactions
These are the most common methods of valuation used by/in corporate finance professionals, investment banking, private equity, equity research, mergers & acquisitions and most areas of finance. Let’s take a look in them:
DCF analysis: Discounted Cash Flow (DCF) these types of financial models falls under the class of Valuation models and are typically, though not exclusively, used in equity research and other areas of the capital markets. A DCF model is a detailed type of financial model used to value a business. DCF model is a projection of a company’s unlevered free cash flow discounted back to today’s value, which is called the Net Present Value.
Precedent transactions: is another form of relative valuation where you compare the company in question to other businesses that have been sold recently or acquired in the same industry. These transaction values comprise of the takeover premium included in the price for which they were acquired.
Comparable company analysis (“Comps”): Comparable company analysis (also called “peer group analysis” or “trading multiples”) is yet another relative valuation method in which you compare the current value of a business to other similar businesses by studying the trading multiples like EV/EBITDA, P/E, or other ratios. Multiples of EBITDA are the most used valuation method.
“Although financial modelling is a collective word that means different stuff to different users, the orientation typically recounts either to quantitative finance applications or to accounting and corporate finance applications”.
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