Financial Modeling Foundations (LinkedIn Learning)


  1. Be simple
  2. Focus on key cash flow drivers
  3. Convey assumptions and conclusions
  4. Help evaluate risks through:
    1. Sensitivity analysis
    2. Break-even analysis
    3. Scenario analysis

Deterministic (known inputs, precise outputs) vs stochastic (probability-based, Monte Carlo simulations; more complex)

Three Statement Model DCF Model Buyout Model
Valuation from model Present value of discounted free cash flow or multiples lnvestment decision and implied value depends on equity IRR versus market hurdle rate Entry multiple and acquisition premium depends on equity IRR and hurdle rate
Base case risk measurement Weighted average cost of capital, multiples, terminal growth Debt capacity, debt terms Senior and subordinated debt financing and exit multiple
Traditional risk assessment from equity perspective Sensitivity analysis and scenario analysis of DCF and multiple value Sensitivity analysis and scenario analysis of equity IRR Sensitivity analysis and scenario analysis of equity IRR
Tradition risk assessment from debt perspective Break-even analysis to determine ability to refinance and maintain credit rating Break-even analysis to determine at what point cash flow can’t service debt Break-even analysis to determine IRR on senior and subordinated debt
Monte Carlo analysis with model Probability distribution of EPS and DCF valuation Probability distribution of equity IRR and probability of DSCR below 1.0 Probability distribution of equity IRR, senior IRR and junior IRR
lnformation base Historical financial statements, analysis of value drivers Contracts and analysis of commodity prices and other value drivers Historical financial statements, analysis of value drivers, transaction terms
Model starting point Historic balance sheet Sources and uses analysis Sources and uses and pro-forma balance sheet
Cash flow process Net cash flow after dividends that result in changes in short-term debt or surplus cash Cash flow waterfall that ultimately measure dividends paid to equity Cash flow waterfall that ends in dividends paid to equity
Debt analysis New and existing New debt issues from transaction New debt issues from transaction
Model termination Arbitrary terminal period End of project life Transaction holding period
Model output DCF valuation, EPS projection, implied P/E, credit quality Equity IRR, project IRR, DSCR Equity and debt IRRs, debt/EBlTDA

02-0X, 03-0X files


  1. Gather: historic financial statements
  2. Change: arrangement of financial statements
  3. Compute: ratios from historic financial statements to develop mechanical assumptions
  4. Develop: revenue, expense, and capital expenditures by working through value drivers
  5. Work through: income statement, cash flow statement, balance sheet to check, only for forecast years
  6. Valuation: sensitivity analysis and presentation

04-0X files

Need: Starting cash flow, growth rates (and change over time), discount rates (relates to risk)(often WACC is used)

Present Value: =PV(discount rate, number of periods, dividends, free cash flow (but -ve), 0)

Dividend Discount Model (DDM) Terminal Value: Latest value * (1 + future growth (%)) / (discount rate (%) - future growth (%)) → then calculate PV

Multiples Terminal Value: Latest EBITDA * EBITDA Multiple

Total Value of Firm = Sum of FCFs + TV

Discounted Cash Flow (DCF) Valuation = =NPV()/# shares

Internal rate of return (IRR): =IRR(CFs) → If IRR > discount rate/WACC, invest. Higher WACC = lower IRR.

Often includes DCF model and 3S model



  • Don’t use long formulae
  • Do keep inputs together
  • Avoid circular references (check Formulas > Error Checking; also check Formulas > Trace in Excel) → potentially use fixed values instead of formulae (add comment or change colour so as not to lose track)
  • Blue = hard-coded value, black = formula, green = link to other sheet
  • Corkscrews: output of one as input of another, and repeat (e.g. year 1 end cash = year 2 start cash)
  • Waterfall: input flowing through multiple calculations to final output (e.g. revenues → operating income → net income → total cash from operations → net cash)
  • Toggles: e.g. scenario cell: best case, normal case, worst case → =IF(scenario=1,100,IF(scenario=2,50,IF(scenario=3,10)))
  • Sensitivity analysis charts: Terminal Growth Rate or Terminal EBITDA Multiple vs Discount Rate; IRR vs Exit Multiple or % Debt
  • FRED (Federal Reserve Economic Data) Excel Add-In → Interest rates, corporate bond yields, …

Year-Over-Year Growth Rate: CAGR → most basic form, doesn’t change annually so can’t consider predicted recessions etc

Top-Down Analysis: Company market share (TAM: total addressable market) → Geographic segment → Product → Customer unit → Revenue

Top Down Growth Rate (%) = ((1 + Total Market Sales Growth (%)) * (1 + Market Share Growth (%)) * (1 + Order Value Growth (%)) - 1

Bottom-Up Analysis: Website traffic → Conversion rate → Order value → Revenue

Bottom Up Growth Rate (%) = ((1 + Prospect Traffic Growth (%)) * (1 + Conversation Rate Growth (%)) * (1 + Price Growth (%)) - 1

Regression Analysis: Relationships between factors e.g. marketing spend