What to do if the balance sheet assumptions provided to you are not balanced?

When your balance sheet assumptions are not balanced, and you're tasked with building a CF/DF model, here are some actionable steps based on the most helpful WSO content:

1. Use Equity as the Plug:

   • As you mentioned, using equity as the plug is a standard approach when assumptions only provide assets and liabilities. This ensures the balance sheet balances initially. However, this is just the starting point.

2. Check Cash Flow Statement Linkages:

   • Ensure that your cash flow statement is correctly linked to the balance sheet. Specifically:
     • CFO (Cash Flow from Operations): Should reflect changes in working capital and net income adjustments.
     • CFI (Cash Flow from Investing): Should capture capex, acquisitions, or disposals.
     • CFF (Cash Flow from Financing): Should include debt raises/repayments, equity issuances, and dividends.
   • The ending cash balance from the cash flow statement must tie to the cash line on the balance sheet.

3. Revisit the Cash Assumption:

   • If your closing balance sheet is off by an amount equal to the cash in the assumptions, it suggests that cash flow movements are not fully accounted for. Double-check:
     • Are all cash inflows and outflows properly captured in the cash flow statement?
     • Is the cash flow statement correctly flowing into the balance sheet?

4. Reconcile Historical Balances:

   • If you're working with historical data, ensure that the opening balances for assets, liabilities, and equity are accurate. Any mismatch here will cascade through your model.

5. Common Errors to Avoid:

   • Unlinked Items: Ensure every line item in the balance sheet is linked to a driver or calculation.
   • Circular References: Be cautious of circularities, especially in financing calculations (e.g., interest on debt or fees).
   • Hardcoding: Avoid hardcoding values unless absolutely necessary. Use comments to document any hardcodes.

6. Iterative Debugging:

   • Start with a simple model and gradually add complexity. For example:
     • Begin with a basic cash flow statement and ensure it ties to the balance sheet.
     • Add more detailed assumptions (e.g., capex, working capital changes) one at a time, verifying balance at each step.

7. Minimum Cash Balance:

   • If the assumptions include a minimum cash balance, ensure this is treated as a non-operating asset and not inadvertently double-counted.

8. Seek Feedback:

   • If you're still stuck, consider sharing your model with a peer or mentor for a second set of eyes. Sometimes, fresh perspective helps identify overlooked issues.

Lastly, remember that balance sheet imbalances are often due to small errors in linking or assumptions. Take a systematic approach to debug, and you'll likely find the issue. If you'd like, you can share specific details or screenshots (if allowed), and I can guide you further!

Sources: https://www.wallstreetoasis.com/forum/investment-banking/need-help-with-cashflow?customgpt=1, 1st Yr Banking Analyst Open for Questions, 21 Finance Interview Questions and Answers, What I Wish Every First Year Analyst Knew, Ways of Underperformance - and how to avoid them (Part 1)