Modular Models
It organizes information by breaking down complex statements into smaller components.
What is a Modular Model?
A modular model organizes information by breaking down complex statements into smaller components, addressing each calculation independently.
This process is akin to how software engineers divide their tasks into smaller modules and then utilize them by calling functions to execute specific functions at the required locations.
This approach ensures that the primary statements remain easily comprehensible, while additional schedules, acting as supporting documents, handle more intricate calculations and provide detailed evidence for the information presented in a primary document, validating ending balances.
Key Takeaways
- A modular model is a way to organize our model into smaller parts to make it less complicated, prevent mistakes, and be easily understood.
- It is simpler to identify flaws or inaccuracies as the data has been divided. The model's modularity facilitates comprehension of the data flow.
- A modular model simplifies adding new data, accounts, or schedules to the core statements based on the information required.
- A modular model is made up of different parts. For example, a company's budgeting and forecasting system includes core statements, supporting schedules, integration, and flexibility.
Understanding Modular Model
The implementation of modular financial modeling dramatically decreases the time required for model construction, typically resulting in the model build phase accounting for approximately 40% of the project timeline.
The initial 40% of the timeline is typically allocated to model scoping and design, while the remaining 20% is dedicated to model documentation and handover. However, this allocation may vary depending on factors such as project complexity and the expertise of the modeler.
There are solid reasons why most things, like websites, mobile phones, or even cars, aren't made from scratch anymore. Creating things from the ground up is time-consuming, costly, risky, and often leads to a final product of lower quality.
Similar reasons apply to financial models. Much like 0websites, mobile phones, and cars, financial models can usually be crafted more efficiently and effectively using existing financial models' components.
Suppose someone suggests that building financial models from scratch is a good idea. In that case, it's likely they either don't grasp the concept of modular financial modeling or have motives influenced by conflicts of interest.
In a horizontal model, these extra schedules might be on different tabs from the main statements.
Once all the math is done, we can check the results against the main statements. Most things on the balance sheet, income statement, and cash flow statements refer to the extra schedules instead of having their numbers or formulas right in them.
In this specific article, our focus will be on constructing the key elements for the modular model. We'll explain the types of schedules employed, providing a detailed discussion of each one. This exploration aims to offer a comprehensive understanding of the topic.
Modular Model Essential Components
The efficiency of this model is grounded in the establishment of a shared structure that streamlines operations. An illustrative example within the financial domain is a company's financial forecasting and budgeting system, embodying the principles of a modular model.
The essential components of this model(financial forecasting and budgeting system) are:
- Core Statements:
- Income Statement: It shows how much money a company has made or spent, or the final loss or profit
- Balance Sheet:It provides a snapshot of the company's assets, liabilities, and equity at a specific point in time.
- Cash Flow Statement: It details the cash inflows and outflows over a specific period.
- Supporting Schedule:
- Sales Forecast Schedule: It predicts how much a company will sell by looking at past sales, market trends, and other things.
- Expense Budget Schedule: This breaks down anticipated operating expenses, capital expenditures, and other costs.
- Working Capital Schedule: Looks at what a company owns and owes right now to ensure there is enough money to pay its short-term bills.
- Depreciation and Amortization Schedule: It calculates the loss of value of assets over time.
- Integration:
- Integration Module: Once the smaller plans are done, a special part gathers information from each to make the main financial statements.
- Quality Check Module: Checks to ensure the information in the main statements matches the details in the smaller plans so everything is correct.
- Flexibility:
- Scenario Analysis Module: It lets you make different situations to see how changing things can affect the money results.
- Sensitivity Analysis Module: The module checks how changing one thing can impact the whole money plan.
Working using financial models makes it simpler for analysts to update parts, study changes, and adjust the model to new business situations without messing up everything. It also makes it easier for different teams to work together on financial plans.
Which schedules are employed in modular models?
The subsequent schedules are examples of supporting schedules that underpin the core statements in a modular model:
- Working Capital Schedule
- PP&E and Depreciation Schedule
- Intangibles and Amortization Schedule
- Debt and Interest Schedule
- Stockholders Equity Schedule
Working Capital Schedule
Working capital might not be a daily topic, but it is crucial for your company's success. It tells you how much money you have right now.
So, to make sure how much working capital you have, you need to know how much you have now and what you will need in the future to find ways to have cash.
Current Assets – Current liabilities = Net working capital
Distinguishing Between Positive and Negative Working Capital
Positive working capital is like a thumbs-up for your company's short-term money health. It means you have enough quick cash to handle urgent bills and fuel your business growth from within.
On the flip side, if a working capital shortfall exists, your company might need extra funds from a bank or explore investment options for more money.
Negative working capital suggests a problem in using assets effectively and might lead to a money crisis.
Even if your company has big investments in fixed stuff, troubles can pop up when it's time to pay what you owe. This might lead to more borrowing, late payments to suppliers, and even a lower credit rating for your company.
Distinguishing between immediate and long-term needs
Mixing up immediate needs with ongoing financial commitments is a common mistake. Using a working capital line of credit for significant investments may seem tempting, but it's crucial to know that these expenses need different types of financing.
Misusing your working capital for these big projects might leave it unavailable for its main job – handling short-term needs.
Talk to your small business banker for guidance. They can help you determine your working capital needs, making distinguishing between urgent and longer-term financial demands easier.
This clarity helps you use your resources wisely and prepares your working capital for its main purpose.
Seeking guidance for preparation
You cannot predict every detail of running a company, but being prepared for different situations is crucial for managing working capital effectively.
Seeking advice from professionals can help you counter these situations as they can guide you in understanding your working capital needs, providing insights into potential issues and solutions.
Having a clear view of your working capital ensures smooth daily operations and sets your business up for long-term growth.
PP&E and Depreciation Schedule
In finance, a depreciation schedule is a helpful tool that predicts how much a company's things are worth over time.
This info shows up on the balance sheet, like a business's money report card. It also helps figure out how much money is spent on the wear and tear of these things, and this cost appears in the income statement.
Additionally, it estimates future spending on these things, and this prediction is in the cash flow statement.
Think of it this way: when a company uses stuff like buildings or machines (they call this property, plant, and equipment or PP&E), these things naturally wear out and lose value. Different things lose value at different rates.
A depreciation schedule's main job is to accurately track this loss.
The schedule lists different types of things, tells us how they lose value, and shows how much value they've lost over time. It even covers past and future spending on these things, helping businesses understand the money side of using their stuff.
This tool is like a guide that helps businesses see how their things are doing financially, giving them the info they need to plan and make smart money decisions.
If you want to dive deeper into this topic, you can check out the article below for more details on the WSO depreciation schedule article.
Intangibles and Amortization Schedule
When discussing non-physical assets such as trademarks and patents, we refer to them as intangible assets. These assets gradually lose value over time after a company purchases them.
This is why we use the term "amortization" to describe the process of spreading out the cost of these assets over their useful life, similar to how we use "depreciation" when referring to the decline in value of physical assets after purchase.
For accounting and tax purposes, the cost of these intangibles can now be spread out over 15 years with amortization.
The cost-spreading procedure is monitored using an amortization-specific expense account.
Physical objects, on the other hand, require different treatment. With a process known as depreciation, their worth gradually decreases.
The amount we use for regular accounting and the amount we use for tax purposes can differ at times. This happens because tax rules and financial reporting rules can be different.
Businesses need to understand and manage changes to make sure they report things accurately and follow tax rules. Keeping things clear and following regulations helps with financial transparency and obeying the law.
Whether it's a physical thing like the building or a non-physical thing like the patent, these methods help businesses track their expenses in a way that matches the lifespan of what they own.
Check out the article WSO Intangibles and Amortization Schedule.
Debt and Interest Schedule
A Debt and Interest Schedule is like a detailed plan showing how much money an organization owes and the interest it needs to pay.
Every organization needs money, and they get it from two places: their funds or borrowed funds. When they borrow money, they should pay the lender an extra cost called interest.
Therefore, everything about how much money is borrowed, the interest rate, and the maturity date of payment, or in other words, when our loan is fully paid, is put in a debt schedule.
Before an organization decides to borrow money, it thinks about how it will pay it back and whether it is accurate by making an adequate analysis using this record.
Importance of debt schedule
Making a debt schedule helps us figure out the payments we need to make, including how much is for the loan and how much is for interest. It shows all the details of the calculations over time. Some important things in a debt schedule are:
- Principal Repayment: This shows how much of the initial money borrowed is being repaid over time.
- Interest Payments: Interest paid through time on the money borrowed, in other words, the price of the borrowed money
- Total Payment: Total amount paid, i.e., the sum of the interest and principal repayments
- Outstanding Debt Balance: The remaining amount of debt after each payment is made. It gets smaller as more of the borrowed money is paid back.
- Maturity Date: When the loan will be fully compensated
- Interest Rate: Interest is added to the borrowed money at the rate. It can be a fixed rate or change, depending on the terms of the debt agreement.
A debt schedule is like a guide for managing money, making budgets, and understanding if a company can pay back what it owes. It is a major factor to see; therefore, we can predict if a company is doing good financially.
It can also see how much a fluctuation in the interest rate can affect its situation in paying its debt back.
Stockholders Equity Schedule
Stockholders' equity is determined by subtracting the company's liabilities, typically made up of debts, from its assets. It represents the ownership interest, initial investments, earnings, and other factors contributing to the company's value.
A positive stockholders' equity indicates that the company is performing well and enjoys a level of stability, reflecting good financial health. Conversely, a negative stockholders' equity signals potential financial distress and the risk of bankruptcy. This is unfavorable news for investors.
There are two types of assets:
- Current Assets encompass items owned by a company that can be converted into cash within approximately one year. This category typically includes cash on hand, accounts receivable, and inventory.
- Non-current assets are things the company plans to keep for a long time, more than a year. It's like long-term stuff that can't be quickly converted into cash, such as investments, property and equipment, and things like patents.
Understanding How Stockholders' Equity Works
Stockholders' equity is like the company's book value, and it comes from two main places:
First, there is the money people put into the company by buying shares.
The second part is the money the company keeps in its pocket after its profit, called retained earnings. Now, stockholder equity can be in either the positive or the negative.
If it's positive, it shows that the company can afford to pay all its debts and has enough assets to compensate.
If it's negative, the company owes more than it owns. If this situation goes on for a long time, the company will be in financial trouble, leading to bankruptcy.
In other words, the balance sheet problem can’t be solved. Because of this, many people who invest in companies get worried if the stockholder equity is negative.
But more than just looking at stockholder equity alone is needed to know how healthy a company is. Using it with other tools and numbers is better to understand if a company is doing well.
Conclusion
The modular model functions much like constructing with building blocks, providing a structured and efficient way to work with data.
By breaking down calculations into distinct components, managing smaller pieces of information becomes more straightforward, enabling easier error detection.
The model's initial setup is instrumental in comprehending the flow of data, shedding light on how various elements interact.
What makes the modular model truly powerful is its flexibility. The ease of incorporating new information or introducing additional categories without disrupting the integrity of the primary statements is a notable advantage.
Unlike the conventional approach of inserting new lines and formulas directly into the primary statements, the modular model allows for the addition of new schedules dedicated to the new elements.
There are several types of schedules, such as the working capital schedule that tells how much money we have right now and the depreciation schedule that calculates the loss in value of tangible assets.
The amortization schedule calculates the loss of value in intangible assets such as patents, and the debt and interest schedule shows how much money the company owes and the interest rate at which it should return the money.
The stockholder equity schedule involves deducting the company's liabilities and telling the investors about the performance of the company.
This modular flexibility not only simplifies the incorporation of fresh data but also enhances the overall clarity of the model.
Subsequently, integrating these new details into the main statements is a straightforward process.
A simple line addition referring to the newly created schedule seamlessly incorporates the additional information, maintaining the model's coherence and facilitating efficient data management.
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