Transactional Financial Models

What are Transactional Financial Models?

Transactional financial models are the mathematical models created to forecast the future earnings of the business either to help inform investors about how management determined their own forecasts or to help the vendor to reach their own assessment of value.

Transactional financial models are the comprehensive models that allow your company to predict its future financial performance based on a series of underlying assumptions. These models, along with their underlying assumptions, can be presented to potential investors as part of the due diligence materials provided or can be used by you and your advisers solely as an internal tool to help determine the likely value. A number of different types of models exist including the following popular options:

• Discounted Cash Flow Model (DCF): This model uses projected free cash flows and discounts them to arrive at the present value of a company
• Merger Model: This model is used by publicly listed companies to evaluate the impact of a transaction on the acquirer’s Earnings Per Share (EPS)
• Leveraged Buyout Model (LBO): This model is used by private equity firms who assess value by looking at particular metrics that reflect the unique nature of their investment style where high levels of debt are utilised and each investment has a limited duration
• Sum-of-the-Parts Analysis Model: This model determines a company’s value by first calculating the value of individual components or divisions of the business and then adding them together

Why are Transactional Financial Models important for business today?

Transactional financial models enable your company to:

• Develop an internal sense of the current value of the business
• Run scenarios on hypothetical projects and transactions to determine their likely impact on the key metrics of the business and its value

Why are Transactional Financial Models important for an event tomorrow?

Transactional financial models are important for an event tomorrow, as they help:

• Communicate to investors the underlying assumptions behind management’s forecasts as well as the way in which those assumptions combine to generate the future financials
• Communicate to investors the way they should think about the business through the structure of the model
• Facilitate an accurate internal assessment of the company’s value
• Understand how investors will likely view the opportunity
• Determine which investor group is likely to be most competitive based on how they will value the opportunity
• Understand the sensitivity of the value to each assumption and therefore help identify which topics should obtain greater focus when communicating with potential investors

Pros of addressing Transactional Financial Models

• Enhances transparency between your company and potential investors by providing in-depth information on your company’s financials
• Increases investor confidence by providing a model that can be compared and contrasted against their own efforts
• Educates investors on the key drivers of the business
• Facilitates accurate valuation of your company
• Provides insight into the potential impact of transactions prior to them being commenced
• Helps to determine the most competitive investor group

Cons of not addressing this topic

• Makes it difficult to accurately assess the valuation of your company
• Increased potential for investors to develop remain confused on the key drivers of the business
• Makes it more difficult to understand how potential investors are likely to assess the opportunity.