Financial Modeling, Valuation and Corporate Performance Management

Abstract

This paper has three main objectives: (1) to illustrate the principles of financial modeling, (2) to review the different methods used in discounted cash flow valuation and (3) to show how the financial statements of financial accounting can be restructured to improve its usefulness in the management of corporate performance. To accomplish this, a very simple investment example is used. The model assumptions are first presented and then pro forma financial statements are built based on these. Of particular interest in this phase is the construction of a sources and uses of fund statement, which links the income and the cash flow statements to the financial position statement. Next it is shown how these statements, constructed according to the rules of financial accounting, should be rearranged in order to facilitate performance management and firm valuation. Finally, the expected market value of the firm is calculated using six different methods. All of them must yield the same result, and we point to the details that should be observed when constructing the firm’s model in order that this will occur. The example used in this paper is admittedly a very simple one, but we feel that this is a prerequisite if we want to present in a simple and straightforward manner issues that are otherwise rather complex to discuss.