FINANCIAL MODELING TERMS: All Physicians Should Review and Know

Posted on April 10, 2025 by Dr. David Edward Marcinko MBA MEd CMP™

By Staff Reporters

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Financial Modeling is one of the most highly valued, but thinly understood, skills in financial analysis. The objective of financial modeling is to combine accounting, finance, and business metrics to create a forecast of a company’s future results.

According to Jeff Schmidt, a financial model is simply a spreadsheet, usually built in Microsoft Excel, that forecasts a business’s financial performance into the future. The forecast is typically based on the company’s historical performance and assumptions about the future and requires preparing an income statement, balance sheet, cash flow statement, and supporting schedules (known as a three-statement model, one of many types of approaches to financial statement modeling). From there, more advanced types of models can be built such as discounted cash flow analysis (DCF model), leveraged buyout (LBO), mergers and acquisitions (M&A), and sensitivity analysis

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DEFINED TERMS

Discounted Cash Flow (DCF): A valuation method used to estimate the value of an investment based on its expected future cash flows, adjusted for the time value of money. It’s like deciding whether a treasure chest is worth diving for now, based on the gold coins you’ll be able to cash in later.

Sensitivity Analysis: This involves changing one variable at a time to see how it affects an outcome. Imagine tweaking your coffee-to-water ratio each morning to achieve the perfect brew strength.

Budget – A budget is the amount of money a department, function, or business can spend in a given period of time. Usually, but not always, finance does this annually for the upcoming year.

Rolling Forecast – A rolling forecast maintains a consistent view over a period of time (often 12 months). When one period closes, finance adds one more period to the forecast.

Topside – A topside adjustment is an overlay to a forecast. This is typically completed by the corporate or headquarter team. As individual teams submit a forecast, the consolidated result might not make sense or align with expectations. When this occurs, the high-level teams use a topside adjustment to streamline or adjust the consolidated view.

Monte Carlo Simulation: Picture yourself at the casino, but instead of gambling your savings away, you’re using this technique to predict different outcomes of your business decisions based on random variables. It’s like playing financial roulette with the odds in your favor.

What-If Analysis: Ever daydream about what would happen if you took that leap of faith with your business? This tool allows you to explore various scenarios without risking a dime. It’s like trying on outfits in a virtual dressing room before making a purchase.

Leveraged Buyout (LBO) Model: This is a bit like orchestrating a heist, but legally. It’s about acquiring a company using borrowed money, with plans to pay off the debts with the company’s own cash flows. High stakes, high rewards.

Mergers and Acquisitions (M&A) Model: Picture two puzzle pieces coming together. This model evaluates how combining companies can create a new, more valuable entity. It’s the corporate version of a matchmaker.

Three Statement Model: The holy trinity of financial modeling, linking the income statement, balance sheet, and cash flow statement. It’s like weaving a tapestry where each thread is crucial to the overall picture.

Capital Asset Pricing Model (CAPM): A formula that calculates the expected return on an investment, considering its risk compared to the market. It’s like choosing the best roller coaster in the park, balancing thrill and safety.

Cash Flow Forecasting: This is your financial weather forecast, predicting the cash flow climate of your business. It helps you plan for sunny days and save for the rainy ones.

Cost of Capital: The price of financing your business, whether through debt or equity. It’s like the interest rate on your growth engine, pushing you to maximize every dollar invested.

Debt Schedule: A timeline of your business’s debts, showing when and how much you owe. It’s your roadmap to becoming debt-free, one milestone at a time.

Equity Valuation: Determining the value of a company’s shares. It’s like assessing the worth of a rare gemstone, ensuring investors pay a fair price for a piece of the treasure.

Financial Leverage: Using debt to amplify returns on investment. It’s like using a lever to lift a heavy object, increasing force but also risk.

Forecast Model: A crystal ball for your finances, projecting future performance based on past and present data. It’s your guide through the financial wilderness, helping you navigate with confidence.

Operating Model: A detailed blueprint of how a business generates value, mapping out operational activities and their financial impact. It’s like laying out the inner workings of a clock, ensuring every gear turns smoothly.

Revenue Growth Model: This tracks potential increases in sales over time, charting a course for expansion. It’s like plotting your ascent up a mountain, anticipating the effort required to reach the summit.

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PRIVATE EQUITY: Terms and Definitions

Posted on February 21, 2025 by Dr. David Edward Marcinko MBA MEd CMP™

By Staff Reporters

SPONSOR: http://www.MarcinkoAssociates.com

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Capital Call: Definition and Explanation

A capital call is a notice sent to investors requesting that they contribute additional capital to a private equity fund. Capital calls are made when the fund manager has identified a new investment opportunity that requires additional funds.

Investors must be prepared to respond to capital calls with the required funds in a timely manner, as failure to do so could result in penalties or even the loss of their investment.

Carried Interest: Understanding the Concept

Carried interest is a form of incentive fee paid to private equity fund managers. This fee is calculated as a percentage of the profits generated by the fund’s investments.

Carried interest is often criticized as a tax loophole, as it is treated as capital gains, which are taxed at a lower rate than ordinary income.

Deal Flow: What it Means for Investors

Deal flow refers to the number of potential investment opportunities that a private equity firm evaluates. A robust deal flow is important for private equity firms, as it provides a pipeline of potential investments to consider.

Investors may want to investigate a private equity firm’s deal flow as part of their due diligence process, as a strong deal flow can indicate the firm has a good track record of finding attractive investment opportunities.

Due Diligence: A Key Step in Private Equity Investing

Due diligence is the process of evaluating a potential investment opportunity to assess its viability. This process involves a thorough investigation of the company’s financials, operations, and management team.

Due diligence is a critical step in the private equity investment process, as it helps to identify potential risks associated with an investment opportunity. Investors who skip due diligence do so at their own risk.

Exit Strategy: How Private Equity Firms Make Money

Exit strategy refers to the plan that private equity firms have in place to cash out of their investments. Private equity firms typically exit investments through an initial public offering (IPO), a sale to another company, or a management buyout.

Exit strategy is critical to the private equity investment process, as it is how investors ultimately make returns on their investments.

Fund of Funds: An Overview

A fund of funds is a type of investment fund that invests in other investment funds. In the private equity space, fund of funds typically invest in a portfolio of private equity funds.

Fund of funds can be a good way for investors to gain exposure to a wider range of private equity investments with less risk than investing in individual funds.

General Partner vs Limited Partner: What’s the Difference?

The general partner is the party responsible for managing the private equity fund and making investment decisions. Limited partners, on the other hand, are typically passive investors who provide capital but have little involvement in the investment process.

The distinction between general partners and limited partners is important for investors to understand, as it can impact their level of involvement in the investment process.

Investment Horizon: A Crucial Factor in Private Equity Investments

Investment horizon refers to the length of time an investor plans to hold an investment. In the private equity space, investment horizons can be several years or even a decade.

Investment horizon is a critical factor for investors to consider, as it impacts the level of liquidity they will have and the returns they can expect to make on their investment.

Leveraged Buyout (LBO): Definition and Examples

A leveraged buyout is a type of acquisition where the acquiring company uses a significant amount of debt to finance the purchase. The idea is that the acquired company’s assets will be used as collateral to secure the debt.

Leveraged buyouts can be an effective way for private equity firms to acquire companies with minimal capital investment. However, the use of leverage also increases the risk associated with these types of acquisitions.

Management Fee vs Performance Fee: Understanding the Two

The management fee is the fee paid to the general partner for managing the private equity fund. The performance fee, or carried interest, is paid based on the fund’s performance and returns generated for investors.

The distinction between management fees and performance fees is important for investors to understand, as it affects the level of fees they will be responsible for paying.

Pitchbook: A Guide to Creating an Effective Pitchbook

A pitchbook is a presentation used by private equity firms to pitch their investment strategy to potential investors. An effective pitchbook should be clear, well-organized, and provide a compelling rationale for why investors should consider investing in the fund.

Investors reviewing a fund’s pitchbook should look for evidence of a well-thought-out investment strategy and a track record of successful investments.

Private Placement Memorandum (PPM): What it is and Why It Matters

A private placement memorandum is a legal document provided to potential investors that details the terms of the private equity fund. It includes information on the fund’s investment strategy, expected returns, fees, and risks associated with the investment.

Reviewing a fund’s private placement memorandum is a critical step in the due diligence process, as it provides investors with a comprehensive understanding of the investment opportunity.

Recapitalization: A Strategy for Restructuring a Company

Recapitalization is a strategy used by private equity firms to restructure a company’s capital structure. This can involve issuing debt to pay off equity holders or issuing equity to pay off debt holders.

Recapitalization is often used to improve a company’s financial position and increase its value, making it a key tool in the private equity arsenal.

Valuation Techniques Used in Private Equity Investing

Valuation techniques are used to determine the value of a private company. These techniques can include discounted cash flow analysis, market multiples analysis, and asset-based valuation.

Understanding valuation techniques is important for investors, as it allows them to evaluate the relative value of investment opportunities and make informed investment decisions.

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