Corporate Finance

The problem to be solved is the inadequacy of Excel spreadsheet technology, and that of the spreadsheet in general, in Predictive Financial Economic analysis, used in the analysis of Corporate Finance, due to the level of approximation and error and therefore of reliability of the processed Financial Economic Reality, which is, in the best of cases, around 15-20%.

This type of approximation highlights a problem, not only an economic one, but also of social and ethical responsibility for the investor, the consultant, the entrepreneur and for the community, which can no longer be ignored.

CORPORATE FINANCE: DEFINITION

Corporate Finance is an area of finance that deals with the specific financial decisions that companies have to make and the tools, related analysis and valuation techniques used to make those decisions.

The task of Corporate Finance is to identify the best balance between the sources available in the company and the uses in which to invest them, in order to achieve perfect management, both efficient (cost/benefit analysis) and effective (input/output analysis).

Corporate Finance: Objectives

The primary objective of the discipline is to improve the value of the company by ensuring that the return on capital exceeds the cost of capital without exposing the company to excessive financial risk.

This objective is achieved by investing in projects in which the market conditions and the company’s competitiveness lead to a positive net present value (NPV), which, by virtue of the principle of value additivity of the NPV, is added to the previous company value.

On the financing side, the objective is to choose the right balance in the financial structure, i.e. the level of debt and the level of equity such as to maximize the company's value through the tax benefit of debt, which is not subject to taxation, as it is a cost for the company, but at the same time paying attention to the increase in the incidence of any default costs, which occur with the increased probability of insolvency or bankruptcy related to the inability of the company to meet its obligations, consequently increasing the credit risk.

The key point is the consistency between the underlying objectives of management and the process of deploying and acquiring capital. In fact, after clarifying what the objectives are, you can define the criteria by which to judge the validity of an investment.

Corporate Finance: Type of Transactions based on time

The type of transactions can be subdivided, based on the time period considered, into:

  • Long Term Operations
  • Short-term operations

Long-term Operations relate to medium to long-term investments, where the return on investment is measured by the ability of the cash flows generated by the investment to repay the investmentt, the dividend policy generated and the profitability generated based on the Shareholder's NPV and Shareholder's generated IRR.

 Short-term operations , also called Treasury operations, refer to managing the balance between current assets and current liabilities by managing cash, inventory, payment and collection terms, short-term bank exposure and short-term financing policies.

CORPORATE FINANCE: TYPE OF OPERATIONS

The different types of Long Term or Extraordinary Transactions include:

  • M&A, Mergers and Acquisitions, operations involving the transfer of control of a business by means of a transfer of ownership (Acquisitions), while the merger (Merger) can be considered as the instrument that formally sanctions the complete integration between two companies: in essence, the acquisition anticipates the merger
  • Carve-out (Minority Divestmentl), which is the partial divestment of a business unit in which a parent company sells a minority interest in a subsidiary to outside investors. A company undertaking a Carve-out does not sell a business unit outright but, instead, sells an interest in that business or relinquishes control of the business, while retaining an equity interest. A Carve-out allows a company to capitalize on a business segment that may not be part of its core operations
  • Corporate Evaluation , an operation aimed at calculating the value of the company today on the market on the basis of its economic and financial structure by means of the Shareholder's NPV, but also at determining what the best corporate strategies might be to increase its value or to sell or dispose of a shareholding
  • Corporate Restructuring : an operation aimed at the organisational restructuring of the company, but at the same time at financial restructuring by reducing costs and corporate debt, through long-term debt refinancing or through write-off operations
  • Corporate Relaunch : operation aimed at the economic and financial relaunch, with updating of the Business Idea, organizational adjustment of the company, definition of the new Business Model and repositioning on the market
  • Internationalization Project: investment operation in a foreign country of a company branch, production lines to obtain lower production costs and, through the markup obtained, repayment of the investments made to acquire higher market occupancy and at the same time better margins and competitiveness
  • Best Strategy of Paying off Investments : evaluation of the best strategy to find the sources to pay off an investment that can lead to lower production costs or larger sales quotas (e.g. a new production line, a machine that allows higher productivity)
  • Capital Budgeting (Strategic Investment Selection): selection of the best investment projects to be made over time, capable of maximizing company value, and cash flows generated in relation to the risks of the investment itself.

The various types of Short Term or Ordinary Operations include:

  • Debt Analysis (Credit Line Optimisation): which consists of simulating the different conditions of the various Lines of Credit on the company model to find the best combination
  • Working Capital Analysis: managing the balance between current assets and current liabilities by managing cash, inventory, payment and collection terms, short-term bank exposure and short-term financing policies
  • Budgeting: creating a complete and reliable corporate budget forecast
  • Fiscal Planning: for optimal fiscal and financial planning.

CORPORATE FINANCE IN ITALY:

Corporate Finance in Italy is a culture, a sensitivity that is still underdeveloped and little used, practically unknown in small and medium-sized companies and still limited in large companies.

The problem is also to understand where and how it is done, therefore it is interesting to try to understand the attitude, the state of the art in terms of tools used and professional skills.

In small and medium-sized companies, the entrepreneur is used to thinking about the Profit and Loss Account both at year end and on an annual basis. He considers each operation carried out from an economic point of view, speaks of gross margin obtained as the difference between revenues and costs (EBITDA) and possibly, when there is a need to use the lines of credit, adds the cost of interest to the cost. 

However, is this approach correct for a Real and Sustainable Economy? 
For a Better World?

The correct approach is the Economic-Financial one, which consists precisely in forecasting an economic value over time with the possible risks that may arise. Therefore, finance is the subject that, better than any other, is suitable putting the entrepreneur’s business ideas into practice, because it is his very nature that leads him to continuously think about how to improve his business, in terms of new acquisitions, organizational choices, investments, constantly having to simultaneously understand the possible return in terms of economic and financial impacts and risks, such as: sustainability of the investment, or the increase in value of the financial vehicle with which he put it in place (NPV and IRR shareholder).

What skills are needed?
CFO or Managing Director

In English literature, the Chief Financial Officer (CFO) is the person who adds together administrative, financial and management control. That is, he supports the CEO in strategic decisions and responses to stakeholders, takes care of planning and management control, coordinates financial activities, equity investments and investments. Unlike Great Britain, in our country, the role of the CFO is mostly still divided between several managers: the administrative director, the controller, the financial director, even if the title is misused.

But how much is this figure present in Italy?

Research has shown that the CFO is still too uncommon in our country today. Why? On the one hand, there is a lack of a figure who has a vision of the three things together; on the other hand, there is a lack, as mentioned above, of entrepreneurial sensitivity to the problem. It is therefore necessary to lend content and responsibility to the CFO, as an essential figure for a modern, sustainable economy that is not improvised alongside the entrepreneur.

What tools are used for financial analysis?

Management Information Systems, the classic ERP, have the function mainly of providing final balance data aimed at General Accounting (Income Statement and Balance Sheet).

20% goes to management control; another 10% has activated the Short-term operations, aimed at controlling the costs of the credit lines (control of debit and credit figures, account charges, etc..) rather than predictive simulation; an average 5% determines cash flow, which however is only partial, as it is obtained from a projection of receipts and payments of customer / supplier invoices under the conditions indicated.

Therefore, traditional Information Systems are far from being able to support the entrepreneur in his predictive financial economic choices.

Business Intelligence, in some cases, especially in large companies, has been used to integrate information systems to simulate financial projections. The limitations of this type of approach are as follows:

  • It starts from a detailed approach to the final balance (with some logic), to arrive at a predictive system (with other logic) and therefore inconsistent
  • Business Intelligence Systems are very effective in establishing the relationship logic between the data, but are not able to be programmed to set complex algorithms for forecast projections on data
  • The limited programming, however, falls into a concept of subjectivity that becomes the limit for systems that must forecast the sustainability and profitability of hundreds or millions of euros, so they become bearers of too high a degree of risk
  • The concept of certification of algorithms used by institutional sources does not exist
  • It allows a very limited degree of approximation of the economic and financial reality, approximately 10-15%, therefore unreliable
  • All the above obviously refers to the financial management of an ordinary business activity
  • On the other hand, as regards possible extraordinary finance management (medium/long-term operations), the latter is completely inadequate and cannot be used, so the Spreadsheet is used.

The Excel spreadsheet is in fact still the most used tool for making financial simulations in "Corporate Finance".

 

But is the Excel spreadsheet still an adequate tool for a reliable forecast analysis in "Corporate Finance" operations in a modern economy?

In the next few chapters, we will see why it is no longer a reliable technology.

THE LIMITS OF EXCEL SPREADSHEET TECHNOLOGY FOR CORPORATE FINANCE

Any "Corporate Finance" operation must always start from the evaluation of the company on which you want to make the assumptions for both extraordinary and ordinary operations.  The average period considered, depending on the type of transaction, varies from a minimum of 5 years to a maximum, on average, of 20 years.

To simulate this type of transaction, a proper “Business Plan” must have:

  • The company's balance sheet for the previous period in line
  • the company budget (Costs and Revenues) structured for the period considered for which the simulation is to be carried out, with details of the relative VAT rates, days of payment and collection
  • Fiscal Policy
  • Macroeconomic variables
  • Dividend Policy
  • The relative risks that will act on the various quantities defined in the BP in terms of probability and relative deviation in % or absolute value.

On a thus-defined Business Plan, assumptions will be made to verify the impact of an economic and financial investment strategy and the reliability of the values obtained will depend on how it is done, that will allow the investor / entrepreneur to decide the implementation of a policy, a decision, or a strategy in advance.

But what is the reliability of the Business Plan made using an Excel spreadsheet, on which the investor / entrepreneur must decide investments of hundreds, thousands, millions of euros?

The average reliability of any Business Plan made with Excel spreadsheets technology, regardless of the skill of the analyst who made it, is on average 15-20%!

Let's look at the reasons in detail, discovering that, in addition to the lack of Reliability, there is also a lack of opportunity and profitability for Business Plans created using Excel, which greatly limit an investor;s, an entrepreneur ‘s correct choices for a new sustainable economy.

Lack of Reliability

The average reliability of a "Business Plan" created using Excel spreadsheet technology, independently from the competence of the analyst who elaborates it, has been measured on a large number of elaborated BP, created for "Corporate Finance" operations and has been found to be around 15-20%.

Example 1

An approximation of about 20%, in the best case scenario, means that each result obtained has a reliability of 20% or, in other words, has a margin of error equal to its complement, i.e. 80%. This means, for example, that a Cash Flow value of €1,000,000, calculated in this way, ranges from a value of €1,000,000+/- 800,000, i.e. €200,000 to €1,800,000. 

This type of approximation highlights a problem of reliability of the result obtained, but even more of precariousness in making business decisions that have an economic and financial impact on the Business Model.

 

Let's look at the structural reasons for the inadequacy of the "Business Plan" created with Excel Sheet technology for the reliable financial economic representation of a Business Model:

ANNUAL ANALYSIS:

of Business Plans developed with Excel, for a period varying between 5 and 20 years is one of the most striking causes based on unreliability, for these reasons:

Example 1

Cash that is always positive, on an annual basis, may, in fact, turn out to be negative for most months with the need to cover it with Bank Lines or a capital increase. The NPV and IRR values obtained are therefore unreliable. 

Example 2

An annual-based cash flow prevents visualization of tax payments, dividends in specific months, preventing evidence of critical liquidity issues, which become essential to obtain a reliable Predictive Model in Real Economy on which to make correct decisions.

Example 3

Incorrect calculation of working capital. In a recent analysis we found a working capital of 700,000 € versus an investment of 3 million Euro.

LACK OF A SYSTEMATIC APPROACH:

due to the inability of Excel spreadsheet technology to take into account all the inherent variables in a given context such as:

Example 1

The VAT rates associated with each variable that enters the model.

Example 2

Payment/collection days 

Example 3

The different tax rates

Example 4

Risk variables, not taken into due consideration.

PROBLEM OF VAT MANAGEMENT:

in most business plans is handled incorrectly or insufficiently.

Example 1

One striking case was in an M&A operation where VAT was omitted because, to simplify the model, it was considered an endorsement.

Example 2

In one Corporate Restructuring case, horizontal VAT compensation was not considered, which had a negative impact on the restructuring plan.

Example 3

In some Investment Plans the possibility of creating a VAT Finance Line is not considered.

WORKING CAPITAL PROBLEM (DUE TO DIFFERENCES BETWEEN PAYMENT AND COLLECTION DAYS):

in most cases the Business Model is ignored not for competence problems, but due to the impossibility of managing it on an annual and not monthly basis.

Example 1

In a Corporate Evaluation project, the amount of Working Capital was completely neglected.

PROBLEM OF THE ALGORITHMS USED NOT BEING CERTIFIED:

due to the lack of reference to sources declaring their correctness, which is an important element that every Investor/Entrepreneur should require. Certification is required for wine, for oil, but not for BPs, which decide on the analysis of investments or strategies worth millions of euros.

Example 1

In a Corporate Evaluation Project the investor asked what algorithms were used and by whom they were certified. Of course the Algorithms were not certified, because when are they ever certified! Obviously the acquisition, which was supposed to be the result, was not completed.

COMPLEXITY-RELATED ERROR PROBLEM:

due to the fact that the more complete you make the BP model on the Excel sheet, the more the probability of error (of formula, of not connected cell, of calculation, etc.) increases, making the results unreliable.

Example 1

Two well-known professors at MIT drew up the three-year plan of works to be done for a major government department. Unfortunately, a university student at MIT, after a few months, disavowed the BP/PEF for having found a trivial calculation error, but one that rendered the calculations unreliable, and also causing serious damage to the image of the government and the two distinguished professors. 

THEREFORE, THE "EXCEL SPREADSHEET", TO REALIZE THE BUSINESS PLANS FOR "CORPORATE FINANCE" OPERATIONS IS THE FIRST RISK, EVALUATED ON AVERAGE AT 80-85%.

 

For further details you can go to the chapter "Platform"

LACK OF OPPORTUNITY

The possibility to manage the different cases that a Business Model can offer in a flexible manner, is very limited with  Excel spreadsheet technology, as this technology does allow models to be developed that can thoroughly simulate the different economic and financial aspects of reality. The assumption that you can do everything with Excel is simply not true!

In fact, reproducing the various assumptions on an Excel spreadsheet, means repersonalising the model every time, with consequent loss of time, rendering operativity impossible and obviously the principle that it is always possible to do so is not applicable, as it goes against the principle of unmanageability due to excessive complexity.

However, not managing them means not being able to translate the entrepreneur's ideas into reliable financial economic data to find the best solution.

What does this limit mean for the investor? It means not finding the optimal solution in an M&A operation, corporate restructuring, corporate enhancement, an Internationalization Project, etc.

Let's look at the structural reasons for the inadequacy of the Excel Sheet for the limited number of opportunities it can offer in managing the various operations of "Corporate Finance":

DIFFICULTY/IMPOSSIBILITY IN BREAKING DOWN A BUSINESS MODEL INTO ITS BUSINESS UNITS

due to the complexity that would be induced in the Excel model to handle them. In fact, the Business Unit represents the minimum unit of analysis with its investments, costs and operating revenues, used to break down the company model into its operating divisions in order to allow the entrepreneur to decide priorities in investments, on which business units to focus attention and operate.

Example 1

A Corporate Restructuring operation of about 20 million euros, elaborated with Excel spreadsheet technology, turned out to be inadequate in its possibility of reproducing company divisions, of which there were about 20, each one with their Investments, Dedicated Costs and Revenues, fiscal policy, etc. It was possible, however, with "Finance Atena".

DIFFICULTY/IMPOSSIBILITY OF ANALYSING A BUSINESS MODEL IN ITS VARIOUS SCENARIOS 

based on the different assumptions, having to work on the formulas which is time consuming and increases the possibility of errors.

Example 1

An M&A project, initially drawn up on a spreadsheet, was found to be inadequate, firstly because it lacked meaningful summary data, secondly because it lacked detailed scenario analysis functions that would make the entrepreneur understand the best solution.

LIMIT OF MANAGING SEVERAL DEBT LINES AT THE SAME TIME

Example 1

In a complex Corporate Restructuring project, the Excel model was completely inadequate for the optimal restructuring of the Debt, which was divided into 8 Debt Lines, each with different terms and different trigger criteria.

DELEGATION DIFFICULTIES

due to the fact that in the BP created using spreadsheets, the data are wired with formulas and therefore only the person who has drawn up the Economic Financial Plan can work on it with all imaginable limits and cannot delegate to other departments.

Example 1

In Budgeting projects it becomes a problem, always forcing the CFO to manage it directly.

LACK OF PROFITABILITY

The Business Plan (BP) of a "Corporate Finance" plan elaborated using a spreadsheet, besides having a reliability of 15-20% and therefore not significant for seriously analyzing a financial operation of hundreds/millions of euro, of great impact for the Entrepreneur, presents this recurrent issue:

OVERESTIMATION OF SOURCES TO COVER INVESTMENTS (EQUITY, BANK LINES, SHAREHOLDER FINANCING)

because it does not allow financial optimization of cash flows, which is instead possible by breaking down the Company Model into Business Units, by managing flows on a monthly basis and by managing self-financing, which is too complex to reproduce using Excel technology. This causes an Entrepreneur to waste useful capital that he could use in other ventures, it also reduces the profitability of the Company or financial operation, decreasing the shareholder's NPV.

Example 1

An Internationalisation Project in Morocco, carried out on an Excel spreadsheet, was overestimated with a need for 4.5 million euros compared to what was obtained with the dynamic management of sources, with Finance Atena, which was only 2.8 million euros. 

SUSTAINABILITY IS ALWAYS CRITICAL

because it does not take into account all the financial variables involved which are, among other things, displayed in an annual analysis and not monthly as it should be. The reasons for these results are mainly due to the fact that a predictive financial economic analysis is a very complex analysis and it is inadequate to try to translate it on an Excel spreadsheet due to its structural limitations, due to the problem posed.

Example 1

Sustainability on an annual basis is critical in most cases as it does not take into account cash flows on a monthly basis, creating unrealistic expectations and, ignoring the necessary hedges, leading to an underestimation of the debt.

UNFULFILLED PROFITABILITY

due to Excel technology that leads easily to calculate NPV and IRR values, but the problem is not obtaining these values, that are obtained very simply using Excel functions, the problem is upstream, from which cash flows they were obtained. Precisely for this reason, the values obtained never correspond to reality, constituting a problem for everyone, first and foremost for the entrepreneur.

Example 1

An Investment Project for a new Production Line, created on an Excel spreadsheet, turned out with a forecast profitability with a IRR of 25%, when realized with "Finance Atena" it was found to be only 7%, therefore the project was remodeled just in time in order to achieve the desired margins and to avoid subsequent problems of shortfall.

DOCUMENTS

Blog: LATEST ARTICLES

Share this Article

Download in PDF format