UNIT-I

Introduction to Modelling – Types and purposes of business models – Rules for model
design–Model layout flow charting – Steps to building a model – Best practice principles
of modelling – Documentation – Preparing and presentation of Model results – Model
review –Auditing a Model.
Introduction to Modelling:

A financial model is a mathematical representation of the financial operations and financial

statements of a company. It is used to forecast future financialperformance of the company by
making relevant assumptions of how the company would realistic in the coming financial
years.
Financial Modeling is the main core element to take the major business decisions in a
corporate world. Financial models are the most valuable tools for executing business choices
to get perfect solutions. A model can advise you regarding the grade of risk associated with
implementing certain decisions. They can also be utilized to devise an effective financial
statement that reflects the finances and operations of company. These models help online
internet businesses take quick decisions more confidently.
Definition: Financial modelling involves combining key accounting, finance, and business
metrics to build an abstract representation, or model, of a company‘s financial situation. This
exercise helps a company visualize its current financial position and predict future financial
performance.
Financial modelling can be quite handy in a number of situations. It can help inform investment
decisions, securities pricing, and plans for corporate transactions such as mergers,
acquisitions, Investment Baking etc. But the most common use of a financial model is for
making operational business decisions and performing financial analysis. Executives
typically use financial models to make decisionsregarding:
 Budgeting and forecasting
• Organic business growth
• Valuing the company
• Raising capital in the form of debt or equity
• Acquiring new assets or other businesses
• Ranking projects
• Distributing the organization‘s financial resources
• Risk management
Uses of Financial Modelling:

In the finance industry the value of financial modelling is increasing rapidly. Financial
modelling acts as an important tool which enables business ideas and risks to be estimated in
a cost-effective way. Financial modelling is an action of creating attractive representation of a
financial situation of company. Financial Models are mathematical terms aimed at
representing the economic performanceof a business entity.
Financial Modelling are widely used in Various Sectors like:
• Investment Banks
• Credit Rating Agencies
• Equity Research
• Mutual Funds
• Financial KPOs
 • Project Finance companies.
Career opportunities: Financial Modelling is the main component of business decision-
making program. The Financial model allows corporate industries to explore the outcome
under different scenarios. Some of the skills/areas that you can learn and work in after
pursuing financial modelling are:
 Merger and acquisition
 Project finance
 DCF Modelling
 Venture Capital
 IP Valuation- Option Based Method
 IP Valuation- Market Based Method
 Ratio Analysis
 Asset Allocation
 Qualitative Analysis
 Sensitivity Analysis
Financial modelling is the process of estimating the financial performance of a project or
business by taking into account all relevant factors, growth and risk assumptions, and
interpreting their impact. It enables the user to acquire a concise knowledge of all the
variables involved in financial forecasting.
• To show the path to profitability
• To quantify the investment requirement
• To facilitate valuation of the business
• Raising capital (debt and/or equity)
• Budgeting and forecasting (planning for the years ahead)
• Financial statement analysis/ratio analysis
Types of financial models:

 Three Statement Model

 Discounted Cash Flow (DCF) Model
 Merger Model (M&A)
 Initial Public Offering (IPO) Model
 Leveraged Buyout (LBO) Model
 Sum of the Parts Model
 Forecasting Model
 The comparable company analysis (CCA) model
 Option Pricing Model
 Asset and Liability Management
1. Three Statement Model: The three-statement financial model integrates and forecasts a
company‘s three financial statements—the income statement, balance sheet, and cash-flow
statement—into the future.
The three-statement model represents the real meat and potatoes when it comes to financial
modelling. This model acts as a standard that gives a comprehensive overview of the
company‘s financial history, current standing, and future performance.
2. Discounted Cash Flow (DCF) Model: A financial analyst may turn to the discounted cash
flow (DCF) model when they need a way of determining valuation.One of the key attributes of
the DCF model is that it calculates current value while taking into account predictions for
 how much money something will make inthe future.
The DCF model can be used to value an entire company, but you can also use this model
to value:
• Shares of a company
• A project or investment within a company
• A cost-saving initiative within a company
3. Merger Model (M&A): The merger and acquisition (M&A) model calculate the impact of
a merger or acquisition on the earnings per share (EPS) of the newly formed company. This
value can then be compared to the company‘s current EPS. If the M&A model shows an
increase in EPS, then the transaction is considered accretive, meaning it should result in
growth. But if the M&A model shows a decrease in EPS, the transaction is considered
dilutive, meaning it will reduce thecompany‘s value
4. The comparable company analysis (CCA) model: It is another way for a business to
calculate its value. It‘s a more basic valuation method than the DCF model.
• The CCA financial model is based on the assumption that similar companies will have
similar valuation multiples. It uses metrics from other businesseswith similar sizes and
operations in the same industry.
• EV/S – Enterprise Value to Sales
• P/E – Price to Earnings
• P/B – Price to Book
• P/S – Price to Sales
5. Initial Public Offering (IPO) Model: The IPO pricing model has several different
components that it includes issuing of company shares etc. For example, it will make use of
the comparable company analysis, looking at their P/Erelative to industry peers.
This model also takes into account previous funding round valuations, and what share price
would be attractive to institutional investors that are subscribing to the IPO.
6. Leveraged Buyout (LBO) Model: The leveraged buyout (LBO) model is used to analyse
an acquisition that finances the cost mostly with debt. How much debt? Typically, a
leveraged buyout is 90% debt and 10% equity. Due to this incredibly high debt-to-equity
ratio, the bonds being issued are not investment grade – i.e. junk bonds. Some people
consider LBOs to be an incredibly aggressive and risky move, but with great risk comes great
reward
 Key credit metrics in an LBO model include:
 Debt/EBITDA
 Interest Coverage Ratio (EBIT/Interest)
 Debt Service Coverage Ratio (EBITDA – Capex) / (Interest + Principle)
 Fixed Charge Coverage Ratio (EBITDA – Capex – Taxes) / (Interest +
Principle)
7. Sum of the Parts Model: The sum-of-the-parts financial model allows large
conglomerate organizations with many divisions to simplify their valuation. As the name
suggests, the sum-of-the-parts model values each business unit, division, or subsidiary
separately and then adds them all together.
This can sometimes make it difficult for the FP&A department as they are having to gather
financial data from multiple entities and assemble it into a single model

8.Forecasting Model: Forecasting is one of the most important tasks that the FP&A
department takes care of on a regular basis. It is typically used to predict future revenues,
expenses, and capital costs.
• Straight-Line Model-It makes use of historical data to estimate what will happen in
the future.
• Moving Average Model-companies use the moving average model to evaluate
performance on a monthly basis and makes use of three-month and five-month
moving averages.
• Linear Regression Model-This forecasting method is best used to compare the
relationship between two different variables. A common example is advertising
budget and revenue
• Time Series Model-machine learning or specialized software like Tidemark.
9. Option Pricing Model: Option pricing models are typically used by market makers
and securities traders looking to turn a profit or hedge risk. These financial models are
used to assign a price (premium) for the options contract based on statistics and
probability (i.e. how likely the option will be in-the-moneyat expiration).
• In -the- Money- option: An in-the-money call option means the option holder has the
pportunity to buy the security below its current market price.
• At-the- Money- option: equal (options contract with a strike price that is identical to
the underlying market price.)
• Out-the –Money –option: An in-the-money call option means the option holder has
the opportunity to buy the security higher its current market price.
10. Asset and Liability Management (ALM): Asset and liability financial models are
primarily used by financial institutions (banks and insurance companies) and pension funds
(corporate or public) to manage their financial objectives. For example, pension funds must
be able to pay pensioners during any economic conditions.
Most pension funds conduct a comprehensive review every three to five years. During this
process, they use financial analysis and modelling to adjust their assetand liability management
strategies to reduce portfolio sensitivity to economic conditions, interest rate changes, and
foreign exchange rates.
Steps to building a model: The building is the process of designing and developing a new
financial model with a logical flow and structural compactness to
the point that it can transform a given set of assumptions into trustworthy projections that
describe and illustrate a deal in a quantitative manner.
 Step: 2 Step 3:
Step: 1
Define the Decide
Define and
input and output who will use the
structure the
variables of the model and how
problem
model often

Step 4:
Understand Step 5: Design
the Step 6: Create the
the financial and
model spreadsheets
mathematical

aspects of the
Step 8: Protect
model the
Step 9: Document
Step 7: Test the model
the model
model

Step 10: Update

the model
Define and structure the problem: the first step of every financial model starts with the
historical results of the company. First, load the historical financial statements into Excel,
preferably three years. Followed by performing reverse engineering on the assumptions for
the historical period, i.e. calculating things like revenue growth rate, gross margins,
variable costs, fixed costs, AP days, inventory days, etc. From the past calculations, you can
build assumptions to forecast the future period.
Define the input and output variables of the model: It analyses the performance of Excel
spreadsheet simulation analysis on supply chain. The spreadsheet was used to model the
inventory control issue that developed in order to minimize the total cost of inventory,
shortages and transportations for single supplier multi retailer problem who face a stochastic
demand
Decide who will use the model and how often: Financial models are used to estimate the
valuation of a business or to compare businesses to their peers in the industry. They also are
used in strategic planning to test various scenarios, calculate the cost of new projects, decide
on budgets, and allocate corporate resources.
Understand the financial and mathematical aspects of the model: Financial models are
 activities that prepare a model representing a real-world financial situation. they are intended
to be used as decision-making tools. Company executives might use financial models to
estimate the costs and project the profits of a proposed new project. Financial analysts use
financial models to anticipate the impact of an economic policy change or any other event on
a company‘s stock.
Design the model: Many people are still using spreadsheets for financial modelling.
Consider when it may make sense to transition your models to a different tool. Large-scale
modelling in spreadsheets may become problematic for a variety of reasons. There are lots of
tools available that have been purpose- built for financial modelling that are improvements on
the standard spreadsheet tools most modelers use and many offers free trials, so do your
homework and choose the right tool.
Create the spreadsheets: Spreadsheets are grid-based files designed to organize information
and perform calculations with scalable entries. People all around the world use spreadsheets
to create tables for any personal or businessneed.
Test the model: Nowadays Microsoft Excel is a spreadsheet tool which is used worldwide
for performing, financial modelling as it gives more flexibility. With proper analysis of the
model the decisions like fund requirement, risk associated, offerings, investment and return
analysis can be done.
Protect the model: Protecting Excel data in financial modelling is critical. Users prefer to
secure and protect cells that they will not tweak or change while leaving certain cells free to
adjust assumptions and inputs. By doing so, users are protected from potential inconsistencies
and mistakes that may result from typosand unwanted changes in output cell functions.
Document the model:
• Income statement
• Balance sheet
• cash flow statement
• Supporting Schedule
Update the model or Audit: A model audit is done in order to make sure that spreadsheet
errors are corrected. Thus, it needs to be specific with its scope and purpose to ensure that the
relevant tasks are completely and correctly carried out.
Best Practices in Financial Modelling: financial modelling best practices in Excel, it is
important to note that model building is not an mathematical process in order to minimize
errors when building your financial models, be mindful of thefollowing five basic steps:
• Clarify the business problem
• Plan your structure
• Build structural integrity
• Inputs and Assumptions
• Detailed Calculations and Operating Build-up
• Test the model/Formatting Your Model (COLOURS)
Preparing and presentation of Model results:
• Use MS Excel Spread sheet or VBA code
• Use white space instead of gridlines
• Assumptions and drivers
• Income statement
• Balance sheet
• Cash flow statement
• Supporting schedules
 • Company Valuation
• Sensitivity analysis
• Charts and graphs
Documentation:
Financial Statement Analysis: The process of critical evaluation of the financial information
contained in the financial statements in order to understand and make decisions regarding the
operations of the firm is called ‗Financial StatementAnalysis‘.
• Income statement
• Balance sheet
• cash flow statement
• Supporting Schedule
The Income Statement Module is one of the three Module Types in the Financial Statements
Module Area. As with all Modules, the Income Statement Module can be used in many
different ways to create many different spreadsheet models.
The Income Statement Module could be used to create a spreadsheet model thatcontains
Balance sheet: The Balance Sheet shows the status of an entity's assets, liabilities and
owner's equity at a point in time, usually the close of a month. A Balance Sheet provides a
snapshot of the entity's financial position, including the cumulative results of the Income
Statement and Cash Flow Statement, at a point in time. A Balance Sheet is also referred to as a
„Statement of Financial Position‟.
Most balance sheets are arranged according to this equation: Assets =
Liabilities + Shareholders’ Equity
Assets:

• Current assets are typically what a company expects to convert into cash within a
year‘s time, such as cash and cash equivalents, prepaid expenses, inventory,
marketable securities, and accounts receivable.
• Non-current assets are long-term investments that a company does not expect to
convert into cash in the short term, such as land, equipment, patents, trademarks, and
intellectual property.
Liabilities:
• Current liabilities are typically those due within one year, which may include accounts
payable and other accrued expenses.
• Non-current liabilities are typically those that a company doesn‘t expect to repay
within one year. They are usually long-term obligations, such as leases, bonds
payable, or loans
Shareholder’s equity: Shareholders‘ Equity: Shareholders‘ equity refers generally to the net
worth of a company, and reflects the amount of money that would be left over if all assets
were sold and liabilities paid. Shareholders‘ equity belongs to the shareholders, whether they
be private or public owners
Shareholders’ Equity = Assets - Liabilities
Common line items found in this section of the balance sheet include:
• Common stock
• Preferred stock
• Treasury stock
• Retained earnings
Cash flow statement:
 Cash comprises cash on hand and demand deposits with banks. Cash equivalents are
 short term, highly liquid investments that are readily convertible into known amounts
of cash and which are subject to an insignificant risk of changes in value.
 Cash flows : cash inflows and cash outflows of cash and cash equivalents.
• Operating activities: Cash, Changes in working capital, Depreciation.
 Investing activities: Fixed Assets, capital Expenditure, PP&E.
Financing activities: owners‘ capital (including preference share capital in the case of a
company) and borrowings of the enterprise
Build 3 Statement – Model by Using Excel:

• Income statement
• Balance sheet
• cash flow statement
• Supporting Schedule
The Income Statement Module is one of the three Module Types in the Financial Statements
Module Area. As with all Modules, the Income Statement Module can be used in many
different ways to create many different spreadsheet models.
Financial Modeling ( Three Statement Projection
Model )
Company name : Hinduja Pvt
Ltd

Income Statement 2011 2012 2013 2014 2015 2016 2017

Revenue 74,4 83,492 91,841 1,01,025 1,11,12 1,22,24 1,34,46

52 8 1 5
Growth% NA 12% 10% 10% 10% 10% 10%
Cost of Goods Sold 64,4 72,524 79,634 87,675 96,400 1,06,06 1,16,65
40 4 7
% Sales 87% 87% 87% 87% 87% 87% 87%
Gross profit 10,0 10,968 12,208 13,350 14,728 16,177 17,808
12
% Sales 13% 13% 13% 13% 13% 13% 13%
operating expenses 6389 6545 7,540 8,107 9,021 9,866 10,884
% Sales 9% 8% 8% 8% 8% 8% 8%
operating income( EBIT) 3,623 4,423 4,667 5,243 5,707 6,311 6,924
Intrest ex 518 474 414 340 300 260 220
pre income tax( PBT) 3,105 3,949 4,253 4,903 5,407 6,051 6,704
Income tax Expenses 1,087 1,382 1,276 1,471 1,622 1,815 2,011
Tax rate NM NM 30% 30% 30% 30% 30%
Net Income 2,018 2,567 2,977 3,432 3,785 4,236 4,693
Income statement
Assumptions
Operating income 3,623 4,423 4,667 5,243 5,707 6,311 6,924
Depreciation 2,648 2,981 3,273 3,604 3,962 4,359 4,795
Amortization 0 0 0 0 0 0 0
EBITDA 3,623 4,423 4,667 5,243 5,707 6,311 6,924

BALANCE SHEET 2011 2012 2013 2014 2015 2016 2017

Current Assets:
Cash 1,773 2,000 9,181 9,624 10,826 12,037 13,348
Accounts Reciviabls 7,750 8,852 9,649 10,662 11,702 12,887 14,167
Inventory 4,800 5,700 6,095 6,801 7,428 8,200 9,004
Pre paid expenses 456 1,849 - - - -
Total Current Assets: 14,7 18,401 24,925 27,087 29,956 33,123 36,519
79
Fixed Assets
PP&E, Net of Accumulated 10,9 10,932 11,159 11,556 12,094 12,734 13,440
Depreciation 13
Total Assets 25,6 29,333 36,085 38,642 42,049 45,858 49,959
92
Current laibilities:
Accounts payble 5,665 6,656 7,155 7,962 8,708 9,606 10,551
Line of Credit 792 1,375 - - - - -
Current Maturities of long term 500 500 500 500 500 500 500
Debt
Total current liabilties 6,957 8,531 7,655 8,462 9,208 10,106 11,051
Long term libalities:
Long term debt, Net of Current 5000 4500 4,000 3,500 3,000 2,500 2,000
maturities
Total liabilties 11,9 13,031 11,655 11,962 12,208 12,606 13,051
57
Common Stock 15 15 15 15 15 15 15
Additional Paid in Capital 5,000 5,000 5,000 5,000 5,000 5,000 5,000
Retained earnings 8,720 11,287 14,264 17,696 21,481 25,717 30,410
Total equity 13,7 16,302 19,279 22,711 26,496 30,732 35,425
Total laibilities & equity 35
25,6 29,333 30,934 34,673 38,704 43,338 48,476
92
Check - - 5,151 3,970 3,346 2,520 1,483
Balance sheet Assumptions
AR Days 38 39 38 39 38 38 38
Inventory 27 29 28 28 28 28 28
Days AP 32 33 33 33 33 33 33
Days
CASH FLOW STATEMENT 2011 2012 2013 2014 2015 2016 2017
Cash flow operating Actvities
Net Income 2,977 3,432 3,785 4,236 4,693
Add Back Non-Cash items
Dpereciation 3,273 3,604 3,962 4,359 4,795
Amortization 0 0 0 0 0
Changes in Working Capital
Accounts Recivables -797 -1,014 -1,039 -1,185 -1,281
Inventory -395 -706 -627 -772 -804
Accounts payable 499 807 746 899 945
Net Cash provided by operqting 5,556 6,124 6,826 7,537 8,348
Actvities
Cash flow from Investing
Actvities
Capital Expenditure -Purchase of 3500 4000 4500 5000 5500
PP& E
Net Cash used in Investing 3500 4000 4500 5000 5500
Actvities
Cash flow from Financing
Actvities
Revolving Credit Facility ( Line of -1,375 - - - -
Credit)
Long term Debt -500 -500 -500 -500 -500
Net Cash used in Financiang -1875 -500 -500 -500 -500
Actvities
Net Cash Flow /Blance 7,181 9,624 10,826 12,037 13,348
Beginning cash Balance 2,000 0 0 0 0
Opening Cash Balance 9,181 9,624 10,826 12,037 13,348

SUPPORTING SCHEDULES:
Company Name: Hinduja Pvt
Ltd
Debt Schedule 2011 2012 2013 2014 2015 2016 2017
Cash balance @ Beg of year( end of last year) 2,000 9,181 9,624 10,826 12,037
Plus: Free cash flow from operating and 3,681 5,624 6,326 7,037 7,848
investing
Plus: Free cash fow from Financing ( before -500 -500 -500 -500 -500
L.O.C)
Less: Minimum Cash Balnce 2000 2000 2000 2000 2000
Total Cash Available or Required from 3,181 12,305 13,450 15,363 17,385
L.O.C
Line of Credit 792 1,375 - - - - -
Debt
Long term Debt , Net of Current 5000 4500 4,000 3,500 3,000 2,500 2,000
Maturities
Current Portion of Long Term Debt 500 500 500 500 500 500 500
Interest Expenses
Interest Rate on Long term debt 8% 8% 8% 8% 8%
Intrest Rate on Line of Credit 5% 5% 5% 5% 5%

Interest expenses on long term debt 380 340 300 260 220
Interest expenses on line of credit 34 - - - -
 Total Interest Expenses 414 340 300 260 220

PP&E Schedule
Beg: PP&E, Net of 10,932 11,159 11,556 12,094 12,734
Accoum.Depreciation
Plus: Capital Expenditure 3500 4000 4500 5000 5500

Less: Depreication 3,273 3,604 3,962 4,359 4,795

Depreciation as % of Revenue 4% 4% 4% 4% 4% 4% 4%
END: PP&E, NET OF 11,159 11,556 12,094 12,734 13,440
ACCOUM.DEPRECIATION
Model review & Auditing a Model: A model audit is an important task in financial auditing
that helps ensure that spreadsheet errors are eliminated it also called a model review, it is
commonly used by banking organizations in order to make accurate, supportive to lenders
and investors.
Scope of a Model Audit: A model audit is done in order to make sure that spreadsheet errors
are corrected. Thus, it needs to be specific with its scope and purpose to ensure that the
relevant tasks are completely and correctly carried out. The audit‘s scope includes the
following
• The audit should successfully review the logic used in the model under scrutiny.
• An audit should check for the model‘s consistency in terms of transactions and
documentation.
• The audit should make sure that the model is consistent and parallel with GAAP and
taxation rules.
Purpose of a Model Audit:
• The audit should be able to yield accurate results and the auditor needsto provide an
assurance to the party seeking the audit that such results will be obtained.
• the audit aims to ensure that the financial model used by a business is accurate and
that the assumptions contained within it are effective
All 10 types of Financial Models
• It confirms or denies that the financial model does what it is expected to do and that
any errors are minimal and will not cause any derail or delay of the business‘
projects.
Categories:
High-level review
A high-level review provides added confidence to clients about the financial modelthat they are
using. Aside from just correcting errors on a spreadsheet, a special
feature of the model audit is that it is keener and more sensitive to spotting errors without
checking every single detail of the model in question. It makes the process less time-
consuming, while still maintaining a very high accuracy of results, and it includes a check of
the model‘s logic.
Formal model audit: A formal audit is what stakeholders and investors may require even
after the completion of an audit and submission of a report saying that the model is good
enough to use. Often, they require an audit that is formal and most comprehensive, and the
formal audit satisfies this requirement.
 Cost and Duration of a Model Audit: The audit is completed usually within one to five
weeks, depending on how extensive the review is.
The fee depends on the following factors:
• Scope of the review
• Complexity of the model checked
• Volume and complexity of the documentation to be reviewed
• The seniority of the staff who does the work
How to Conduct a Model Audit: In order to perform the audit, it is important to recognize
that a model is produced by using MS Excel spreadsheetsand, therefore, contains data, figures,
and formulas. The auditors usually conducta bottom-up review or a cell-by-cell check of every
formula. They can also do a ―top-down‖ analysis of the model.
• Get familiar with its look and feel. Look through each sheet to see what colour
schemes have been used.
• Run an error check. Press the Error Checking button on the Formula Auditing
section of the Formulas tab in the Ribbon to see at a glance whether there are any
Excel errors on the sheet that might cause problems.
• Check automatic calculations. Formulas should calculate automatically, but
sometimes when a file is very large, or a modeler likes to control the
changes manually, the calculation has been set to manual instead ofautomatic
Important Questions:
1. What is Financial Modelling? Explain how it is helpful in analysing a firms‘
Financial Position?
2. How do you build a Financial Model?
3. How is Financial Modelling applied to three statement projection modelwith using
Excel?
4. Explain different types of Financial Models with suitable examples?
5. Discuss the best practice principles of modelling and how it is useful in Financial
Statement analysis?
 Unit II

Excel functions – Importing and exporting data – Financial functions (PV, FV Rate,
NPER, IRR, NPV, MIRR, XNPV, XIRR, effect, nominal, Price) – Lookup and reference
functions (Choose, Offset, Match, Indirect, Look up) – Statistical functions – Date and Time
functions– What if functions Goal Seek, Solver - Pivot Table – Data Analysis – Conditional
formatting– Array Formulas - Dynamic named ranges - Working with Charts – Creating
dynamic charts.
Introduction:
Excel is a spreadsheet program that is used to record and analyze numerical data. Think of a
spreadsheet as a collection of columns and rows that form a table. Alphabetical letters are
usually assigned to columns and numbers are usually assigned to rows. The point where a
column and a row meet is called a cell. The address of a cell is given by the letter
representing the column and the number representing a row. Let's illustrate this using the
following image
UNDERSTANDING THE RIBBON: The ribbon provides shortcuts to commands in Excel.
A command is an action that the user performs. An example of a command is creating a new
document, printing a documenting, etc. The image below shows the ribbon used in Excel

RIBBON COMPONENTS EXPLAINED: Ribbon start button - it is used to access

commands i.e. creating new documents, saving existing work, printing, accessing the options
for customizing Excel, etc
Ribbon tabs – the tabs are used to group similar commands together. The home tab is used
for basic commands such as formatting the data to make it more presentable, sorting and
finding specific data within the spreadsheet.
Ribbon bar – the bars are used to group similar commands together. As an example, the
Alignment ribbon bar is used to group all the commands that are used to align data together.
UNDERSTANDING THE WORKSHEET (ROWS AND COLUMNS, SHEETS,
WORKBOOKS): A worksheet is a collection of rows and columns. When a row and a column
meet, they form a cell. Cells are used to record data. Each cell is uniquely identified using a cell
address. Columns are usually labelled with letters while rowsare usually numbers.
A workbook is a collection of worksheets. By default, a workbook has three cells in Excel.
You can delete or add more sheets to suit your requirements. By default, the sheets are named
Sheet1, Sheet2 and so on and so forth. You can rename the sheet names to more meaningful
names i.e. Daily Expenses, Monthly Budget, etc
Excel functions:

A function in Excel is a formula-based program, that helps perform mathematical,statistical and

logical operations
There are now over 400 functions are available in Excel, and Microsoft keeps adding more
with each new version of the software.

The most frequently used functions in Excel are:

Function What It Does

SUM Adds up, or sums together, a range of cells.

MIN Calculates the minimum value of a range of cells.

MAX Calculates the maximum value of a range of cells.

AVERAGE Calculates the average value of a range of cells.

ROUND Rounds a single number to the nearest specified value, usually to a

whole number.

ROUNDUP Rounds up a single number to the nearest specified value, usually to a

whole number.

ROUNDDOWN Rounds down a single number to the nearest specified value, usually to
a whole number.

INDEX Works like the coordinates of a map and returns a single value
based on the column and row numbers you input into the function
fields.

MATCH Returns the position of a value in a column or a row. Modelers often

combine MATCH with the INDEX function to create a lookup
function, which is far more robust and flexible and uses less memory
than the LOOKUP functions earlier.

PMT Calculates the total annual payment of a loan.

IPMT Calculates the interest component of a loan.

PPMT Calculates the principal component of a loan.

 NPV Takes into account the time value of money by giving the net present
value of future cash flows in today‘s dollars, based on the investment
amount and discount rate.

Importing and exporting data:

Import data:
Excel can import data from external data sources including other files, databases,or web pages.
STEP 1: Click the Data tab on the Ribbon
STEP 2: Click the Get Data button.
STEP 3: Select from File.

STEP 4: Select From Text/CSV.

STEP 5: Select the file you want to import.

STEP 6: Click Import.

STEP 7: Verify the preview looks correct.
STEP 8: Click Load.
Financial functions (PV, FV Rate, NPER, IRR, NPV, MIRR, XNPV, XIRR, effect, nominal,
Price):

PV: The PV function is a widely used financial function in Microsoft Excel. It calculates the
present value of a loan or an investment. In financial statement analysis, PV is used to
calculate the dollar value of future payments in the presenttime.
Example
Suppose you are buying a refrigerator. The salesperson tells you that the price of the
refrigerator is 32000, but you have an option to pay out the amount in 8 years with an interest
rate of 13% per annum and yearly payments of 6000. You also have an option to make the
payments either at the beginning or end of each year.
You want to know which of these options is beneficial for you. You can use
Excel function PV −
PV (rate, nper, pmt, [fv ], [type]
To calculate present value with payments at the end of each year, omit type orspecify 0 for type.
To calculate present value with payments at the end of each year, specify 1 fortype.
Results:
If you make the payment now, you need to pay 32,000 of present value.
If you opt for yearly payments with payment at the end of the year, you need to pay

28, 793 of present value.

If you opt for yearly payments with payment at the end of the year, you need to pay
32,536 of present value.
You can clearly see that option 2 is benefited
FV Rate: The FV Function Excel formula is categorized under financial functions. This
function helps calculate the future value of an investment. the FV function helps calculate the
future value of investments made by a business, assuming periodic, constant payments with a
constant interest rate. It is useful in evaluating low-risk investments such as certificates of
deposit or fixed rate annuities with low interest rates. It can also be used in relation to interest
paid on loans.
NPER: The function helps calculate the number of periods that are required to pay off a loan
or reach an investment goal through regular periodic payments andat a fixed interest rate.
IRR: The function is very helpful in financial modelling, as it helps calculate the rate of
return an investment would earn based on series of cash flows. It is frequently used by
businesses to compare and decide between capital projects
Internal Rate of Return (IRR) of an investment is the rate of interest at which NPV is 0. It is
the rate value for which the present values of the positive cash flows exactly compensate the
negative ones. When the discount rate is the IRR, the investment is perfectly indifferent, i.e.
the investor is neither gaining nor losing money.
Consider the following cash flows, different interest rates and the corresponding NPV
values.

As you can observe between the values of interest rate 10% and 11%, the sign of NPV
changes. When you fine-tune the interest rate to 10.53%, NPV is nearly 0. Hence, IRR is
10.53%.
Determining IRR of Cash Flows for a Project
You can calculate IRR of cash flows with Excel function IRR.
 The IRR is 10.53% as you had seen in the previous section. For the
given cash flows, IRR may −
exist and unique
exist and multiple
not exist
Unique IRR
If IRR exists and is unique, it can be used to choose the best investment among several
possibilities.
If the first cash flow is negative, it means the investor has the money and wants to
invest. Then, the higher the IRR the better, since it represents the interest rate the
investor is receiving.
If the first cash flow is positive, it means the investor needs money and is looking for a
loan, the lower the IRR the better since it represents the interest rate the investor is
paying.
To find if an IRR is unique or not, vary the guess value and calculate IRR. If IRR remains
constant then it is unique.
As you observe, the IRR has a unique value for the different guess values.

NPV: The NPV Function is an Excel Financial function that will calculate the Net Present
Value (NPV) for a series of cash flows and a given discount rate. It is
important to understand the Time Value of Money, which is a foundational building block of
various Financial Valuation methods.
In financial modelling the NPV function is useful in determining the value of an investment
or understanding the feasibility of a project. It should be noted that it‘s usually more
appropriate for analysts to use the XNP function instead of theregular NPV function.
MIRR: The modified internal rate of return (commonly denoted as MIRR) is a financial
measure that helps to determine the attractiveness of an investment and that can be used to
compare different investments.
Essentially, the modified internal rate of return is a modification of the internal rate of return
(IRR) formula, which resolves some issues associated with that financial measure
Consider a case when your finance rate is different from your reinvestment rate. If you
calculate Internal Rate of Return with IRR, it assumes same rate for both finance and
reinvestment. Further, you might also get multiple IRRs.
For example, consider the cash flows given below −
As you observe, NPV is 0 more than once, resulting in multiple IRRs. Further, reinvestment
rate is not taken into account. In such cases, you can use modified IRR (MIRR).

You will get a result of 7% as shown below −

Note − Unlike IRR, MIRR will always be unique.

 XNPV: The XNPV function in Excel uses specific dates that correspond to each cash flow
being discounted in the series, whereas the regular NPV function automatically assumes all
the time periods are equal. For this reason, the XNPV function is far more precise and should
be used instead of the regular NPV function.
XNPV (Net Present Value of an Investment for Payments or Incomes at Irregular Intervals)
Returns the net present value of an investment based on a discount rate and a set of future
payments (negative values) and income (positive values). These payments or incomes do not
need to occur at regular intervals
XIRR: XIRR stands for the individual rate of return. It's your real investment return. XIRR is
a tool for calculating returns on assets where many transactionsoccur at different times.
XIRR meaning in mutual fund is to calculate returns on investments where there are multiple
transactions taking place in different times. Full form of XIRR is Extended Internal Rate of
Return.
EFFECT: This function calculates the effective annual interest rate for non- annual
compounding loans. Analysts often need to make decisions on which financial loan will be
best for a business
NOMINAL: The Excel NOMINAL function is a Financial formula that calculatesand returns
the nominal annual interest rate, for a given effective annual interest rate and number of
compounding periods per year. The nominal annual interest rate is used for calculating
financial loans and investments with different compounding terms.
PRICE: The price function is a financial function in excel. This is mostly used when an investor
borrows the money by selling bonds instead of stocks. It requires few more attributes, usually
more than other financial function such as settlement, maturity, yield, redemption, and
frequency as mandatory attributes
Lookup and reference functions (Choose, Offset, Match, Indirect, Look up): Choose: The
CHOOSE Function in Excel returns a value from the given data range(array) when the position
(index) is specified by the user. This lookup and reference function of excel is most commonly
used to create scenarios in financialmodels.

Offset: OFFSET will return a range of cells. That is, it will return a specified number of rows
and columns from an initial range that was specified.
The OFFSET function can be used to build a dynamic named range for pivot tablesor charts to
make sure that the source data is always up to date
Match: MATCH is an Excel function used to locate the position of a lookup value in a row,
column, or table. It is commonly used with the INDEX function. Learn how to combine
INDEX MATCH as a powerful lookup combination
Indirect: The Excel INDIRECT Function returns a reference to a range. The INDIRECT
function does not evaluate logical tests or conditions. Also, it will not perform calculations.
Basically, this function helps lock the specified cell in a formula.
Look up: The LOOKUP Function is categorized under Excel Lookup and Reference
functions. The function performs a rough match lookup either in a one-row or one-column
range and returns the corresponding value from anotherone-row or one-column range.
While doing financial analysis, if we wish to compare two rows or columns, we can use
the LOOKUP function. It is designed to handle the simplest cases of vertical and
horizontal lookup.
The more advanced versions of the LOOKUP function are :
HLOOKUP: HLOOKUP stands for Horizontal Lookup and can be used to retrieve
 information from a table by searching a row for the matching data and outputting from the
corresponding column. While VLOOKUP searches for the value in a column, HLOOKUP
searches for the value in a row
VLOOKUP: VLOOKUP stands for ‗Vertical Lookup‘. It is a function that makes Excel
search for a certain value in a column (the so called ‗table array‘), in order to return a value
from a different column in the same row. This article will teach you how to use the
VLOOKUP function.
Statistical functions:
In Excel, we have a range of statical functions, we can perform basic mean, median mode to
more complex statistical distribution, and probability test. In order to understand statistical
Functions, we will divide them into two sets:
• Basic statistical Function
• Intermediate Statistical Function
COUNT: The COUNT function is used to count the number of cells containing anumber. Always
remember one thing that it will only count the number.
COUNTA: This function will count everything, it will count the number of the cell containing any
kind of information, including numbers, error values, empty text. COUNTBLANK:
COUNTBLANK function, as the term, suggest it will only countblank or empty cells.
COUNTIFS: COUNTIFS function is the most used function in Excel. The function will
work on one or more than one condition in a given range and counts the cell that meets the
condition.
Intermediate Statistical Function:
AVERAGE: This function is one of the most used intermediate functions. The function will
return the arithmetic mean or an average of the cell in a given range. AVERAGEIF- The
function will return the arithmetic mean or an average of the cell in a given range that meets
the given criteria.
MEDIAN -The MEDIAN function will return the central value of the data. Its syntax is
similar to the AVERAGE function.
MODE- The MODE function will return the most frequent value of the cell in a given range.
STANDARD DEVIATION: This function helps us to determine how much observed value
deviated or varied from the average. This function is one of the useful functions in Excel
VARIANCE: To understand the VARIANCE function, we first need to know what is
variance? Basically, Variance will determine the degree of variation in your dataset. The more
data is spread it means the more is variance.
CORRELATION function: CORRELATION function, help to find the relationship between
the two variables, this function mostly used by the analyst to study the data. The range of the
CORRELATION coefficient lies between -1 to +1.
MAX function: The MAX function will return the largest numeric value within a given set
of data or an array.
MIN function: The MIN function will return the smallest numeric value within a given set of
data or an array
Date and Time functions:
Function Description

DATE function Returns the serial number of a particular date

DATEDIF function Calculates the number of days, months, or years between two
dates. This function is useful in formulas where you need to
calculate an age.

DATEVALUE function Converts a date in the form of text to a serial number

DAY function Converts a serial number to a day of the month

DAYS function Returns the number of days between two dates

DAYS360 function Calculates the number of days between two datesbased on

a 360-day year

EDATE function Returns the serial number of the date that is the indicated
number of months before or after the startdate

MINUTE function Converts a serial number to a minute

MONTH function Converts a serial number to a month

NETWORKDAYS function Returns the number of whole workdays between two

dates

NETWORKDAYS.INTL Returns the number of whole workdays between two

function dates using parameters to indicate which and how many
days are weekend days

SECOND function Converts a serial number to a second

TIME function Returns the serial number of a particular time

 TIMEVALUE function Converts a time in the form of text to a serialnumber

TODAY function Returns the serial number of today's date

WEEKDAY function Converts a serial number to a day of the week

WEEKNUM function Converts a serial number to a number representing

where the week falls numerically with a year

WORKDAY function Returns the serial number of the date beforeor after a
specified number of workdays

WORKDAY.INTL function Returns the serial number of the date before or after a
specified number of workdays using parameters to
indicate which and how many days are weekend days

YEAR function Converts a serial number to a year

YEARFRAC function Returns the year fraction representing the number of

whole days between start date and end date

What if functions Goal Seek:

The Goal Seek in excel is a ―what-if-analysis‖ tool that calculates the valueof the input
cell (variable) with respect to the desired outcome. In other words, the tool helps
answer the question, ―what should be the value of the input in order to attain the given
output?‖
What-If Analysis is one of the most powerful Excel features and one of the least
understood. In most general terms, What-If Analysis allows you to test out various
scenarios and determine a range of possible outcomes
 Microsoft Excel comes with three built-in What-If Analysis tools: Data Tables,
Scenarios, and Goal Seek. All three tools are used in ―what-if‖ scenarios to
understand how changing certain input values will affect the output value, or the
desired outcome. The Goal Seek function is used to understand what input value is
needed in order to realistically achieve your set goal.
(Or)
Goal Seek is a What-If Analysis tool that helps you to find the input value that results in a
target value that you want. Goal Seek requires a formula that uses the input value to give
result in the target value. Then, by varying the input value in the formula, Goal Seek tries to
arrive at a solution for the input value.
Goal Seek works only with one variable input value. If you have more than one input value
to be determined, you have to use the Solver add-in. Refer to the chapter – Optimization
with Excel Solver in this tutorial.
Analysis with Goal Seek
Suppose you want to take a loan of 5,000,000 and you want to repay in 25 years. You can pay
an EMI of 50000. You want to know at what interest rate you can borrow the loan.
You can use Goal Seek to find the interest rate at which you can borrow the loanas follows
Step 1 − Set up the Excel cells for Goal Seek as given below.

Step 2 − Enter the values in column C corresponding to column D. The cell Interest Rate is
kept empty, as you have to retrieve that value. Further, though you know the EMI that you can
pay (50000), that value is not included as you have
to use the Excel PMT function to arrive at it. Goal Seek requires a formula to find the result.
The PMT function is placed in the cell EMI so that it can be usedby Goal Seek.
Excel computes the EMI with the PMT function. The table now looks like

As the Interest_Rate cell is empty, Excel takes that value as 0 and calculates the EMI. You
can ignore the result -13,888.89.
Perform the Analysis with Goal Seek as follows:
Step 1 − Go to DATA > What If Analysis > Goal Seek on the Ribbon.

The Goal Seek dialog box appears.

Step 2 − Type EMI in the Set cell box. This box is the reference for the cell that contains the
formula that you want to resolve, in this case the PMT function. It is the cell C6, which you
named as EMI.
Step 3 − Type -50000 in the To value box. Here, you get the formula result, in this case, the
EMI that you want to pay. The number is negative because it represents a payment.
Step 4 − Type Interest_Rate in the By changing cell box. This box has the reference of the
cell that contains the value you want to adjust, in this case the interest rate. It is cell C2, which
you named as Interest_Rate.
Step 5 − This cell that Goal Seek changes, must be referenced by the formula in the cell that
you specified in the Set cell box. Click OK.

Goal Seek produces a result, as shown below −

 As you can observe, Goal Seek found the solution using cell C6 (containing the formula) as
12% that is displayed in the cell C2, which is the interest rate. Click OK.
Goal Seek Parameters:
The parameters to be specified in the ―Goal Seek‖ dialog box are stated asfollows:
Set cell–In this box, enter the cell reference of the formula to be resolved. This is the target cell
or the formula cell.
To value–In this box, enter the desired output to be achieved. This is the value of the ―set
cell‖ to be attained.
By changing cell–In this box, enter the reference of the input cell (variable) to be adjusted.
This is the cell we want to change in order to impact the ―set cell.‖ EXAMPLE:
The following table shows the votes received by the two candidates, A and B, who contested in
an election. In the present situation, candidate B is leading by 10,000 votes. It is given that to
win the election, 50.01% votes are required. We want to change the voting percentage (column
C) of candidate A in such a way that he wins the election. Calculate the total number of votes
required by candidate A to win.

Let us calculate the present voting percentage for both the candidates. This is done by
dividing the individual votes received by the total votes. Candidate A has won 46.43% of the
total votes. Therefore, he needs only 3.67% votes to win theelection.
The steps to use Goal Seek in excel are stated as follows:
1. In the Data tab, click “Goal Seek” from the “what-if-analysis” drop-down.

2. The “Goal Seek” excel window appears as shown in the following image

3. Enter $C$2 in the “set cell” box. This is because C2 is the target cell

4. Enter 50.01% in the ―to value‖ box. This is the value of the ―set cell‖ that we want to
obtain. In other words, the ―set cell‖ should change to the target value of 50.01%.
 5. Enter $B$2 in the ―by changing cell‖ box. This is the cell we want to change to impact
the ―set cell‖ C2. Since all the parameters are set, click ―Ok‖ to get the result.

6. The output is shown in the following image. Candidate A should secure 70,014 votes
to win the election. With 70,014 votes, the voting percentage of candidate A will
become 50.01%. Click ―Ok‖ to apply the changes.

The total number of votes and the voting percentage of candidate A has changed.Consequently,
the votes and the voting percentage of candidate B also changes.

The votes of candidate B are calculated by subtracting 70,014 from 140,000. Thefinal output is
displayed in the following image. Hence, candidate A wins the election.
Example:
Mr. A opens a retail shop and sells goods at an average selling price of $25 per unit. To
meet his operating expenses, he wants to generate monthly revenue of
$250,000.
We want to calculate the quantity of the goods Mr. A should sell to earn the givenrevenue.

Step 1: In cell B3, apply the formula unit price*units (B1*B2).

Step 2: In the Data tab, click ―Goal Seek‖ from the ―what-if-analysis‖ drop-down. The ―Goal
Seek‖ window appears as shown in the following image.

Step 3: Enter $B$3 in the ―set cell‖ box. The target cell is the revenue cell B3.
Step 4: Enter 250000 in the ―to value‖ box. This is the value of the ―set cell‖ tobe achieved.

Step 5: Enter $B$2 in the ―by changing cell.‖ The quantity has to be calculated in cell B2. So,
this is the cell that has to be adjusted to achieve the given revenue.Click ―Ok.‖

Step 6: The output is displayed in the following image. Hence, Mr. A needs to sell10,000 units
of goods to generate revenue of $250,000. Click ―Ok‖ to apply the changes.

Advantages:

1) Solver can solve formulas (or equations) which use several variables whereas Goal Seek
can only be used with a single variable.
 2) Solver will allow you to vary the values in up to 200 cells whereas Goal Seek only
allows you to vary the value in one cell.
3) It is possible to save one (or more) models with Solver.
Solver:

Solver is a Microsoft Excel add-in program you can use for what-if analysis. Use Solver to
find an optimal (maximum or minimum) value for a formula in one cell —called the objective
cell — subject to constraints, or limits, on the values of otherformula cells on a worksheet.
Excel Solver is an optimization tool that can be used to determine how the desired outcome can
be achieved by changing the assumptions in a model. It is a typeof what-if analysis and is
particularly useful when trying to determine the ―best‖ outcome, given a set of more than two
assumptions
How to Use Excel Solver
The best example of how to use Excel solver is by graphing a situation where there is a non-
linear relationship between, for example, the number of salespeople in a company and the profit
that they generate. There is a diminishing return on salespeople, so we want to figure out
what the optimal number of people to hire is. Put another way, we want to figure out how
many salespeople we should hire to get the maximum amount of profit.
Solver is an Excel solution used for What-if analysis. Excel Solver is similar to Goal
Seek in that it works backward to achieve a numeric objective by changingvariables.
Excel Solver belongs to a special set of commands often referred to as What-if Analysis
Tools. It is primarily purposed for simulation and optimization of various business and
engineering models.
The Excel Solver add-in is especially useful for solving linear programming problems, aka
linear optimization problems, and therefore is sometimes called a linear programming
solver. Apart from that, it can handle smooth nonlinear and non-smooth problems. Please see
Excel Solver algorithms for more details.
While Solver can't crack every possible problem, it is really helpful when dealing with all
kinds of optimization problems where you need to make the best decision.For example, it can
help you maximize the return of investment, choose the
 optimal budget for your advertising campaign, make the best work schedule for your
employees, minimize the delivery costs, and so on.
Load the Solver Add-in
To load the solver add-in, execute the following steps.
1. On the File tab, click Options.
2. Under Add-ins, select Solver Add-in and click on the Go button.

3. Check Solver Add-in and click OK

4. You can find the Solver on the Data tab, in the Analyze group.

Formulate the Model

The model we are going to solve looks as follows in Excel.

1. To formulate this linear programming model, answer the following three questions.

a. What are the decisions to be made? For this problem, we need Excel to find out how
much to order of each product (bicycles, mopeds and child seats).
b. What are the constraints on these decisions? The constrains here are that the amount of
capital and storage used by the products cannot exceed the limited amount of capital and
storage (resources) available. For example, each bicycle uses 300 units of capital and 0.5 unit
of storage.
c. What is the overall measure of performance for these decisions? The overall measure of
performance is the total profit of the three products, so the objective is to maximize this
quantity.
2. To make the model easier to understand, create the following named ranges.
 Range Name Cells

Unit Profit C4:E4

Order Size C12:E12

Resources Used G7:G8

Resources Available I7:I8

Total Profit I12

3. Insert the following three SUMPRODUCT functions.

Explanation: The amount of capital used equals the sum product of the range C7:E7 and
OrderSize. The amount of storage used equals the sum product of the range C8:E8 and
OrderSize. Total Profit equals the sum product of Unit Profit and OrderSize.
Trial and Error
With this formulation, it becomes easy to analyze any trial solution.
For example, if we order 20 bicycles, 40 mopeds and 100 child seats, the total amount of
resources used does not exceed the amount of resources available. This solution has a total
profit of 19000.
 It is not necessary to use trial and error. We shall describe next how the ExcelSolver can be used
to quickly find the optimal solution.
Solve the Model
To find the optimal solution, execute the following steps.
1. On the Data tab, in the Analyze group, click Solver.

Enter the solver parameters (read on). The result should be consistent with thepicture below.
 You have the choice of typing the range names or clicking on the cells in the
spreadsheet.
2. Enter Total Profit for the Objective.
3. Click Max.
4. Enter OrderSize for the Changing Variable Cells.
5. Click Add to enter the following constraint.

Result:
 The optimal solution:

Conclusion: it is optimal to order 94 bicycles and 54 mopeds. This solution gives the
maximum profit of 25600. This solution uses all the resources available.
Pivot Table:

A PivotTable is a powerful tool to calculate, summarize, and analyze data that lets you see
comparisons, patterns, and trends in your data.
Advantages:
1. Pivot tables allow you to see how your data works – Pivot tables are one of the many
tools out there that can help users get deeper insights into their data. You can create
multiple reports on multiple data sets from a single pool of data.
2. Works well with SQL exports – A lot of data we have in our business are often
generated from SQL queries. Pivot tables can work with both SQL exports (data
downloaded/exported from SQL databases) and directly toSQL servers. This makes it
easier for you to harvest data and transfer it directly into a format that you can easily
analyze data.

3. Large amounts of data can be segmented – One problem with data analysis is that it
gets harder the more data you have. With pivot tables, you can easily segment data no
matter how big the whole data set is. This makes analysis much easier and can
actually help you spot trends in the data.

4. Creating instant data is possible – When data is loaded into a pivot table, you have
the freedom to use it any way you want. You can even program
 equations directly into the pivot table or use formulas to create instantdata.

Disadvantages:

1. Mastering pivot tables takes time – Sure, creating a pivot table requires a few clicks
inside Excel but truly mastering the tool takes time. First-time users of pivot tables
might see it as confusing and overwhelming. Only when you have ―tamed the beast‖ can
you properly use it for data analysis.
2. Can be time-consuming to use – Depending on how you would like to use your data
within the pivot table, using it can actually take some time. This is because the tool
itself does not include a robust collection of calculation options. This means the user
is required to manually calculate the data or to manually input equations which can
take some time

3. There are no automatic updates – Unless you regularly update your pivot table with
new data, you are basically relying on old data for your metrics and analytics. This
means it will be hard to rely on pivot tables for real- time analytics.

4. Older computers might not be able to handle large data sets – When you are working
with a couple of thousand lines of data then any computer will do just fine. But once
you hit the tens of thousands mark, old computers might struggle to produce the data
that you need. It‘s also not rare to see computers crash just because they can‘t handle
the amount of data they are processing.

Pivot tables are one of Excel's most powerful features. A pivot table allows you to
extract the significance from a large, detailed data set.

Our data set consists of 213 records and 6 fields. Order ID, Product, Category,
Amount, Date and Country.

Insert a Pivot Table

To insert a pivot table, execute the following steps.
1. Click any single cell inside the data set.
2. On the Insert tab, in the Tables group, click PivotTable.
 3. Click OK.

Drag fields:
The PivotTable Fields pane appears. To get the total amount exported of each product, drag
the following fields to the different areas.
1. Product field to the Rows area.
2. Amount field to the Values area.
3. Country field to the Filters area.
Sort:
To get Banana at the top of the list, sort the pivot table.
1. Click any cell inside the Sum of Amount column.
2. Right click and click on Sort, Sort Largest to Smallest.

Result:
Filter:
Because we added the Country field to the Filters area, we can filter this pivot table by
Country. For example, which products do we export the most to France?
1. Click the filter drop-down and select France.
 Result. Apples are our main export product to France.

Note: you can use the standard filter (triangle next to Row Labels) to only show the amounts
of specific products.
Change Summary Calculation
By default, Excel summarizes your data by either summing or counting the items. To
change the type of calculation that you want to use, execute thefollowing steps.
1. Click any cell inside the Sum of Amount column.
2. Right click and click on Value Field Settings.

2. Choose the type of calculation you want to use. For example, click Count.
Two-dimensional Pivot Table
If you drag a field to the Rows area and Columns area, you can create a two- dimensional
pivot table. First, insert a pivot table. Next, to get the total amount exported to each country,
of each product, drag the following fields to the different areas.
1. Country field to the Rows area.
2. Product field to the Columns area.
3. Amount field to the Values area.
4. Category field to the Filters area.

Below you can find the two-dimensional pivot table.

 to easily compare these numbers, create a pivot chart and apply a filter. Maybe this is one
step too far for you at this stage, but it shows you one of the many other powerful pivot table
features Excel has to offer.

Data Analysis:

Microsoft Excel is one of the most popular applications for data analysis. Equipped with built-in
pivot tables, they are without a doubt the most sought-after analytic tool available. It is an all-
in-one data management software that allows you to easily import, explore, clean, analyze,
and visualize your data. In this article, we will discuss the various methods of data analysis in
Excel.
Data Analysis with Excel is a comprehensive tutorial that provides a good insight into
the latest and advanced features available in Microsoft Excel. It explains in detail how
to perform various data analysis functions using the features available in MS-Excel.
The tutorial has plenty of screenshots that explain how to use a particular feature, in a
step-by-step manner.
Data Analysis is a process of inspecting, cleaning, transforming and modelling data
with the goal of discovering useful information, suggesting conclusions and
supporting decision-making
Types of Data Analysis
Several data analysis techniques exist encompassing various domains such as business,
science, social science, etc. with a variety of names. The major data analysis approaches are −
Data Mining
Business Intelligence
Statistical Analysis
Predictive Analytics
Text Analytics
Data Mining: Data Mining is the analysis of large quantities of data to extract previously
unknown, interesting patterns of data, unusual data and the dependencies. Note that the goal
is the extraction of patterns and knowledge from large amounts of data and not the extraction
of data itself.
Data mining analysis involves computer science methods at the intersection of the artificial
intelligence, machine learning, statistics, and database systems.
Business Intelligence: Business Intelligence techniques and tools are for acquisition and
transformation of large amounts of unstructured business data to help identify, develop and
create new strategic business opportunities.
Statistical Analysis: Statistics is the study of collection, analysis, interpretation,
presentation, and organization of data.
In data analysis, two main statistical methodologies are used −
Descriptive statistics –
In descriptive statistics, data from the entire population or a sample is summarized with
numerical descriptors such as −
Mean, Standard Deviation for Continuous Data
Frequency, Percentage for Categorical Data
Inferential statistics − It uses patterns in the sample data to draw inferences about the
represented population or accounting for randomness. These inferences can be −
answering yes/no questions about the data (hypothesis testing)
estimating numerical characteristics of the data (estimation)
 describing associations within the data (correlation)
modelling relationships within the data (E.g. regression analysis) Predictive
Analytics: Predictive Analytics use statistical models to analyze current and historical
data for forecasting (predictions) about future or otherwise unknown events. In business,
predictive analytics is used to identifyrisks and opportunities that aid in decision-making.
Text Analytics: Text Analytics, also referred to as Text Mining or as Text Data Mining is the
process of deriving high-quality information from text. Text mining usually involves the
process of structuring the input text, deriving patterns within the structured data using means
such as statistical pattern learning, and finally evaluation and interpretation of the output.
Data Analysis Process:
Data Analysis is defined by the statistician John Tukey in 1961 as "Procedures for analysing
data, techniques for interpreting the results of such procedures, ways of planning the
gathering of data to make its analysis easier, more precise or more accurate, and all the
machinery and results of (mathematical) statistics which apply to analyzing data.‖
Thus, data analysis is a process for obtaining large, unstructured data from various sources
and converting it into information that is useful for −
Answering questions
Test hypotheses
Decision-making
Disproving theories
Data Analysis with Excel
Microsoft Excel provides several means and ways to analyze and interpret data. The data can
be from various sources. The data can be converted and formatted in several ways. It can be
analyzed with the relevant Excel commands, functions and tools - encompassing Conditional
Formatting, Ranges, Tables, Text functions, Date functions, Time functions, financial
functions, Subtotals, Quick Analysis, Formula Auditing, Inquire Tool, What-if Analysis,
Solvers, Data Model, PowerPivot, PowerView, PowerMap, etc.
Data Analysis is a process of collecting, transforming, cleaning, and modelling data with the
goal of discovering the required information. The results so obtained are
communicated, suggesting conclusions, and supporting decision-making. Data visualization
is at times used to portray the data for the ease of discovering the useful patterns in the data.
The terms Data Modelling and Data Analysis mean the same.
Data Analysis Process consists of the following phases that are iterative innature −
Data Requirements Specification
Data Collection
Data Processing
Data Cleaning
Data Analysis
Communication
 Data Requirements Specification: The data required for analysis is based on a question or
an experiment. Based on the requirements of those directing the analysis, the data necessary
as inputs to the analysis is identified (e.g., Populationof people). Specific variables regarding a
population (e.g., Age and Income) may be specified and obtained. Data may be numerical or
categorical.
Data Collection: Data Collection is the process of gathering information on targeted
variables identified as data requirements. The emphasis is on ensuring accurate and honest
collection of data. Data Collection ensures that data gathered is accurate such that the related
decisions are valid. Data Collection provides both a baseline to measure and a target to
improve.
Data Processing: The data that is collected must be processed or organized for analysis. This
includes structuring the data as required for the relevant Analysis Tools. For example, the data
might have to be placed into rows and columns in a table within a Spreadsheet or Statistical
Application. A Data Model might have to be created.
Data Cleaning: The processed and organized data may be incomplete, contain duplicates, or
contain errors. Data Cleaning is the process of preventing and correcting these errors. There
are several types of Data Cleaning that depend onthe type of data. For example, while cleaning
the financial data, certain totals might be compared against reliable published numbers or
defined thresholds. Likewise, quantitative data methods can be used for outlier detection that
wouldbe subsequently excluded in analysis.
Data Analysis: Data that is processed, organized and cleaned would be ready for the analysis.
Various data analysis techniques are available to understand, interpret, and derive
conclusions based on the requirements. Data Visualization may also be used to examine the
data in graphical format, to obtain additional insight regarding the messages within the data.
Communication: The results of the data analysis are to be reported in a format as required
by the users to support their decisions and further action. The feedback from the users might
result in additional analysis.
Conditional formatting: In Microsoft Excel, you can use Conditional Formatting for data
visualization. You have to specify formatting for a cell range
based on the contents of the cell range. The cells that meet the specified conditions would be
formatted as you have defined.
MS Excel 2010 Conditional Formatting feature enables you to format a range of values so that
the values outside certain limits, are automatically formatted.
Highlight Cells Rules
To highlight cells that are greater than a value, execute the following steps.
1. Select the range A1:A10.
4. Enter the value 80 and select a formatting style.

5. Click OK.
Result. Excel highlights the cells that are greater than 80.
Note: you can also use this category (see step 3) to highlight cells that are less than a value,
between two values, equal to a value, cells that contain specific text, dates (today, last week,
next month, etc.), duplicates or unique values.
Clear Rules
To clear a conditional formatting rule, execute the following steps.
1. Select the range A1:A10.
Top/Bottom Rules
To highlight cells that are above average, execute the following steps.
1. Select the range A1:A10.
2. On the Home tab, in the Styles group, click Conditional Formatting.
3. Click Top/Bottom Rules, Above Average.
4. Select a formatting style.
5. Click OK.
Note: you can also use this category (see step 3) to highlight the top n items, thetop n percent,
the bottom n items, the bottom n percent or cells that are below average.
Conditional Formatting with Formulas
Take your Excel skills to the next level and use a formula to determine which cells to format.
Formulas that apply conditional formatting must evaluate to TRUE or FALSE.
1. Select the range A1:E5.
2. On the Home tab, in the Styles group, click Conditional Formatting.
3. Click New Rule.

Result. Excel highlights all odd numbers.

Explanation: always write the formula for the upper-left cell in the selected range. Excel
automatically copies the formula to the other cells. Thus, cell A2 contains the formula
=ISODD(A2), cell A3 contains the formula =ISODD(A3), etc.
7. Select the range A2:D7.
Result. Excel highlights all USA orders.
Explanation: we fixed the reference to column C by placing a $ symbol in front of the column
letter ($C2). As a result, cell B2, C2 and cell D2 also contain the formula =$C2="USA", cell
A3, B3, C3 and D3 contain the formula =$C3="USA", etc.
Advantages of Conditional formatting:
Conditional formatting is a way of formatting cells in the spreadsheet software Microsoft
Excel. It allows cells within a particular spreadsheet to be formatted automatically in
accordance to what is in the cell. For example, if there is a figure that is negative in a cell, the
cell color would automatically turn to red, positive numbers may turn the cell green and so
on. So what are the advantages of conditional formatting
Updates occur in real time: The spreadsheet will have the ability to format itself as you are
working on it in real time. This means that anything you do within the spreadsheet will be
brought to your attention quicker if the cells were to change their format. For example, if you
have entered the same data into the spreadsheet twice, you could set up conditional
formatting to change this cell to red. That way you are constantly up to date with everything
that is going on in your spreadsheet.
Stops you from wasting time: If all of this formatting is happening on its own, this leaves
you with a lot more time to complete the more important tasks. You will have more free time
to spend analyzing the spreadsheet thoroughly or indeed to do whatever else you want to do
with you spare time now that the formatting is complete.
More in-depth analysis: The conditional formatting can allow you to control data in you
spreadsheet in a way that will help you analyze the data in a much deeper way. This will give
you a much better understanding of your statistics in the longrun.
Array Formulas:

Before we start on array functions and formulas, let's figure out what the term "array" means.
Essentially, an array is a collection of items. The items can be text or numbers and they can
reside in a single row or column, or in multiple rows and columns.
For example, if you put your weekly grocery list into an Excel array format, it would look
like:
{"Milk", "Eggs", "Butter", "Corn flakes"}
Then, if you select cells A1 through D1, enter the above array preceded by an equal sign (=)
in the formula bar and press CTRL + SHIFT + ENTER, you will get the following result:

What is an array formula in Excel?

The difference between an array formula and a regular formula is that an array formula
processes several values instead of just one. In other words, an array formula in Excel
evaluates all individual values in an array and performs multiple calculations on one or
several items according to the conditions expressed in theformula.
Simple example of Excel array formula
Suppose you have some items in column B, their prices in column C, and you want to
calculate the grand total of all sales.
Of course, nothing prevents you from calculating subtotals in each row first with something as
simple as =B2*C2 and then sum those values:
 However, an array formula can spare you those extra key strokes since it gets Excel to store
intermediate results in memory rather than in an additional column. So, all it takes is a single
array formula and 2 quick steps:
Select an empty cell and enter the following formula in it:
=SUM(B2:B6*C2:C6)

Press the keyboard shortcut CTRL + SHIFT + ENTER to complete the array formula.
Once you do this, Microsoft Excel surrounds the formula with {curly braces}, which is a
visual indication of an array formula.
What the formula does is multiply the values in each individual row of the specified array
(cells B2 through C6), add the sub-totals together, and output the grand total:

Why use array formulas in Excel?

Excel array formulas are the handiest tool to perform sophisticated calculations and do
complex tasks. A single array formula can replace literally hundreds of usual formulas. Array
formulas are very good for tasks such as:
 Sum numbers that meet certain conditions, for example sum N largest or smallest
values in a range.
 Sum every other row, or every Nth row or column, as demonstrated in thisexample.
 Count the number of all or certain characters in a specified range. Here is an array
formula that counts all chars, and another one that counts any given characters.
Example 1. A single-cell array formula
Suppose you have two columns listing the number of items sold in 2 different months, say
columns B and C, and you want to find the maximum sales increase.
Normally, you would add an additional column, say column D, that calculates the sales
change for each product using a formula like =C2-B2, and then find the maximum value in
that additional column =MAX(D:D).
An array formula does not need an additional column since it perfectly stores intermediate
results in memory. So, you just enter the following formula and press Ctrl + Shift + Enter:
=MAX(C2:C6-B2:B6)

Example 2. A multi-cell array formula in Excel

In the previous SUM example, suppose you have to pay 10% tax from each sale and you
want to calculate the tax amount for each product with one formula.
Select the range of cell in some blank column, say D2:D6, and enter the following formula in
the formula bar:
=B2:B6 * C2:C6 * 0.1
Once you press Ctrl + Shift + Enter, Excel will place an instance of your array formula in each
cell of the selected range, and you will get the following result:
Example 3. Using an Excel array function to return a multi-cell array
As already mentioned, Microsoft Excel provides a few so called "array functions" that are
specially designed to work with multi-cell arrays. TRANSPOSE is one of such functions and
we are going to utilize it to transpose the above table, i.e. convert rows to columns.
 Select an empty range of cells where you want to output the transposed table. Since
we are converting rows to columns, be sure to select the same number of rows and
columns as your source table has columns and rows, respectively. In this example, we
are selecting 6 columns and 4 rows.
 Press F2 to enter the edit mode.
 Enter the array function =TRANSPOSE (array) and press Ctrl + Shift + Enter. In our
example, the formula is =TRANSPOSE($A$1:$D$6).The result is going to look
similar to this:

this is how you use an array function in Excel. To learn the nuts and bolts of TRANSPOSE,
please check out this tutorial: How to transpose in Excel - convertrows to columns.
Dynamic named ranges:
How to use the OFFSET formula with a defined name
To do this, follow these steps, as appropriate for the version of Excel that you are running.
Microsoft Office Excel 2007, Microsoft Excel 2010 and Microsoft Excel 2013
1. On the Formula tab, in the Defined Names group, click Define Name. Or, press Ctrl
+ F3 to open the Excel Name Manger, and click the New… button.
2. Either way, the New Name dialogue box will open, where you specify the following
details:
 In the Name box, type the name for your dynamic range.
 In the Scope dropdown, set the name's scope. Workbook (default) is
recommended in most cases.
 In the Refers to box, enter either OFFSET COUNTA or INDEX COUNTA
formula.
 3. Click OK. Done!
In the following screenshot, we define a dynamic named range items that
accommodates all cells with data in column A, except for the header row:

Working with Charts :

A chart is a tool you can use in Excel to communicate data graphically. Chartsallow your
audience to see the meaning behind the numbers, and they make showing comparisons
and trends much easier. In this lesson, you'll learn howto insert charts and modify them so
they communicate information effectively. Charts
Excel workbooks can contain a lot of data, and this data can often be difficult to interpret.
For example, where are the highest and lowest values? Are the numbers increasing or
decreasing?
The answers to questions like these can become much clearer when data is represented as a
chart. Excel has various types of charts, so you can choose one that most effectively
represents your data.
A simple chart in Excel can say more than a sheet full of numbers. As you'll see, creating
charts is very easy.
Create a Chart
To create a line chart, execute the following steps.
1. Select the range A1:D7.
Result:

Note: enter a title by clicking on Chart Title. For example, Wildlife Population.
Change Chart Type
You can easily change to a different type of chart at any time.
1. Select the chart.
2. On the Design tab, in the Type group, click Change Chart Type.
4. Click OK.Result:

Switch Row/Column
If you want to display the animals (instead of the months) on the horizontalaxis, execute
the following steps.
1. Select the chart.
2. On the Design tab, in the Data group, click Switch Row/Column.

Result:
Legend Position
To move the legend to the right side of the chart, execute the following steps.
1. Select the chart.
2. Click the + button on the right side of the chart, click the arrow next to Legend and
click Right.

Result:
 Data Labels
You can use data labels to focus your readers' attention on a single data seriesor data point.
1. Select the chart.
2. Click a green bar to select the Jun data series.
3. Hold down CTRL and use your arrow keys to select the population of Dolphins in June
(tiny green bar).
4. Click the + button on the right side of the chart and click the check box next to Data
Labels.

Result:

Creating dynamic charts:

How to Create a Dynamic Chart Range in Excel?
There are two ways to create a dynamic chart range in Excel:
Using Excel Table
Using Formulas
In most of the cases, using Excel Table is the best way to create dynamic rangesin Excel.
Let‘s see how each of these methods work.
Using Excel Table
Using Excel Table is the best way to create dynamic ranges as it updates automatically when
a new data point is added to it.
Excel Table feature was introduced in Excel 2007 version of Windows and if you‘re versions
prior to it, you won‘t be able to use it (see the next section on creating dynamic chart range
using formulas).
in the example below, you can see that as soon as I add new data, the Excel Table expands to
include this data as a part of the table (note that the border and formatting expand to include it
in the table).

Now, we need to use this Excel table while creating the charts.
Here are the exact steps to create a dynamic line chart using the Excel table: Select the
entire Excel table.

Go to the Insert tab

In the Charts Group, select ‗Line with Markers‘ chart.

The above steps would insert a line chart which would automatically update when you
add more data to the Excel table.
Note that while adding new data automatically updates the chart, deleting data would
not completely remove the data points. For example, if you remove 2 data points, the
chart will show some empty space on the right. To correct this, drag the blue mark at
the bottom right of the Excel tableto remove the deleted data points from the table (as
shown below).
Using Excel Formulas
As I mentioned, using Excel table is the best way to create dynamic chart ranges. However, if
you can‘t use Excel table for some reason (possibly if you are using Excel 2003), there is
another (slightly complicated) way to create dynamic chart ranges using Excel formulas and
named ranges.
Suppose you have the data set as shown below:

to create a dynamic chart range from this data, we need to:

Create two dynamic named ranges using the OFFSET formula (one each for ‗Values‘ and
‗Months‘ column). Adding/deleting a data point would automatically update these named
ranges.
Insert a chart that uses the named ranges as a data source.
Step 1 – Creating Dynamic Named Ranges
Below are the steps to create dynamic named ranges: Go to
the ‗Formulas‘ Tab

Click on ‗Name Manager‘

In the Name Manager dialog box, specify the name as Chart Values and enter the following
formula in Refers to
part:

Click OK.
In the Name Manager dialog box, click on New.
In the Name Manager dialog box, specify the name as Chart Months and enter the
following formula in Refers to
part: =OFFSET(Formula!$A$2,,,COUNTIF(Formula!$A$2:$A$100,‖<>‖))

Click Ok.
Click Close.
The above steps have created two named ranges in the Workbook – Chart Value and
ChartMonth (these refer to the values and months range in the data set respectively).If you go
and update the value column by adding one more data point, the Chart Value named range
would now automatically update to show the additional data point in it. The magic is done by
the OFFSET function here.
In the ‗Chart Value‘ named range formula, we have specified B2 as the reference point.
OFFSET formula starts there and extends to cover all the filled cells in the column. The Same
logic works in the ChartMonth named range formula as well. Step 2 – Create a Chart Using
these Named Ranges
Now all you need to do is insert a chart that will use the named ranges as the data source. Here
are the steps to insert a chart and use dynamic chart ranges:
Go to the Insert tab
With the chart selected, go to the Design tab

Click on Select Data

In the ‗Select Data Source‘ dialog box, click on the Add button in ‗Legend Entries(Series)‘

In the Series value field, enter =Formula! Chart Values (note that you need to specify the
worksheet name before the named range for this to work).
 Click OK.
Click on the Edit button in the ‗Horizontal (Category) Axis Labels‘.

In the ‗Axis Labels‘ dialog box, enter =Formula! Chart Months

Click Ok.
That‘s it! Now your chart is using a dynamic range and will update when you add/delete
data points in the chart.
 Important Questions (Unit1 & 2):
1. What is Financial Modelling? Explain how it is helpful in analysing a
firms‘Financial Position?
2. How do you build a Financial Model?
3. How is Financial Modelling applied to three statement projection model
with using Excel?
4. Explain different types of Financial Models with suitable examples?
5. Discuss the best practice principles of modelling and how it is useful in
Financial Statement analysis?
6. What are different types of Finance Functions applied in Modelling with
using Excel?
7. What are different types of Look up and reference Functions applied in
Modelling with using Excel?
8. What are different types of Statistical Functions applied in Modelling with
using Excel?
9. What are different types of Array formulas applied in Modelling with using
Excel?
10. How do you create Pivot table and discuss its
Advantages anddisadvantages?
11. What is Goal seek analysis? and explain how it is useful in Modelling?
12. What is Data Analysis? And explain its types, process?
Case Study:
Yes Bank confident of Fortis fetching good valuation
Fortis Healthcare, is one of the best hospitals in India, which provide all kinds of
medical treatment and surgeries by experience surgeons at affordable price. Yes, Bank
is the single largest shareholder of this hospital. Yes, Bank exuded confidence of a
sound resolution with a good valuation and thus help drive out of the management
crisis plaguing one of the largest corporate hospital chains in thecounty.
In February 2018, Yes Bank, which was the largest lender to the hospital, had
acquired a 17.31 per cent stake by invoking nearly 9 crore pledged share. Later in
mid-March, it sold 2.17 per cent of its Stake, thereby, bringing down its
shareholding to 15.14 per cent as of March 2018.
Still, this makes the city-based private lender the single largest shareholder in the
New Delhi headquartered corporate hospital chain. Yes Bank has acquired
8,97,81,906 equity shares having nominal value of Rs 10 per share of the company
pursuant to invocation of pledge on the said equity shares subsequent to default by
promoter group companies in the credit facility provided by the bank. Yes Bank faces
problem in the valuation of the Fortis Health Care , as it the performing asset for
Yes Bank. Does the Yes bank able to resolve the problem?
They were not focusing on the quality of the bidders as Fortis is a prime healthcare
asset in the country which is a major concern area. Yes Bank as a major shareholder
was not active in the valuation process of the Fortis Hospital chain but only good in
transparency which may lead to improvement. Improper Bidding will be affecting the
small and big investors and impact the valuation of a company.
1. Does YES Bank fetch good valuation to Fortis Health Care.
2. What impact the transparency and full disclosure plays in valuation of a company.
Financial Functions
PMT | RATE | NPER | PV | FV
To illustrate Excel's most popular financial functions, we consider a loan with monthly
payments, an annual interest rate of 6%, a 20-year duration, a present value of $150,000
(amount borrowed) and a future value of 0 (that's what you hope to achieve when you pay off
a loan).
We make monthly payments, so we use 6%/12 = 0.5% for Rate and 20*12 = 240 for Nper
(total number of periods). If we make annual payments on the same loan, we use 6% for Rate
and 20 for Nper.
PMT
Select cell A2 and insert the PMT function.

Note: the last two arguments are optional. For loans, Fv can be omitted (the future value of a
loan equals 0, however, it's included here for clarification). If Type is omitted, it is assumed
that payments are due at the end of the period.
Result. The monthly payment equals $1,074.65.

Tip: when working with financial functions in Excel, always ask yourself the question, am I
making a payment (negative) or am I receiving money (positive)? We pay off a loan of
$150,000 (positive, we received that amount) and we make monthly payments of $1,074.65
(negative, we pay). Visit our page about the PMT function for many more examples.
RATE
If Rate is the only unknown variable, we can use the RATE function to calculate the interest
rate.

NPER
Or the NPER function. If we make monthly payments of $1,074.65 on a 20-year loan, with an
annual interest rate of 6%, it takes 240 months to pay off this loan.
We already knew this, but we can change the monthly payment now to see how this affects
the total number of periods.

Conclusion: if we make monthly payments of $2,074.65, it takes less than 90 months to pay
off this loan.
PV
Or the PV (Present Value) function. If we make monthly payments of $1,074.65 on a 20-year
loan, with an annual interest rate of 6%, how much can we borrow? You already know the
answer.

FV
And we finish this chapter with the FV (Future Value) function. If we make monthly
payments of $1,074.65 on a 20-year loan, with an annual interest rate of 6%, do we pay off
this loan? Yes.

But, if we make monthly payments of only $1,000.00, we still have debt after 20 years.

Top of Form
 Unit III
Financial Analysis Techniques - Ratio analysis, Du point Analysis – Cash budgeting –
Master budgeting - Break-even analysis – Profit planning - Loan amortization - Capital
Budgeting Decisions – Sensitivity analysis – Scenario Analysis with Scenario Manager –
Computing rates of returns, averages and variances of financial data.
Ratio Analysis
Ratio: It is the quantitative relation between two amounts showing the number of times one
value contains or is contained within the other. Accounting Ratio: It means ratio calculated
on the basis of accounting information.
Ratio analysis: A ratio analysis is a quantitative analysis of information contained in a
company's financial statements. Ratio analysis is used to evaluate various aspects of a
company's operating and financial performance such as its efficiency, liquidity, profitability
and solvency.
Objective of Ratio Analysis:
To assess the earning capacity, financial soundness and operating efficiency of an enterprise.
To simplify the accounting information.
To help in comparative analysis.
Ratios are categorized into following basic categories:
Liquidity Ratios
Solvency Ratios
Activity or Turnover Ratios
Profitability Ratios

Liquidity Ratios:
These ratios measure the paying capacity of the entity to meet its short-term financial
obligations. These includes: Current Ratio and Quick Ratio/Liquid Ratio/Acid Test Ratio.
Current Ratio/Working Capital Ratio:
Current Ratio = current assets
Current liabilities
Current Assets = (Current Investments + Inventories + Trade Receivable + Cash & Cash
Equivalents + Short-Term Loans & Advances
+ Other Current Assets)
Current Liabilities = (Short-term Borrowings + Trade Payables + Other Current Liabilities +
Short-term Provisions)
This Ratio Shows short-term financial soundness of the business. Higher ratio means better
capacity to meet its current obligation. The ideal Current Ratio Is 2:1. In case it is very high
it shows the idleness of funds.

Quick Ratio/Liquid Ratio/Acid Test Ratio:

Quick Ratio/Liquid Ratio/Acid Test Ratio = liquid assets

Current liabilities
Liquid/Quick Assets = (Current Assets - Inventories – Prepaid Expenses)
Current Liabilities = (Short-term Borrowings + Trade Payables + Other Current Liabilities +
Short-term Provisions)
This Ratio is a fairly stringent measure of liquidity. It is based on those current assets which
are highly liquid, i.e., can be converted into cash and cash equivalents quickly. Quick Ratio
of 1:1 is considered as ideal. Higher the Quick Ratio better the short-term financial position.
Solvency Ratios:
These ratios measure the long-term financial position of the enterprise. These includes: Debt to
Equity Ratio; Total Asset to Debt Ratio; Proprietary Ratio; Interest Coverage Ratio; Debt
Service Coverage Ratio and Capital Gearing Ratio.

Debt to Equity Ratio:

Debt to Equity Ratio = debts
Equity
Debt = Long-term Borrowings (i.e., Debenture+Mortgage public deposits)
+ Long-term Provisions
Equity = Share Capital + Reserve and Surplus
Or
= Non-current Assets + Working Capital – Non-current Liabilities
This Ratio assesses the long-term financial position and soundness of enterprises. In general,
lower the Debt to Equity Ratio higher the degree of protection enjoyed by the lenders.

Total Asset to Debt Ratio:

Total Assets to Debt Ratio = total assets
debts

Total Assets = Non-Current Assets + Current Assets + Inventories + Trade Receivables +

Cash & Cash Equivalent + Short-termLoans & Advances + Other Current Assets
Debt = Long-term Borrowings (i.e., Debenture+Mortgage public deposits)
+ Long-term Provisions
This Ratio measures the safety margin available to lenders of long-term debts. It measures the
extent to which debt is being covered by Assets.

Proprietary Ratio:
Proprietary Ratio = Shareholder‘s Fund/Equity
Total assets
Shareholder‘s Fund/Equity = Share Capital + Reserve and Surplus
Or
= Non-current Assets + Working Capital – Non- current Liabilities
Total Assets = Non-Current Assets + Current Assets + Inventories + Trade Receivables +
Cash & Cash Equivalent + Short-termLoans & Advances + Other Current Assets

This Ratio shows the extent to which total assets have been financed by the proprietor.
Higher the Ratio, higher the safety margin for lenders & creditors.

Interest Coverage Ratio:

Interest Coverage Ratio= EBIT
INEREST ON LONG TERM DEBT
EBIT = Profit After Tax + Tax + Interest

Interest on L.T. Debt = Interest on Debenture + Interest on L.T. Loan

This Ratio shows how many times the interest charges are covered by the profits available to
pay interest. Higher the Ratio, more secure the lender is in respect of payment of interest
regularly.
Debt Service Coverage Ratio:

𝑷𝒓𝒐𝒇𝒊𝒕 𝑨𝒇𝒕𝒆𝒓 𝑻𝒂𝒙 𝑩𝒆𝒇𝒐𝒓𝒆 𝑰𝒏𝒕(𝑷𝑨𝑻𝑩𝑰)

Debt Service Coverage Ratio =
𝑰𝒏𝒆𝒓𝒆𝒔𝒕 𝒐𝒏 𝑳.𝑻. 𝑳𝒐𝒂𝒏𝒔 & 𝑫𝒆𝒃𝒕𝒔 + 𝑰𝒏𝒔𝒕𝒂𝒍𝒍𝒎𝒆𝒏𝒕𝒔
PATBI = Profit After Tax + Interest
This is a measure of the cash flow available to pay current debt obligations. The ratio states
net operating income as a multiple of debt obligations due within one year, including interest,
principal, sinking-fund and lease payments.

Capital Gearing Ratio:

Capital Gearing Ratio = 𝑬𝒒𝒖𝒊𝒕𝒚 𝑺𝒉𝒂𝒓𝒆 𝑪𝒂𝒑𝒊𝒕𝒂𝒍
𝑭𝒖𝒏𝒅𝒔 𝑩𝒆𝒂𝒓𝒊𝒏𝒈 𝑭𝒊𝒙𝒆𝒅 𝑷𝒂𝒚𝒎𝒆𝒏𝒕𝒔
Equity Share Capital = Share Capital + Reserve and Surplus
FBFP = L.T. Loans + L.T. Debts + Preference Share Capital
The gearing ratio is a measure of financial risk and expresses the amount of a company's debt
in terms of its equity. A company with a gearing ratio of 2.0 would have twice as much debt as
equity.

Activity or Turnover Ratios:

These ratios are used to indicate the efficiency with which Assets and Resources of the firm
are being utilized. These includes: Inventory Turnover Ratio; Debtor Turnover ratio; Creditor
Turnover ratio; Fixed Asset Turnover Ratio and Working Capital Turnover Ratio.
Inventory Turnover Ratio:
Inventory Turnover Ratio = 𝑺𝒂𝒍𝒆𝒔
𝑨𝒗𝒆𝒓𝒂𝒈𝒆 𝑺𝒕𝒐𝒄𝒌
Sales = Cash Sales + Credit Sales – Returns
(Opening Stock + Closing Stock)
Average Stock =
2
Inventory turnover is a ratio showing how many times a company has sold and replaced
inventory during a given period.

Debtor Turnover ratio:

Debtor Turnover ratio = 𝑵𝒆𝒕 𝑪𝒓𝒆𝒅𝒊𝒕 𝑺𝒂𝒍𝒆𝒔
𝑨𝒗𝒆𝒓𝒂𝒈𝒆 𝑻𝒓𝒂𝒅𝒆 𝑹𝒆𝒄𝒆𝒗𝒂𝒃𝒍𝒆
Net Credit Sales = Credit Sales – Returns
(Opening Trade Receivable + Closing Trade Receivable)
Avg Trade Receivable =
𝟐
365
Avg. Collection Period =
DTR
The receivables turnover ratio is an accounting measure used to quantify a firm's
effectiveness in extending credit sales and in collecting debts on those credit sales. Normally
higher the debtors turnover ratio better it is. Higher turnover signifies speedy and effective
collection. Lower turnover indicates sluggish and inefficient collection leading to the doubts
that receivables might contain significant doubtful debts. Receivables collection period is
expressed in number of days. It should be compared with the period of credit allowed by the
management to the customers as a matter of policy. Such comparison will help to decide
whether receivables collection management is efficient or inefficient.

Creditor Turnover ratio:

Creditor Turnover ratio = 𝑵𝒆𝒕 𝑪𝒓𝒆𝒅𝒊𝒕 𝑷𝒖𝒓𝒄𝒉𝒂𝒔𝒆𝒔
𝑨𝒗𝒆𝒓𝒂𝒈𝒆 𝑻𝒓𝒂𝒅𝒆 𝑷𝒂𝒚𝒂𝒃𝒍𝒆𝒔
Net Credit Purchases = Credit Purchases – Returns
(Opening Trade Payables + Closing Trade Payable)
Avg Trade Payables =
2
365 DAYS
Avg. Payment Period =
CTR
It indicates the speed with which the payments are made to the trade creditors. Shorter
average payment period or higher payable turnover ratio may indicate less period of credit
enjoyed by the business it may be due to the fact that either business has better liquidity
position; believe in availing cash discount and consequently enjoys better credit standing in the
market or business credit rating among suppliers is not good and therefore they do not allow
reasonable period of credit.

Fixed Asset Turnover Ratio:

Fixed Asset Turnover Ratio = 𝑺𝒂𝒍𝒆𝒔
𝑵𝒆𝒕 𝑭𝒊𝒙𝒆𝒅 𝑨𝒔𝒔𝒆𝒕𝒔
Sales = Cash Sales + Credit Sales – Returns
Net Fixed Assets = Fixed Assets – Accumulated Depriciation

This Ratio indicates the efficiency with which the firm is utilizing its investment in Fixed
Assets.

Working Capital Turnover Ratio:

Working Capital Turnover Ratio = 𝑺𝒂𝒍𝒆𝒔
𝑾𝒐𝒓𝒌𝒊𝒏𝒈 𝑪𝒂𝒑𝒊𝒕𝒂𝒍
Sales = Cash Sales + Credit Sales – Returns
Cost of Sales = Sales + Closing Stock – Gross Profit
Or
= Opening Stock + Net Purchases + Direct Expenses – Closing Stock
Working Capital = Current Assets – Current Liabilities
The working capital turnover ratio measures how well a company is utilizing its
working capital to support a given level of sales. A high turnover ratio indicates that
management is being extremely efficient in using a firm's short-term assets and liabilities to
support sales. Conversely, a low ratio indicates that a business is investing in too many
accounts receivable and inventory assets to support its sales, which could eventually lead to
an excessive amount of bad debts and obsolete inventory.
Profitability Turnover Ratios:
These ratios show the Profitability or efficiency of the enterprise. These includes: Gross
Profit Ratio; Net Profit Ratio; Operating Ratio; Operating Profit Ratio; Return on Investment;
Return on Equity; Earnings Per Share (EPS); Dividend Payout Ratio and Price Earnings
Ratio.
Gross Profit Ratio:
Gross Profit Ratio = 𝑮𝒓𝒐𝒔𝒔 𝑷𝒓𝒐𝒇𝒊𝒕 × 100
SALES
Gross Profit = Net Sales – Cost of Goods Sold
Net Sales = Sales – Returns
It shows weather Sales Prices are adequate or not. It also indicates the extent to which Sales
Prices may be reduced without resulting losses.

Net Profit Ratio:

net profit
Net Profit Ratio = × 100
sales
Net Profit = Net Operating Profit + Non-Operating Income – Non-Operating Expenses Or
= Gross Profit – All Expenses + All Incomes
Net Sales = Sales – Returns
It reveals the remaining profit after all costs of production, administration, and financing have
been deducted from sales, and income taxes recognized.
Operating Profit Ratio
Operating Profit Ratio = Operating Profit × 100
sales
Operating Profit = Gross Profit – (Office and administrative expenses + Selling and
distribution expenses)
Net Sales = Sales – Returns
This ratio helps in determining the ability of the management in running the business.

Operating Ratio:
𝑪𝒐𝒔𝒕 𝒐𝒇 𝑮𝒐𝒐𝒅𝒔 𝑺𝒐𝒍𝒅+𝑶𝒑𝒆𝒓𝒂𝒕𝒊𝒏𝒈 𝑬𝒙𝒑𝒆𝒏𝒔𝒆𝒔
Operating Ratio × 100
sales
Cost of Goods Sold = Opening Stock + Net Purchases + Direct Expenses – Closing Stock
Operating Expenses = Office and administrative expenses + Selling and distribution expenses
Net Sales = Sales – Returns
Operating Ratio is a yardstick to measure the efficiency with which a business is operated.
Operating ratio plus operating profit ratio is 100. The two ratios are obviously interrelated.
For example, if the operating profit ratio is 20%, it means that the operating ratio is 80%. A
rise in the operating ratio indicates a decline in the efficiency. Lower the operating ratio, the
better is the position because greater is the profitability and management efficiency of the
concern. The higher the ratio, the less favorable is the situation, because there will be smaller
margin of profit available for the purpose of payment of dividend and creation of reserves.

Return on Equity(ROE):
𝑷𝒓𝒐𝒇𝒊𝒕 𝑨𝒇𝒕𝒆𝒓 𝑰𝒏𝒕𝒆𝒓𝒆𝒔𝒕 & (𝑷𝑨𝑻)
Return on Equity = ×100
𝑺𝒉𝒂𝒓𝒆𝒉𝒐𝒍𝒅𝒆𝒓′𝒔 𝑭𝒖𝒏𝒅
PAT = EBIT – Tax – Interest
Shareholder‘s Fund = Share Capital + Reserve and Surplus
It measures the ability of a firm to generate profits from its shareholders investments in the
company. In other words, the return on equity ratio shows how much profit each Rupee of
common stockholders‘ equity generates.
Earning Per Share(EPS):
𝑷𝑨𝑻−𝑷𝒓𝒆𝒇𝒆𝒓𝒆𝒏𝒄𝒆 𝑫𝒊𝒗𝒊𝒅𝒆𝒏𝒅
Earnings Per Share =
𝑵𝒐.𝒐𝒇 𝑬𝒒𝒖𝒊𝒕𝒚 𝑺𝒉𝒂𝒓𝒆𝒉𝒐𝒍𝒅𝒆𝒓𝒔
It is a market prospect ratio that measures the amount of net income earned per share of stock
outstanding. In other words, this is the amount of money each share of stock would receive if
all the profits were distributed to the outstanding shares at the end of the year.
Dividend Payout Ratio:
Dividend Payout Ratio = 𝑫𝒊𝒗𝒊𝒅𝒆𝒏𝒅 𝑷𝒆𝒓 𝑺𝒉𝒂𝒓𝒆
𝐄𝐚𝐫𝐧𝐢𝐧𝐠𝐬 𝐏𝐞𝐫 𝐒𝐡𝐚𝐫𝐞
It measures the percentage of net income that is distributed to shareholders in the form of
dividends during the year. In other words, this ratio shows the portion of profits the company
decides to keep to fund operations and the portion of profits that is given to its shareholders.
Price Earnings Ratio:
𝑴𝒂𝒓𝒌𝒆𝒕 𝑷𝒓𝒊𝒄𝒆 𝑷𝒆𝒓 𝑺𝒉𝒂𝒓𝒆
Price Earnings Ratio =
𝐄𝐚𝐫𝐧𝐢𝐧𝐠𝐬 𝐏𝐞𝐫 𝐒𝐡𝐚𝐫𝐞
It is a market prospect ratio that calculates the market value of a stock relative to its earnings
by comparing the market price per share by the earnings per share. In other words, the price
earnings ratio shows what the market is willing to pay for a stock based on its current
earnings.

Advantages of Ratios Analysis:

Ratio analysis is an important and age-old technique of financial analysis. The following are
some of the advantages / Benefits of ratio analysis:
1. Simplifies financial statements:
It simplifies the comprehension of financial statements. Ratios tell the whole story of
changes in the financial condition of the business
2. Facilitates inter-firm comparison:
It provides data for inter-firm comparison. Ratios highlight the factors associated with with
successful and unsuccessful firm. They also reveal strong firms and weak firms, overvalued
and undervalued firms.
3. Helps in planning:
It helps in planning and forecasting. Ratios can assist management, in its basic functions of
forecasting. Planning, co-ordination, control and communications.
4. Makes inter-firm comparison possible:
Ratios analysis also makes possible comparison of the performance of different divisions of
the firm. The ratios are helpful in deciding about their efficiency or otherwise in the past and
likely performance in the future.
5. Help in investment decisions:
It helps in investment decisions in the case of investors and lending decisions in the case of
bankers etc.

What Is the DuPont Analysis?

The DuPont analysis (also known as the DuPont identity or DuPont model) is a framework
for analyzing fundamental performance popularized by the DuPont Corporation. DuPont
analysis is a useful technique used to decompose the different drivers of return on equity
(ROE). The decomposition of ROE allows investors to focus on the key metrics of financial
performance individually to identify strengths and weaknesses.
DuPont analysis (also known as the DuPont identity, DuPont equation, DuPont
framework, DuPont model or the DuPont method) is an expression which breaks ROE (return
on equity) into three parts.
The name comes from the DuPont company that began using this formula in the 1920s.
DuPont explosives salesman Donaldson Brown invented the formula in an internal efficiency
report in 1912

Basic formula
ROE = (Profit margin)*(Asset turnover)*(Equity multiplier) = (Net
profit/Sales)*(Sales/Average Total Assets)*(Average Total Assets/Average Equity) = (Net
Profit/Equity) Or
Profit/Sales*Sales/Assets=Profit/Assets*Assets/Equity Or ROS*AT=ROA*Leverage=ROE
Profitability (measured by profit margin)
Asset efficiency (measured by asset turnover)
Financial leverage (measured by equity multiplier)
ROE analysis
The DuPont analysis breaks down ROE (that is, the returns that investors receive from a
single dollar of equity) into three distinct elements. This analysis enables the analyst to
understand the source of superior (or inferior) return by comparison with companies in
similar industries (or between industries).
The DuPont analysis is less useful for industries such as investment banking, in which the
underlying elements are not meaningful. Variations of the DuPont analysis have been
developed for industries where the elements are weakly meaningful. [citation needed]
Examples
High margin industries
Some industries, such as fashion, may derive a substantial portion of their competitive
advantage from selling at a higher margin, rather than higher sales. For high-end fashion
brands, increasing sales without sacrificing margin may be critical. The DuPont analysis
allows analysts to determine which of the elements is dominant in any change of ROE.
High turnover industries
Certain types of retail operations, particularly stores, may have very low profit margins on
sales, and relatively moderate leverage. In contrast, though, groceries may have very high
turnover, selling a significant multiple of their assets per year. The ROE of such firms may be
particularly dependent on performance of this metric, and hence asset turnover may be
studied extremely carefully for signs of under-, or, over-performance. For example, same-
store sales of many retailers is considered important as an indication that the firm is deriving
greater profits from existing stores (rather than showing improved performance by
continually opening stores).
High leverage industries
Some sectors, such as the financial sector, rely on high leverage to generate acceptable ROE.
Other industries would see high levels of leverage as unacceptably risky. DuPont analysis
enables third parties that rely primarily on their financial statements to compare leverage
among similar companies.
ROA and ROE ratio
The return on assets (ROA) ratio developed by DuPont for its own use is now used by many
firms to evaluate how effectively assets are used. It measures the combined effects of profit
margins and asset turnover.[2]

The return on equity (ROE) ratio is a measure of the rate of return to

stockholders.Decomposing the ROE into various factors influencing company performance is
often called the DuPont system.

Where
Net Income = net income after taxes
Equity = shareholders' equity
EBIT = Earnings before interest and taxes
Pretax Income is often reported as Earnings Before Taxes or EBT
This decomposition presents various ratios used in fundamental analysis.
The company's tax burden is (Net income ÷ Pretax profit). This is the proportion of the
company's profits retained after paying income taxes. [NI/EBT]
The company's interest burden is (Pretax income ÷ EBIT). This will be 1.00 for a firm with
no debt or financial leverage. [EBT/EBIT]
The company's operating income margin or return on sales (ROS) is (EBIT ÷ Revenue). This
is the operating income per dollar of sales. [EBIT/Revenue]
The company's asset turnover (ATO) is (Revenue ÷ Average Total Assets).
The company's equity multiplier is (Average Total Assets ÷ Average Total Equity). This is a
measure of financial leverage.
CASH BUDGET –
A Cash Budget is a projected cash transaction in future that is utilized in controlling actual
receipts and payments by mending for the variances. It starts with a given ‗Cash Balance‘
which may be either big or small. But the said balance is, in any case, desired to be ‗the
optimum balance‘. The sign of optimality for a given cash balance is obviously its ability to
produce the highest rate of return for the minimum cost for mainly the said cash balance.
The main aim of Cash Budget is to ascertain whether there is excess or deficit of cash. It
involves different steps.
The First element is selection of time period to be covered which is known as planning
horizon. This coverage will differ from firm to firm depending upon its nature and degree of
accuracy.
The Second element is the factors affecting the cash flows. Non cash items such as,
depreciation are excluded from Cash Budget. The cash flow is affected by two factors
operating and financial. The operating category includes cash flow generated by operations of
the firm and are known as operating cash flows. The other category is known as financial
cash flow.

Operating Cash Flow contains the following.

INFLOW OUTFLOW
1. Cash Sales 1. Cash Purchases
2. Collection from Debtors 2. Payment to Creditors
3. Sale of Assets 3. Purchase of Assets.
4. Operating Expenses Paid
b) Financial Cash Flow contains the following.
INFLOW OUTFLOW
1. Loans taken 1. Repayment of Loan
2. Sale of Investments 2. Purchase of Investment
3. Issue of Shares 3. Redemption of Shares
4. Interest, Divided, 4. Interest, Dividend, Rent Paid
Rent Received.

METHODS OF PREPARATION OF CASH BUDGET

Methods used for cash forecasting – There are two recognized ways of preparing a cash
forecasting.
1 The Receipt & Payment Method.
2 The Income Statement Cash Flow Method (Adjusted Profit & Loss method)
1 THE RECEIPT AND PAYMENT METHOD –
Under this method, all expected cash receipts and payments during the period; under
consideration are taken into account. The expected cash balance of a week or month will be
equivalent to the difference between total expected Cash Receipts including opening balance,
if any, and total expected Cash Payment during that period. The budget is generally prepared
from various plans.
Cash Receipts from Customers, based on sales forecast, the term of sale, lag in payment etc.
are generally taken into consideration. Cash Receipts from other sources, such as dividend
on trade investments, rent, issue of capital, sale of; investment and fixed assets etc.
Cash requirements for materials, wages and salaries and overhead expenses based on
purchasing, personnel and overhead budgets. The policy of the business with regard to the
payment of supplier‘s accounts, the term of cash discount, the lag in payment of wages etc.
are given due consideration.
Cash requirements for capital expenditure as per capital expenditure budget.
Cash requirement for other purposes, such as payment of dividend, income tax, fines,
penalties etc.
ADJUSTED PROFIT AND LOSS ACCOUNT:
This method is based on cash and non‐cash transactions. This method estimates closing cash
balance by converting profit into cash. The hypothesis of this method is that the earning of
profit brings equal amount of cash into the business. The net profit shown by profit and loss
account does not signify the actual cash flow into the business. This also leads to another
assumption, that is the business will remain static, i.e. there will be no wearing out or increase
of assets and changes of working capital so that the total cash on hand for the business would
be equal to the profit earned.

MASTER BUDGET –
It is defined as summary budget which includes different functional budgets and which is
finally approved adopted and employed. It is defined as a budget which summarises all
functional budgets when all functional budgets are prepared they are summarized to produce.
Profit & Loss Account and Profit & Loss Appropriation Account.
Balance Sheet. Master Budget takes the form of budged Profit & Loss Account and Balance
Sheet.
It is overall business plan and familiar to financial statements. The only difference is that the
accountant here deals with expected future data rather than historical data. The budget
committee will prepare the master budget based on the functional budget. Once it is approved
by the committee it becomes the target for the firm during the budget period.
BREAK EVEN ANALYSIS:
Break-even analyses help business owners determine when they‘ll begin to turn a profit and
help them price their products with that in mind. It provides a dynamic overview of the
relationships among revenues, costs and profits. However, typical variable and fixed costs
differ widely among industries. This is why comparison of break-even points is generally
most meaningful among companies within the same industry, and the definition of a "high" or
"low" break-even point should be made within this context. A break-even analysis is a
calculation of the point at which revenues equal expenses. In securities trading, the break-
even point is the point at which gains equal losses.

Beak even analysis is defined as ―No profit or No Loss‖ it denotes the minimum volume of
production to be undertaken to avoid losses.
It point outs how much minimum is to be produced to see the profits.
It is a technique for profit planning and control and therefore is considered as available
marginal tool.
Break even analysis is defined as analysis of cost and there possible impacts on revenues and
value of the firm. A firm is said to attain BEP when its total revenue is equal to total cost.

DETERMINANTS OF BEP:
BEP in units =Fixed cost / Contribution (margin) per unit

Contribution margin per unit = selling price per unit – variable cost per unit.
Fixed cost * sales
2. BEP in sales =_________________________
Sales – Variable cost
3. Total cost = fixed cost + variable cost
4. Profit = Contribution – fixed cost
5. Margin of safety (in units) = No. of units sold –BEP in units
6. BEA = P/V ratio
7. P/V ratio = Contribution/ Sales
Profit
8. Margin of safety =___________________
P/V ratio
Fixed cost + Targeted profit
9. Volume of sales attain profit =________________
Contribution per margin
Profit
10. Margin of safety =_______
P/V ratio

Illustration 1:
The P/V ratio of Bharat Pharmaceuticals Ltd is 50% and the margin of safety is 40%.
Calculate the break-even point and the net profit if the sales volume is Rs. 1, 00,000.
Solution:

Managerial Uses of Break-Even Analysis:

1. Product planning: it helps the firm in planning its new product development. Decisions
regarding removal or addition of new products in their product line.
2. Activity planning: the firm decides the expansion of production capacity.
3. Profit planning: this helps the firm to plan about their profit well in advance and at the
same time it helps to identify the quantity to be sold to achieve the targeted profit.
4. Target capacity: the targeted sales quantity helps to decide the purchase, inventory and
management.
5. Price and cost decision: Decision regarding how much the price of the commodity should
be reduced or increased to cover their cost of production.

What is profit planning?

Whether your business is run from your dining room table, a small office, or a large
manufacturing plant, you should be using profit planning. A profit plan not only looks at how
your business will earn a profit today but also creates a plan for future profits.
Profit planning doesn‘t have to be complicated, but it does need to be put into writing and
carried out accordingly. Profit planning helps you set business goals while creating a plan for
reaching those goals. The profit plan for a small business will initially be very simple but will
grow in complexity as the business grows.
A profit plan is always created as part of a larger plan, such as a master budget or a strategic
plan, and should include the following information:
Target market
Product or service pricing
Staffing
Marketing and advertising
Collection processes
Business investment
Operating expenses

Profit planning typically takes four steps. Source: economicsdiscussion.net.

Why profit planning is important for your business

What is your goal for your business? Do you want to break even your first year and continue
to grow year after year, or would you rather start strong and sustain your profits in the
coming years? Profit planning answers those questions and a lot more, allowing you to
carefully plan out not just how much profit you‘d like to earn, but the steps necessary to
achieve those goals.
As an integral part of the planning process, profit planning should always be part of any
business plan or forecast you create for your business and not just the number left over after
expenses have been subtracted from revenues. By planning for profit intentionally, rather
than by default, you‘re more likely to build profit levels each year.

For example, you manufacture and sell coffee mugs for $10. For your first year in business,
your goal is to earn a $2 profit for every coffee mug you sell. By planning for profit first, you
now know that only $8 per cup sold is available for all of the other expenses involved in
selling your coffee cups. And because you know that, you can plan your expenses
accordingly, including materials, labor, selling costs, and even a business emergency fund.
Profit is the most important part of your business. It should always come first. These are just
a few of the reasons why.
It helps business owners achieve their goals
If you don‘t plan for profit, how will you know if you‘ve achieved your goals? In your head
you may be thinking, ―I want to earn $50,000 a year in profit,‖ but in reality, you have no
idea how you‘re going to make that happen. Before you can earn your $50,000 profit, you‘ll
have to create a method for achieving that goal. That‘s what profit planning does.
Assists with future decisions
Profit planning can be used to achieve both short-term and long-term objectives. For
example, you start a business in January of 2021, with the modest goal of earning $40,000 in
profit your first year in business. However, as your brand becomes better known and your
sales techniques improve, you expect your profit in 2022 to double to $80,000.
While these are achievable goals, profit planning provides the details you need to give you
the best shot at achieving them by taking into account details such as increased materials
costs and labor costs.

Provides a baseline to measure against

It‘s important to establish a baseline to measure success against. In our earlier example, we
talked about the business owner that wanted to earn $50,000 a year but didn‘t have a plan in
place. Do you think that a business owner would feel successful if they earned $25,000 their
first year?
Probably not. Establishing a baseline, and continuing to measure against that baseline as your
business grows will allow you to make adjustments along the way, giving your business a
better shot at success.
Benefits of profit planning
Simply wanting to earn a profit is not an achievable goal. Profit planning provides you with a
way to set and achieve your goals. There are a lot of benefits to profit planning. The
following are just a few.
It allows you to set a target and create a roadmap to that target
The most important thing about profit planning is that it allows you to create a target profit
and then build a detailed plan around it. For example, if your target profit for the year is
$100,000, you can then devise a strategy around achieving that goal by answering the
following questions:
How many items/units/services will I need to sell to achieve my goal?
Do I plan on reinvesting profits?
What are my maximum costs?
How much should I charge for my products and services?
How many salespeople will I need to achieve my goals?
Are there any places where I need to reduce expenses?
Where do I want my gross profit margin to be?
Once these questions have been answered, you‘re well on your way to creating a
sound business budget to go along with your profit plan.

Profit planning should always be part of any budget you create.

It strengthens the business overall
A profit plan is designed to be used with other financial projections such as a business plan,
financial forecast, or organizational budget. When you create a detailed profit plan, you can
compare progress each accounting period to see just how close or how far away you are from
your initial targeted profit, and more importantly, take corrective action to get back on track.
It provides owners, managers, and employees with clear objectives
It‘s only fair that all key employees are on the same page about the strategic goals of your
business. It‘s difficult to hold an employee responsible for underselling if they have no idea
or input into your profit-planning process. Bringing your employees into the process provides
them with a key stake in the outcomes and also gives them a much clearer picture of
expectations.
4 best practices for profit planning
If you‘re a new business owner, chances are that you‘ve created a rudimentary business plan
and didn‘t pay a lot of attention to profit; it was just what was left over after your expenses
were subtracted from your revenue. But detailed profit planning is important, even for
smaller businesses. So let‘s get started planning today, using some of these best practices.
1. Create a profit plan as part of a business plan
A profit plan should always be part of a business plan or strategic plan. Planning for profit is
impossible without using a complete budget approach for profit planning, which includes
expense budgeting and estimating production levels.
2. Use a cash flow forecast to map out goals
Once profit planning and expense budgeting are complete, create a cash flow forecast that
provides the details of your plan. Not only does this give key players a guide to use, but it can
also help you see where your projections are off, allowing you to make changes when
needed.
3. Plan for profit first
Always define the profit level you wish to achieve and then plan your expenses around it,
instead of the other way around. While this sounds simple, in reality, many business owners
estimate revenue and expenses, with operating profit anything that‘s left over. By
determining the profit that you wish to make and by planning for it properly, you‘re much
more likely to achieve your goals.
4. Hold yourself (and others) accountable
Having a strategic plan in place that includes a detailed plan for profit helps to hold you, your
managers, and your employees accountable. It‘s impossible to achieve a goal without
knowing what goal it is you wish to achieve. Be as detailed as you can, and rely on your team
to make it happen.
Loan Amortization Schedule

This example teaches you how to create a loan amortization schedule in Excel.
1. We use the PMT function to calculate the monthly payment on a loan with an annual
interest rate of 5%, a 2-year duration and a present value (amount borrowed) of $20,000. We
use named ranges for the input cells.

2. Use the PPMT function to calculate the principal part of the payment. The second
argument specifies the payment number.
3. Use the IPMT function to calculate the interest part of the payment. The second argument
specifies the payment number.

4. Update the balance.

5. Select the range A7:E7 (first payment) and drag it down one row. Change the balance
formula.
6. Select the range A8:E8 (second payment) and drag it down to row 30.

It takes 24 months to pay off this loan. See how the principal part increases and the interest
part decreases with each payment.

Capital Budgeting Techniques?

Capital budgeting technique is the company’s process of analyzing the decision of
investment/projects by taking into account the investment to be made and expenditure to be
incurred and maximizing the profit by considering following factors like availability of funds,
the economic value of the project, taxation, capital return, and accounting methods.
List of Top 5 Capital Budgeting Techniques (with examples)
Profitability index
Payback period
Net present value
Internal rate of return
Modified rate of return
Let us discuss this one by one in detail along with examples –

#1 – Profitability Index
Profitability Index is one of the essential techniques, and it signifies a relationship between
the investment of the project and the payoff of the project.
The formula of profitability index given by:-
Profitability Index = PV of future cash flows / PV of initial investment
Where PV is the present value.
It is mainly used for ranking projects. According to the rank of the project, a suitable project
is chosen for investment.
#2 – Payback Period
This method of capital budgeting helps to find a profitable project. The payback period is
calculated by dividing the initial investment by the annual cash flows. But the main drawback
is it ignores the time value of money. By the time value of money, we mean that money is
more today than the same amount in the future. So if we payback to an investor tomorrow, it
includes an opportunity cost. As already mentioned, the payback period disregards the time
value of money.
It is calculated by how many years it is required to recover the amount of investment done.
Shorter paybacks are more attractive than more extended payback periods. Let‘s calculate the
payback period for the below investment:-
Example
For example, there is an initial investment of ₹1000 in a project, and it generates a cash flow
of ₹ 300 for the next five years.

Therefore the payback period is calculated as below:

Payback period = no. of years – (cumulative cash flow/cash flow)
Payback period = 5- (500/300)
= 3.33 years
Therefore it will take 3.33 years to recover the investment.
#3 – Net Present Value
Net Present Value is the difference between the present value of incoming cash flow and the
outgoing cash flow over a particular time. It is used to analyze the profitability of a project.
The formula for the calculation of NPV is as below:-
NPV = [Cash Flow / (1+i)n ] – Initial Investment
Here i is the discount rate, and n is the number of years.
Example
Let us see an example to discuss it.
Let us assume the discount rate is 10%

NPV = -1000 + 200/(1+0.1)^1 + 300/(1+0.1)^2+400/(1+0.1)^3+600/(1+0.1)^4+

700/(1+0.1)^5
= 574.731
We can also calculate it by basic excel formulas.
There is an in-built excel formula of ―NPV‖ which can be used. The discounting rate and the
series of cash flows from the 1st year to the last year are considered arguments. We should not
include the year zero cash flow in the formula. We should later subtract it.
= NPV (Discount rate, cash flow of 1st year: cash flow of 5th year) + (-Initial investment)
= NPV (10%, 200:700) – 1000
= 574.731
As NPV is positive, it is recommended to go ahead with the project. But not only NPV but
IRR is also used for determining the profitability of the project.
#4 – Internal rate of return
The Internal rate of return is also among the top techniques that are used to determine
whether the firm should take up the investment or not. It is used together with NPV to
determine the profitability of the project.
IRR is the discount rate when all the NPV of all the cash flows is equal to zero.
NPV = [Cash Flow / (1+i)n ] – Initial Investment =0
Here we need to find ―i‖ which is the discount rate.
Example
Now we shall discuss an example to understand the internal rate of return in a better way.
While calculating, we need to find out the rate at which NPV is zero. This is usually done by
error and trial method else we can use excel for the same.

Let us assume the discount rate to be 10%.

NPV at a 10 % discount is ₹ 574.730.
So we need to increase the discount percentage to make NPV as 0.
So if we increase the discount rate to 26.22 %, the NPV is 0.5, which is almost zero.
There is an in-built excel formula of ―IRR,‖ which can be used. The series of cash flows is
taken as arguments.

=IRR (Cash flow from 0 to 5th year)

= 26 %
Therefore in both ways, we get 26 % as the internal rate of return.
#5 – Modified Internal Rate of return
The main drawback of the internal rate of return that it assumes that the amount will be
reinvested at the IRR itself, which is not the case. MIRR solves this problem and reflects the
profitability in a more accurate manner.
The formula is as below:-
MIRR= (FV (Positive cash flows* Cost of capital)/ PV(Initial outlays *
1/n −1
Financing cost))
Where,
N = the number of periods
FVCF = the future value of positive cash flow at the cost of capital
PVCF = the present value of negative cash flows at the financing cost of the company.
Example
We can calculate MIRR for the below example:
Let us assume the cost of capital at 12%. In MIRR, we need to consider the reinvested rate,
which we assume as 14%. In Excel, we can calculate as the below formulae

MIRR= (cash flows from year 0 to 4th year, cost of capital rate, reinvestment rate)
MIRR= (-1000: 600, 12%, 14%)
MIRR= 22%

A MIRR in excel is a better estimation than an internal rate of return.

SCENARIO MANAGER IN EXCEL?

Scenario Manager in Excel is used to compare data side by side and also swap multiple sets
of data within a worksheet. In simple words when you have multiple variables and you want
to see their effect on the final result, and also want to estimate between two or more desired
budgets you can use Scenario Manager. It is built-in functionality in excel and can be spotted
under the head What-If Analysis. It allows users to change input values up to a maximum of
32 cells.
Let‘s take an example of Event Management who wish to host an event. An important step is
to decide the venue as it plays a major role in determining expenditure, revenues, profit, or
loss. You can create various scenarios consisting of different venues and then compare them.
Scenario Manager in Excel –
Example #1
A simple example could be your monthly family budget. You will spend on food, travel,
entertainment, clothes, etc.… and see how these affect your overall budget.
Step 1: Create a below table shows your list of expenses and income sources.

In cell B5, you have total income.

In cell B17, you have total expenses for the month.

In cell B19, total money left.

You are ending up with only 5,550 after all the expenses. So, you need to cut down your cost
to save more for the future…
Step 2: From the top of Excel, click the Data menu > On the Data menu, locate the Data
Tools panel > Click on the what-if-Analysis item and select the Scenario Manager in excel
from the menu.
Step 3: When you click on the Scenario Manager below, the dialogue box will open.

Step 4: You need to create a new scenario. So click on the Add button. Then you will get the
below dialogue box.
By default, it shows the cell C10, which means that it is the currently active cell. First, type
the Scenario Name in the box as the Actual Budget.

Now, you need to enter which cells your excel sheet will be changing. In this first scenario,
nothing will be changing because this is my actual budget for the month. Still, we need to
specify the cells will be changing.
Now try to reduce your Food expenses and Clothes expenses. These are in the cells B15 &
B13, respectively. Now your add scenario dialogue box should look like this.
Click, OK, and Excel will ask you for some values. Since we do not want any changes to this
scenario, just click OK.

Now, you will be taken back to the Scenario Manager Box. Now the window will look like
this.
Now, one scenario is done and dusted. Create a second scenario, and this where you need to
make changes to your Food & Clothes expenses.
Click the Add button one more time and give a scenario name as “Plan 2”. Changing the cell
will be B15 & B13 (Food & Cloth expenses).

Now, below Scenario Values dialogue box opens again. This time, we do want to change the
values. Enter the same ones as in the image below:
These are the new values for our new scenario, Plan 2. Click OK, and now you are back to
the Scenario Manager window. Now we already have two scenarios named after Actual
Budget & Plan 2.

Click the Add button one more time and give a scenario name as “Plan 3”. Changing the cell
will be B15 & B13 (Food & Cloth expenses).
Now, below Scenario Values dialogue box opens again. This time, we do want to change the
values. Enter the same ones as in the image below:

These are the new values for our new scenario, Plan 3. Click OK, and now you are back to
the Scenario Manager window. Now you have three scenarios named after Actual Budget,
Plan 2, and Plan 3.
As you can see, we have our Actual Budget, Plan 1 and Plan 2. With Plan 2 selected, click
the Show button at the bottom. The values in your excel sheet will change, and the new
budget will be calculated. The image below shows what it looks like.

Click on the Actual Budget, then click on the Show button to see the differences. Initial
values will be displayed.
Do the same for Plan 2 to look at the changes.

So Scenario Manager in Excel allows you to set different values and allows you to identify
the significant changes from them.
How to Create a Summary Report in Excel?
After we are done with adding different scenarios, we can create a summary report in excel
from this scenario manager in excel. To create a summary report in excel, follow the below
steps.
Click on the Data tab from the Excel menu bar.
Click on What-If-Analysis.
Under the what-if-analysis, click Scenario Manager in Excel.
Now click on Summary.

Click ok to create the summary report in excel.

It will create the summary in the new sheet, as shown in the below image.

It shows the change in savings in three different scenarios. In the first scenario, the savings
was 5,550. In the second scenario, savings are increased to 20,550 due to cost cut down in
Food & Clothes section, and finally, the third scenario shows the other scenario.
All right, now we exercised a simple Family Budget Planner. It looks good enough to
understand. Perhaps this is enough to convince your family to change their lifestyle.
Scenario manager in Excel is a great tool when you need to do sensitivity analysis. You can
create the summary report in excel instantly to compare one plan with the other and decide
the best alternative plan to get a better outcome.

Scenarios
A scenario is a set of values that Excel saves and can substitute automatically on your
worksheet. You can create and save different groups of values as scenarios on a worksheet
and then switch between these scenarios to view the different results.
For example, you can have several different budget scenarios that compare various possible
income levels and expenses. You can also have different loan scenarios from different
sources that compare various possible interest rates and loan tenures.
If the information that you want to use in scenarios is from different sources, you can collect
the information in separate workbooks, and then merge the scenarios from the different
workbooks into one.
After you have all the scenarios you need, you can create a scenario summary report −
That incorporates information from all the scenarios.
That lets you compare the scenarios side-by-side.
Scenario Manager
Scenario Manager is one of the What-if Analysis tools in Excel.
To create an analysis report with Scenario Manager, you have to follow these steps −
Step 1 − Define the set of initial values and identify the input cells that you want to vary,
called the changing cells.
Step 2 − Create each scenario, name the scenario and enter the value for each changing input
cell for that scenario.
Step 3 − Select the output cells, called the result cells that you want to track. These cells
contain formulas in the initial set of values. The formulas use the changing input cells.
The Scenario Manager creates a report containing the input and the output values for each
scenario.
Consider the previous example of loan. Now, proceed as follows −
Define a cell for Loan Amount.
This input value is constant for all the scenarios.
Name the cell Loan_Amount.
Specify the value as 5,000,000.
Define the cells for Interest Rate, No. of payments and Type (Payment at the beginning or
end of the month).
These input values will be changing across the scenarios.
Name the cells Interest Rate, NPER and Type.
Specify the initial values for the analysis in these cells as 12%, 360 and 0 respectively.
Define the cell for the EMI.
This is the result value.
Name the cell EMI.
Place the formula in this cell as −
=PMT (Interest_Rate/12, NPER, Loan_Amount, 0, Type)
Your worksheet looks as shown below −

As you can see that the input cells and the result cells are in column C with the names as
given in column D.
Creating Scenarios
After setting up the initial values for the Scenarios, you can create the scenarios using
Scenario Manager as follows −
Click the DATA tab on the Ribbon.
Click What-if Analysis in the Data Tools group.
Select Scenario Manager from the dropdown list.

The Scenario Manager Dialog box appears. You can observe that it contains a message −
―No Scenarios defined. Choose Add to.‖

You need to create scenarios for each set of changing values in the Scenario Manager. It is
good to have the first scenario defined with initial values, as it enables you to switch back to
initial values whenever you want while displaying different scenarios.
Create the first scenario with the initial values as follows −
Click the Add button in the Scenario Manager Dialog box.
The Add Scenario dialog box appears.
Under Scenario Name, type Scenario 1.
Under Changing Cells, enter the references for the cells i.e. C3, C4 and C5 with the Ctrl key
pressed.
The name of the dialog box changes to Edit Scenario.
Edit the text in the Comment as – Initial Values box.
Select the option Prevent changes under Protection and then click OK.
The Scenario Values dialog box appears. The initial values that you have defined appear in
each of the changing cells boxes.

Scenario 1 with the initial values is created.

Create three more scenarios with varying values in the changing cells as follows −
Click the Add button in the Scenario Values dialog box.
Add Scenario dialog box appears. Note that C3, C4, C5 appear in the Changing cells box.
In the Scenario Name box, type Scenario 2.
Edit the text in the Comment as – Different Interest Rate.
Select Prevent changes under Protection and click OK.
The Scenario Values dialog box appears. The initial values appear in the changing cells.
Change the value of Interest_Rate to 0.13 and click Add.

The Add Scenario dialog box appears. Note that C3, C4, C5 appear in the box under
changing cells.
In the Scenario Name box, type Scenario 3.
Edit the text in the Comment box as – Different no. of Payments.
Select Prevent changes under Protection and click OK.
The Scenario Values dialog box appears. The initial values appear in the changing cells.
Change the value of NPER to 300 and click Add.

The Add Scenario dialog box appears. Note that C3, C4, C5 appear in the Changing cells
box.
In the Scenario Name box, type Scenario 4.
Edit the text in the Comment box as – Different Type of Payment.
Select Prevent changes under Protection and click OK.
The Scenario Values dialog box appears. The initial values appear in the changing cells.
Change the value of Type to 1. Click OK as you have added all the scenarios that you wanted
to add.

The Scenario Manager dialog box appears. In the box under Scenarios, You will find the
names of all the scenarios that you have created.
Click Scenario 1. As you are aware, Scenario 1 contains the initial values.
Now, click Summary. The Scenario Summary dialog box appears.
Scenario Summary Reports
Excel provides two types of Scenario Summary reports −
Scenario summary.
Scenario PivotTable report.
In the Scenario Summary dialog box, you can find these two Report types.
Select Scenario summary under Report type.

Scenario Summary
In the Result cells box, select the cell C6 (Here, we had put the PMT function). Click OK.
Scenario Summary report appears in a new worksheet. The worksheet is named as Scenario
Summary.
You can observe the following in the Scenario Summary report −
Changing Cells − Enlists all the cells used as changing cells. As you have named the cells,
Interest_Rate, NPER and Type, these appear to make the report meaningful. Otherwise, only
cell references will be listed.
Result Cells − Displays the result cell specified, i.e. EMI.
Current Values − It is the first column and enlists the values of that scenario which is selected
in the Scenario Manager Dialog box before creating the summary report.
For all the scenarios you have created, the changing cells will be highlighted in gray.
In the EMI row, the result values for each scenario will be displayed.
You can make the report more meaningful by displaying the comments that you added while
creating the scenarios.
Click the + button to the left of the row containing the scenario names. The comments for the
scenarios appear in the row under the scenario names.

Scenarios from Different Sources

Suppose you get the scenarios from three different sources and you need to prepare the
Scenario summary report in a Master workbook. You can do this by merging the scenarios
from different workbooks into the Master workbook. Follow the steps given below −
Assume that the scenarios are in the workbooks, Bank1_Scenarios, Bank2_Scenarios and
Bank3_Scenarios. Open the three workbooks.
Open the Master workbook, in which you have the initial values.
Click DATA > What-if Analysis > Scenario Manager in the Master workbook.
The Scenario Manager Dialog box appears.
As you can observe, there are no scenarios as you have not yet added any. Click Merge.
The Merge Scenarios dialog box appears.

As you can see, under Merge scenarios from, you have two boxes −
Book
Sheet
You can select specific worksheet from a specific workbook that contains the scenarios,
which you want to add to your results. Click the drop-down arrow of Book to see the
workbooks.
Note − The corresponding workbooks should be open to appear in this list.
Select the book – Bank1_Scenarios.
Bank1 sheet is displayed. At the bottom of the dialog box, the number of scenarios found on
source sheet is displayed. Click OK.

The Scenario Manager dialog box appears. The two scenarios that were merged into the
Master workbook will be listed under Scenarios.
Click the Merge button. The Merge Scenarios dialog box appears. Now,
select Bank2_Scenarios from the drop-down list in the Book box.
Bank2 sheet is dislayed. At the bottom of the dialog box, the number of scenarios found on
source sheet are displayed. Click OK.

The Scenario Manager Dialog box appears. The four scenarios that were merged into the
Master workbook are listed under Scenarios.
Click the Merge button. The Merge Scenarios dialog box appears. Now,
select Bank3_Scenarios from the drop-down list in the Book box.
Bank3 sheet is displayed. At the bottom of the dialog box, the number of scenarios found on
source sheet will be displayed. Click OK.

The Scenario Manager Dialog box appears. The five scenarios that were merged into the
Master workbook will be listed under Scenarios.
Now, you have all the required scenarios to produce the Scenario summary report.
Click the Summary button. The Scenario Summary dialog box appears.
Select Scenario summary.
In the Result cells box, type C6 and click OK.

The Scenario summary report appears on a new worksheet in the Master workbook.

Displaying Scenarios
Suppose you are presenting your scenarios and you would like to dynamically switch from
one scenario to another and display the set of input values and result values of the
corresponding scenario.
Click DATA > What-if Analysis > Scenario Manager from the Data Tools group. The
Scenario Manager Dialog box appears. The list of scenarios appear.
Select the scenario you want to display. Click Show.

The values on the worksheet are updated to that of the selected scenario. The result values are
recalculated.

What is Sensitivity Analysis?

Sensitivity Analysis is a tool used in financial modeling to analyze how the different values
of a set of independent variables affect a specific dependent variable under certain specific
conditions. In general, sensitivity analysis is used in a wide range of fields, ranging from
biology and geography to economics and engineering.
It is especially useful in the study and analysis of a ―Black Box Process‖ where the output is
an opaque function of several inputs. An opaque function or process is one which, for some
reason, can‘t be studied and analyzed. For example, climate models in geography are usually
very complex. As a result, the exact relationship between the inputs and outputs are not well
understood.
Image from CFI‘s Scenario & Sensitivity Analysis in Excel Course

What-If Analysis
A Financial Sensitivity Analysis, also known as a What-If analysis or a What-If simulation
exercise, is most commonly used by financial analysts to predict the outcome of a specific
action when performed under certain conditions.
Financial Sensitivity Analysis is done within defined boundaries that are determined by the
set of independent (input) variables.
For example, sensitivity analysis can be used to study the effect of a change in interest rates
on bond prices if the interest rates increased by 1%. The ―What-If‖ question would be:
―What would happen to the price of a bond If interest rates went up by 1%?‖. This question
can be answered with sensitivity analysis.
The analysis is performed in Excel, under the Data section of the ribbon and the ―What-if
Analysis‖ button, which contains both ―Goal Seek‖ and ―Data Table‖. These functions are
both taught step-by-step in our free Excel Crash Course.
Sensitivity Analysis Example
John is in charge of sales for HOLIDAY CO, a business that sells Christmas decorations at a
shopping mall. John knows that the holiday season is approaching and that the mall will be
crowded. He wants to find out whether an increase in customer traffic at the mall will raise
the total sales revenue of HOLIDAY CO and, if so, then by how much.
The average price of a packet of Christmas decorations is $20. During the previous year‘s
holiday season, HOLIDAY CO sold 500 packs of Christmas decorations, resulting in total
sales of $10,000.
After carrying out a Financial Sensitivity Analysis, John determines that a 10% increase in
customer traffic at the mall results in a 7% increase in the number of sales.
Using this information, John can predict how much money company XYZ will generate if
customer traffic increases by 20%, 40%, or 100%. Based on John‘s Financial Sensitivity
Analysis, such increases in traffic will result in an increase in revenue of 14%, 28%, and
70%, respectively.

Computing rates of returns, averages and variances of financial data

stock's historical variance measures the difference between the stock's returns for different
periods and its average return. A stock with a lower variance typically generates returns that
are closer to its average. A stock with a higher variance can generate returns that are much
higher or lower than expected, which increases uncertainty and increases the risk of losing
money.
Let's go over how to calculate the historical variance of stock returns as we work through an
example step by step.
Step 1: Select the period and measurement period over which you wish to calculate the
variance
There are two things you need to determine before you start the calculation:
What is your time unit: daily, monthly, or annual returns?
You're calculating historical variance. What is your "history" -- i.e., what is the time period
for which you want to calculate the variance: 30 days, six months, 30 years, and so on?
The choice of time unit and your measurement period will depend on your goal in calculating
the variance in the first place.
Discussing these choices is well beyond the scope of this article, so for the purpose of the
following example, we'll start with our data set as a given. We'll calculate the historical
monthly variance of the S&P 500 Total Return Index over a five-year period from August
2010 through July 2015 -- that's 60 observations (5 years x 12 months).
Here's the formula for variance:
Wow, that looks really complicated. Let's start with a translation in English: The variance of
historical returns is equal to the sum of squared deviations of returns from the average ( R )
divided by the number of observations ( n ) minus 1. (The large Greek letter sigma is the
mathematical notation for a sum.)
That still sounds very complicated, which is why we're going to work through an example,
and because no one in this day and age would calculate a variance by hand, we'll use
Microsoft Excel.
The following screenshot of our Excel spreadsheet shows our starting data set. Column B,
from Rows 3 through 62, contains our monthly return series for the S&P 500 Total Return
Index for the period from August 2010 through July 2015:

The first thing we need to do is calculate the average return over

the period. Mathematically, the formula for the average return is
as follows:
Step 2: Calculate the average return
The first thing we need to do is calculate the average return over the period. Mathematically,
the formula for the average return is as follows:
Average return = (1 / n) x (sum of all the returns in the observation period)
Here, n is the total number of observations.
We calculate the average using Excel's "Average" function. The result, 1.32%, is in cell C65.
(The exact Excel formula we use is displayed in the cell immediately to the right.)
This step occurs in column C:
Step 3: Calculate the difference between each of the individual returns and the average return

For example, for August 2010 (row 3), the difference between the
monthly return is -4.51% - 1.32% = -5.83%, which is the figure
found in Cell C3. (The Excel formula we used to obtain that figure
is shown immediately to the right.)
For example, for August 2010 (row 3), the difference between the monthly return is -4.51% -
1.32% = -5.83%, which is the figure found in Cell C3. (The Excel formula we used to obtain
that figure is shown immediately to the right.)
Step 4: Calculate the square of the differences and add them all up
In column D, we square the differences we just obtained:
For example, for August 2010 (row 3), the difference squared is
equal to: -5.83% ^ 2 = 0.34%, which is the figure displayed in Cell
D3. (The Excel formula we used to obtain that figure is shown
immediately to the right.)
For example, for August 2010 (row 3), the difference squared is equal to: -5.83% ^ 2 =
0.34%, which is the figure displayed in Cell D3. (The Excel formula we used to obtain that
figure is shown immediately to the right.)
We then add up all the squared differences using Excel's "Sum" function. The result, 6.77%,
is in C66.
Step 5: Divide the sum of squared differences by n - 1
We're almost home!
Cell C67 below contains the number of observations (i.e., the number of months). Just below
that, in Cell C68, we finally obtain the variance. The formula we use for the variance is
displayed immediately to the right and shows that we divide the sum of squared differences
(Cell C66) by the number of months (Cell C67) less 1.
The variance is 0.1148% (Cell C68).
You can confirm with a calculator that:
variance = 6.77% / 59 = 0.1147%. (The difference is due to rounding errors.)
Is there an easier way to do this?
Yes, there is! Excel has a variance function, "VAR," which calculates the variance of a set of
numbers directly, eliminating the need for all those intermediary steps, which are pretty
tiresome. The result is in Cell C70 below:

Note that the result matches the one we derived independently,

which is comforting.
 UNIT IV
Estimating demand curves – revenue management – Computing marketing metrics –
Take rate, Churn, Customer satisfaction – customer life time value – cost per click –
Transaction conversion rate – bounce rate

Estimating the demand curve

The demand curve D(p) of a product is always changing and depends on actors like
seasonality, competitive pressure, and the state of the economy.
A related concept is the price elasticity which is the percentage decrease in demand when
the price of the product goes up by 1 percent. When elasticity is greater than 1 percent,
demand is price elastic – a price cut increases revenue. When elasticity is less than 1
percent, a price cut decreases demand.
Products like coffee, stocks and high-end restaurants are elastic goods. Products like
gasoline, electricity, water and cell phone plans are inelastic.
To estimate the demand curve, we'll run some experiments (or market research surveys)
with three price points. The highest and lowest price points that seem reasonable, and themid-
way point. With these three price points, we can fit a quadratic curve to estimate a demand
curve:
where a, b and c are the coefficients of the quadratic curve. The three data points will solve
the quadratic curve exactly for the three coefficients.

An example with mobile in-app purchases

Let's take a concrete example: consider a mobile game that monetizes through in-app
purchases. Though the product here is a digital good and doesn't have a real cost of
production, for the sake of argument let's assume that it costs $0.50 in hosting and server
costs.
From experience and looking at other similar apps in the app store, it's reasonable to
charge between $0.99 and $2.99 for it. We then design an experiment to show a percentageof
users the product for $0.99, $1.99 and $2.99 in order to collect data – assuming everything
else stays constant. We have the following demand for the product:

price demand

low price $0.99 60

mid-price $1.99 51

high price $2.99 20

Plugging the three data points into the quadratic equation, we can solve for the coefficients
a, b and c.
 coefficient value

a -18.98

b 47.57

c 31.50

Thus, the demand curve is:

We'll now maximize the profit curve to figure out what the price needs to be.

3. Pricing that maximizes profits

Revenue Management:
Companies predominantly use revenue management in industries characterized by fixed
capacity and costs and products or services that expire. These industries include travel,
hospitality, and event-related retailing.
Revenue management has permeated other industries, including the SaaS sector, despite its
origin in travel and hospitality. Its methodology has quickly proven itself in maximizing
profits for the industry.
Revenue management is the use of optimized pricing to enhance revenues. The intent is only
to increase revenues when doing so will also increase profits. When properly conceived,
revenue management establishes the optimum price for each customer.
Revenue Management Best Practices Possible tactics for enhancing revenue levels
include the actions noted below.

Add Distribution Channels: A business can sell its products through different distribution
channels in order to reach out to different groups of customers, possibly selling at different
price points in each distribution channel. For example, a cruise line could sell at a
reduced price through a discount travel service, while selling at full price through its own
website.

Institute Dynamic Pricing: A company can adjust its prices continually, based on
ongoing changes in its estimates of demand and the remaining amount of supply on
hand. Airlines routinely engage in dynamic pricing, so that the passengers on a flightmay
pay widely differing amounts for essentially the same seats. Hotels also employ dynamic
pricing; for example, they raise room rates when there are major events in town that they
know will increase the demand for rooms.

Selectively Implement Overbooking: When a business has a fixed capacity and there is
a risk of order cancellation, the company can overbook customer orders. The airline, hotel,
and restaurant industries routinely engage in overbooking. Doing so can annoy customers
when they find that there is no available capacity, so organizations have to be careful
about the level of overbooking in which they choose to engage.

Initiate Promotions: A business can engage in various promotions, using such tools as
rebates and coupons, to discount prices for targeted sales periods. For example, a retailer
can use coupons to drive sales during what might otherwise be a slow sales period. Or,
promotions may be used at the beginning of a selling season in order to sell more goods at
full price.

Offer Bundling: A firm can offer a set of related products to its customers for a
discounted price. For example, a travel business could offer a vacation bundle that
includes airfare, a hotel room, and a rental car. This approach locks up all related purchases
that a customer might want to make, thereby maximizing the seller‘s revenue.

Offer Cross-Selling: Present customers with an option to make additional purchases that
complement their initial purchase. For example, a hotel can offer its customers breakfast for
an extra $20, while a bookstore might offer its customers a leather bookmark for an extra
$2. As long as the cross-selling relates to products that customersbelieve to be useful, they
may view cross-selling as an added benefit.

Offer Up-Selling: Many businesses try to sell higher-priced versions of the products in
which customers have initially expressed an interest. This is quite common in car
dealerships, where the sales staff routinely tries to draw the attention of customers to
more expensive models. Similarly, a hotel might offer its customers an upgrade to a suite
from its standard room. Up-selling can result in substantial increases in profits,
especially when the products to which customers are being directed have a higher profit
margin than what they were originally interested in buying.
Employ Rate Fences: In order to keep full-price customers from taking advantage of
discount deals that are intended for more price-sensitive customers, revenue management
can also include the use of rate fences, which are rules or restrictions that allow
customers to segment themselves into certain rate categories based on their needs,
behaviour, or willingness to pay. For example, a common rate fence used by hotels is to
offer a low price, but only if payment is made several months in advance. Since
businesspeople are rarely able to plan that far in advance, they are effectively excluded
from these deals. Similarly, higher-priced business class plane tickets allow their
purchasers to reschedule flights for free, while this option is not available when lower-
cost seats are purchased in the economy section.

Invest in Branding: Use enhanced product quality and expanded marketing programs to
increase customer appreciation for and awareness of the company‘s brands. Doing so
makes it more likely that customers will want to purchase its products, even if the company‘s
price points are somewhat higher than those of the competition. Branding only works if
substantial investments are made in it for an extended period of time, and the firm‘s
products are sufficiently distinctive.

Set Up a Loyalty Program: A classic revenue management technique is to set up a customer

loyalty program. By encouraging customers to buy directly from the company, the firm
can avoid selling to wholesalers and retailers at lower margins. This approach also allows
the company to market directly to its end customers and interact with them, which may
result in new ideas regarding how to better service customers.

Sell Direct: A company can set up a direct sales channel, rather than selling through
wholesalers and retailers. A common approach is to set up an Internet store, while rolling
out physical stores may also work (though the capital cost is higher). The advantage of
selling direct is that the company does not have to give away a portion of its margins, as
is the case when selling through other parties. However, there are also costs associated
with selling direct, which can offset some or all of the profits generated.

Incremental Cost Analysis: Revenue management also takes into account the
incremental costs associated with each sale. For example, when a hotel sells its excess
supply of rooms through several aggregator websites, it makes sense to direct most of the
excess supply to whichever of the sites charges the smallest commission.

Revenue management KPIs: Top metrics to follow

After formulating your revenue management process and strategies, you need to track their
performance and success. The following revenue management key performance
indicators (KPIs) are available for SaaS companies:

Customer lifetime value (CLTV)

You can determine your customer lifetime value using the equation below:
CLTV = average revenue per account/net monthly recurring revenue churn × 100 A steady or
increasing CLTV indicates successful revenue management. A rising CLTV shows that you
are retaining customers longer who are buying more.
Average cost per acquisition (ACPA)
Average cost per acquisition measures if a SaaS company is spending its money in the right
places and keeping its acquisition strategy up-to-date. Aim for organic acquisition channels to
lower your costs as your brand awareness grows.

Monthly & annual recurring revenue (MRR/ARR) :These two holistic KPIs indicate how
your business is performing. They are excellent for showing business growth and progress,
especially when aligned alongside other KPIs.
MRR = total customer revenue within one month
ARR = MRR × 12
ARR gives an annual prediction even if a business has only collected data for a few months.

Customer & revenue churn rate (CRR/RCR)

Customer churn rate sets benchmarks that businesses should aim to beat.
CCR = difference between the number of users at the start and end of a selected period
divided by the number of users present at the start of the period
RCR = The net revenue lost from customers within a period/ the total revenue at the start of
the period Revenue churn rate goes hand-in-hand with CCR unless you have flexible,
monthly pricing plans. In this case, you may realize you are losing revenue but not clients
because they are going for cheaper plans. Fortunately, you can try and upsell them or adjust
your plans to generate more revenue.

Revenue management process in 5 steps

S companies should collect data and use it for forecasting to help predict the future
performance of products and services and make adjustments to maximize revenue. Below is
the revenue management process in detail:
Data collection and recording: Companies should base their revenue management systems
on the collection and recording of data to enable decision making, translating into price and
distribution strategies. Therefore, all the information the company obtains relating to its
customers and purchasing habits is essential for revenue managers—for example,
subscription dates, cancellations, plans, etc.
Historical data analysis: Interpreting and analysing historical data is the basis for producing
sales forecasts and pricing and distribution strategies. Revenue managers have the
complicated task of focusing on market segmentation. The analysis allows SaaS companies to
identify patterns and exploit them to increase their bottom line.

Evaluation of seasonal trends: When preparing the sales forecast, precision is critical in
obtaining a demand measurement, including seasonal trends characterized by activity peaks
and troughs. In turn, forecasting enables companies to react when faced with low demand
periods. It also allows them to design different rate levels and select optimal distribution
channels.

Market trends analysis: It‘s an analysis of past and prevailing market behaviour plus
dominant patterns of consumers and the market. To analyse market trends, keep track of
industry publications and influencers, listen to your customers, absorb up-to-date industry
trends and research, and utilize available digital tools and analytics.
Competitor research: Competitor research and analysis should include competitors' pricing,
features, market share, differentiators, marketing, location, strengths, weaknesses, and
customer reviews.

Marketing Metrics

A marketing report is clear and most effective when it presents a handful of important
marketing metrics. So you‘ve heard. But the question is: what are the most important, must-
track marketing metrics?

If you look at your pool of marketing metrics, it‘d appear that each number is essential
– like your marketing report would be incomplete without all the numbers. But by looking
closer, you‘ll be able to pick out the most important, results-proving metrics that will
make your Marketing Reporting more efficient.

SEO Metrics

These marketing metrics give an idea of how well your SEO efforts are reaping. Some
essential figures to monitor include:

Organic traffic: how many visitors are coming to your page via search.
Conversion metrics: Email signups, Form submissions, and Phone calls (all self-
explanatory).
Backlinks and Referring domains: the links other sites are giving to your content and
the sites that are linking to you, respectively.
Domain authority (DA): how authoritative your site is.
Page speed: how fast your page loads.

Content Marketing Metrics

Consumption metrics: Page views, Average time on page, and Unique visitors meaning
people viewing your pages, how much time they‘re spending on your pages, and how
many new visitors (vs. returning visitors) your pages are attracting.
Retention: Page per visit, which tells how many pages someone visits on your site and
Bounce rate, the measure of people leaving your page after clicking through it.
Engagement: Comments and Session duration (time spent per visit).
Leads: Leads generated or people interested in your service/product.

Social Media Metrics

While there are a ton of social marketing metrics to track, several are vanity metrics such
as likes. Some of the most important social metrics to keep an eye on, however, include:

Awareness metrics: Reach and Impressions which denote how far your posts are going
and how many people are seeing them, respectively.
Engagement metrics: Mentions and Comments that relate to people tagging you on social
and commenting on your posts, respectively.
Customer care metrics: Response Time and Rate, which is the average time it takes your
representative to answer your audience‘s message and the average number of queries
answered, respectively.
ROI: Link Clicks, Referrals, and Conversions. These show how many peopleare clicking
your links, how many people social is sending to your website, and how many of those
people on social complete a specific action, respectively.

Email Marketing Metrics

When reporting on your email campaigns, always include these email marketingmetrics:

Open rates: how many people are opening your emails.

Click-through rates: how many people are clicking the links you share in your emails.
Number of unsubscribes: a measure of how many are leaving your list.
Bounce rates: it shows how many on your list didn‘t receive your email.

Conversion rate: these measures how many people are clicking your email links and
completing a specific action.
List growth rate: the rate at which subscribers are joining your list.
Engagement rate: an estimate of when subscribers are opening, clicking, and replying
to your emails.

Paid Marketing Metrics

Paid marketing metrics largely depend on your goals from ad campaigns. Here‘s arough
idea of some essential metrics to keep an eye on:

Clicks: how many clicks you‘re getting on your ads.

Conversion: how many people are taking a specific step.
Conversion rate: the rate at which people are converting.
Cost per conversion: how much does each conversion cost.
Click-through rate (CTR): the number of clicks on your ads divided by the
impressions your ads generated.

Customer Lifetime Value

―It‘s important to look at the long-term as a marketing professional, especially the value
of your customers in the long run,‖ insists Jack Wang of Amazing Beauty Hair. This is
why Wang thinks it‘s essential to mention Customer Lifetime Value in every marketing
report.
―It will help you establish your VIPs, who will be there for you no matter what. That‘s
an advantage to have, especially during uncertain times like the ongoing pandemic.‖

KNB Communications‘ Crissibeth Cooper agrees: ―In an ideal world, LTV: CAC (lifetime
value of a customer vs the cost per acquisition of customer) would be included in every
marketing report. Oftentimes these numbers are difficult to obtain because they require
calculations to be done. They‘re high-level numbers so they probably won‘t be calculated
often.
However, every report being sent to the CEO or other executives who care about the
bottom line, dollars, and cents, appreciate receiving this ratio because it can tell them a
lot about the process of customer acquisition and where funds should be spent or diverted
from.

If the ratio is very low, you are spending too much on marketing and/or not using your
marketing dollars effectively If the ratio is way too high, you are not spending enough on
marketing and you could be growing faster if you invested more money into marketing.‖

Response Time

―Hands down, a crucial metric in marketing reports is the response time to customers,‖
notes Lilius‘s Osiris Parikh

―This is a crucial metric that examines how quickly a sales or marketing team is answering
questions and engaging with customers. Unlike being on hold in a call center, there should
be no reason a customer is not able to get a question answered quickly.

This can be broken down by company average and individual staff to gaugeeffectiveness and
seek improvement.‖

Return On Investment

―ROI or time spent are important metrics for most marketing reports,‖ suggests 45/RPM‘s
Noriko Harada.

―ROI is important because it reveals the impact of all marketing efforts on the business
and if those efforts are effective. Time spent is important because no matter how many
clicks you have on one website if they don‘t spend time on the site, it is worthless. So,
knowing the time a consumer spends on a website gives insight on the success of the
website.‖

On top of that, ―some campaigns may drive in a lot of business, other campaigns may
not, but the true sign of success is how much you earned in relation to what you spent,‖
adds Melanie Musson of CarInsuranceComparison.com

Visitor Queue‘s Nick Hollinger agrees, ―I think a universally important one that needs
to be included in every marketing report is ROI. The job of a marketer is to use
channels and tools to have a positive impact on the company. If you aren’t
measuring that positive impact, how can you justify you’re doing a good job? ‖

Total Profit Added

―The most important marketing metric across all of our campaigns is total profitadded,‖
recommends Helen White from House of.

―We‘re not simply looking at return on investment (ROI) but more importantly how
much value does a campaign drive for the business by accounting for factors such
as cost and time invested to determine how profitable a campaign was .
It‘s a more holistic measurement of success rather than simply looking at the ROI from
a purely spend/return perspective which doesn‘t quantify the true realities of the total cost
incurred to the business,‖ explains White.

Referrals: Another important marketing metric to include in your marketing report is

referrals. Mavens & Moguls‘ Paige Arnof-Fenn writes, ―for my business the most important
metric is how much repeat business and referrals I get from my clients.
Most of my business comes from referral and word of mouth so keeping current clients
happy is my top priority.‖

Customer Engagement

―One important marketing metric that a brand should include in every marketing report
is customer engagement,‖ says Jacknife Design‘s Michael Kelar

―This can be measured in multiple ways such as activity and usage of a product or service,
social media interactions, website traffic, time spent on site, newsletter open rates or brand
recall.

Customer engagement is ultimately a way to gauge brand awareness and how effectivea
brand is at not only reaching its audience but resonating with them. Collecting this data
allows a brand to optimize its high performing tactics/channels and invest in improving its
less engaging ones—enhancing the overall customer experience at every touchpoint.‖

Take rate

2.66% )
Taking a cut for services is a key profit driver for many companies.

Long before e-commerce began, intermediaries have charged money to link buyers and sellers
of goods and services. For e-commerce businesses such as , eBay ( EBAY -2.92% ), and
PayPal ( PYPL -3.77% ), the take rate refers to thepercentage of the value of the transactions
they facilitate that they get to keep as revenue.
How much an e-commerce company is able to charge as a take rate depends on the strength of
its underlying network of users and the degree of competition within the industry. As
Amazon, eBay, and PayPal have found, building up an internal ecosystem to keep users
within reach can be a key driver in keeping take rates up and boosting profits as much as
possible.

What take rates look like in online marketplaces

For online marketplaces like what Amazon and eBay offer, the take rate refers to the fees and
commissions that the companies collect on sales by third-party sellers. For eBay, those fees
typically take the form of initial listing fees for offering goods and services on its
marketplace in the first place, as well as final value fees that the e-commerce specialist
collects after a successful sale.

The key issue with take rate in online marketplaces is the tug-of-war between maximizing
profit and keeping customers within the network. eBay has traditionally sought to move its
take rate higher, boosting final value fees and taking a bigger piece of its sellers' sales. Yet as
it has done so, eBay has opened the door to competing marketplace services, and the rise of
companies like Etsy has shown that raising take rates too high can enable competitors to
undercut based on price and lure cost-sensitive users away.

In assessing the health of Amazon, eBay, and other marketplaces, it's valuable to look at
gross merchandise volume and segment profitability. Volume growth is important to ensure
that the network is healthy, but the ratio of profits to volume is directly proportional to the
take rate, and growth in profits is necessary to show that the company is finding the optimal
take rate to balance income and revenue.

What take rates look like for payment networks

Meanwhile, the take rate concept is similar for payment services providers like PayPal.
Payment services providers typically take a percentage of every transaction in exchange for
facilitating the movement of funds from the buyer to the seller. For instance, if a buyer
spends $100 on a product, a payment services company might pay the seller $97, keeping the
remaining $3 as a fee. This would work out to a take rate of 3%.

As with online marketplaces, competitive pressures define how payment providers can
optimize take rates. PayPal's net take rate actually depends significantly on the choice of
funding source that customers make, because if customers use a debit or credit card, then
PayPal has to bear the costs that the card network company charges. PayPal actually takes
that into account with certain transactions, charging no fee on personal payments funded with
existing PayPal balances or from a bank account, but charging 2.9% plus a $0.30 transaction
fee if the payment is funded through a debit or credit card. However, for purchase payments,
the seller pays 2.9% plus $0.30 per transaction regardless of the funding source -- meaning
that PayPal gets to keep extra profit if buyers use a bank account rather than a card.

What take rates look like for website analytics

Finally, take rate has a different meaning for marketing activity, including that done
throughe-commerce. Take rate reflects the fact that a great deal of internet marketing
happens in multiple stages, where the first goal is to get a customer to click on an ad, and
the next is to convince that customer to buy a product. The take rate in this case refers to
the percentage ofcustomers who click on the ad, in contrast to the conversion rate, or
percentage of customerswho not only took the ad but actually bought the product.

In general, a high take rate is good, but it's essential that conversion rates be strong as well.
For marketers, a high take rate and a low conversion rate can be the worst of all worlds in
e- commerce. Often, marketing costs are based on the number of people clicking through,
and it's then up to the company to convince those people to buy a product. By contrast, a
lower take rate can be better if it doesn't hurt conversions, because it will cost less to drive
the sameamount of final sales.
Churn Rate
Churn rate, also referred to as attrition rate, measures the number of individuals or units
leaving a group over a specified time period. The term is used in many contexts, including in
business, human resources, and IT.
Most notably, churn rate is referred to as the proportion of contractual (or subscribed)
customers who terminate their contractual relationships/subscriptions with a company in a
given timeframe. In this context, the term is primarily associated with companies operatingon
a subscription basis.
Importance of Measuring Churn Rate
Churn rate is one of the most critical business metrics for the companies using a subscription-
based business model. For example, a high churn rate or a churn rate constantly increasing
over time can be detrimental to a company‘s profitability and limit its growth potential. Thus,
the ability to predict the churn rate is essential for the company‘s success. Many companies
rely on predictive analytics that allows creating models that forecast churn rates.
In order to decrease the churn rate, companies utilize different methods and strategies.
Generally, the strategies are focused on improvements in customer retention and satisfaction
by establishing proactive communication with customers, obtaining constant
customer feedback on the company‘s performance, and improving the company‘s operations.

What is Customer Churn Rate?

Customer churn rate (also known as customer attrition rate) measures the proportion of
contractual customers of a company who cease their subscriptions over a defined time period.
Customer churn rate is one of the important business metrics for companies providing some
services (such as SaaS companies) or those operating on a subscription-based model.

Companies can use two variations of customer churn rate: voluntary churn and involuntary
churn. Voluntary churn rate indicates the proportion of customers who decide to cease their
subscriptions as a result of their own decisions (e.g., dissatisfaction with the company‘s
services). On the other hand, involuntary churn rate is a proportion of customers who
terminate their subscriptions due to some unavoidable circumstances (e.g., relocation).
Generally, companies are primarily concerned with voluntary churn that is directly related to
their core business operations.
Formula for Customer Churn Rate
The customer churn rate is calculated by dividing the number of customers left in a given
period by the total number of customers at the beginning of a given period. Mathematically, it
can be expressed using the following formula:

What is Employee Churn Rate?

In human resources, churn rate is referred to as a proportion of employees who leave a
company in a given period of time. In this context, the churn rate is frequently referred to as
employee attrition rate or employee turnover rate.
Employee churn rate indicates how frequently the company‘s employees quit their jobs
within a given period. Note that employee churn rates can significantly vary among
companies and industries. For example, a consulting company is likely to see a significantly
lower churn rate than a fast-food restaurant.
Generally, companies aim to either maintain churn rates corresponding to the industryaverage
or lower than the industry average.
Formula for Employee Churn Rate
Customer satisfaction
Employee churn rate is calculated by dividing the total number of employees who resigned
within a period by the total number of employees in that period. The mathematical formula
isgiven below:

Customer satisfaction should be the main focus of an organization because customers drive
business. Collecting customer satisfaction data can help your company determine what is
working well with your products, services and internal processes, and what you need to
improve or change completely. In this article, you will learn what customer satisfaction is,
how to measure it effectively and why it's important for the success of your business.

Customer satisfaction (often abbreviated as CSAT) is a measurement of how happy (or

unhappy) customers are with a company's products, services or experience.
Customer satisfaction consists of a customer's perceived quality, value and expectations of
your company and what you offer. This data can reveal major insights into how customers
relate to your brand and how they will interact with your brand in the future.

Customers include anyone a company provides products, services or experiences. For

example, a car dealership's customers are individual buyers and a hospital's customers are
patients. Many businesses are actually both providers and customers. For instance, a hospital
is a provider for patients by offering healthcare and a provider for insurance companies by
releasing data on patients, but hospitals are also customers of insurance companies, which
pay hospitals for their services.

How can we get customer service data?

The most common way for companies to receive customer service data is to analyze their
Customer Satisfaction Score. This score is generated with a customer satisfaction survey
using a Likert scale. In this survey, customers are asked to evaluate statements about their
perceptions and expectations of your business, product or service. Question categories might
include product usage, demographics, satisfaction scale, open-text for long-form responses
and longevity questions that ask customers if they can be contacted again in the future. The
satisfaction scale is typically set on a scale of 1-3, 1-5, or 1-10. All customer rating responses
are then averaged to get the CSAT score.

While the CSAT is a comprehensive way to get customer feedback, there are additional
metrics you can establish to gather more data. They include:
 Net promoter score: This score evaluates customer loyalty by measuring the
likelihood that a customer will refer you to someone. Referrals are important for company
longevity.
Customer effort score: This score measures the effort customers had to use to get their issues
solved. The lower the score the more efficient customer service is and thehappier customers are.
Social media monitoring: Monitoring what your followers are saying on social media helps you
evaluate how customers feel about your company and what they are saying to their closest family
and friends about it.
Measuring complaints: This is the measurement of the number of complaints
received for products or services sold or survey responses, per 100, 1000, or up to

1,000,000 units. Lowering this score means you are proactively reducing
customerdissatisfaction.

Why is customer satisfaction important?

Great customer satisfaction and high customer retention are strongly linked. Customer
retention powers sales and helps businesses maintain sustainability. While metrics like sales
and shares show important details on how well a company is performing at a specific time,
customer satisfaction scores are one of the best indicators to reveal how a company will
perform in the future.

Here are some specific ways knowing your CSAT can help your business:

CSAT identifies your unsatisfied customers

Identifying and addressing unhappy customers is crucial to the success of any business.
Negative customer reviews, or word-of-mouth warnings to friends and family based on bad
experiences, can adversely impact a company's longevity. Asking for feedback through
surveys, and acting on any unfavorable responses by addressing problems and making
adjustments, shows that customers are your top priority. When you show unhappy customers
you care about them, they have a higher chance of coming back.

CSAT identifies your happy customer

Prioritization of customer success is an important aspect to growing your business. To

determine if customers are happy, you'll need to measure and analyze their satisfaction rates.
Your satisfied customers are important because they will maintain loyalty and increase
referrals. You can create customer advocacy programs for these customers to encourage them
to bring in more referrals and advertise on your business's behalf.

CSAT forecasts help you prioritize.

Customer metrics help you focus your priorities. Customer satisfaction data allows your
teams to assess what areas they need to work on to improve the health of your customer base.
Customer success teams, sales, production and marketing are all involved in making your
customers' experiences excellent.
CSAT powers internal processes

Customer satisfaction data gives you powerful insights into who is consuming your product or
service. These metrics can be very advantageous when used correctly. By learning more
about your customer base and who is satisfied with your product, you can adjust your
marketing plans, sales techniques and other internal operations.

CSAT attracts new leads

Customer reviews are one of the most persuasive ways to attract new customers. Greater
customer satisfaction leads to an increase in positive reviews. These strong testimonials
attract more potential customers to your business than a marketing campaign because
peopletrust their peers.

6. CSAT sells.

Customer satisfaction is a selling point for sales teams. High customer satisfaction scores
area compelling highlight to make during a pitch to new leads. Additionally, sales teams can
analyse happy customer reviews to note which parts of your service or product they should
mention as unique advantages over competitors.

7. CSAT guides product updates

Negative reviews can actually be very beneficial for product development. When an
unsatisfied customer relays their problems with a product or service, it opens up an
opportunity to fix a problem that could affect many other customers in the future. This is
especially important for businesses that regularly update software where bugs must be fixed
immediately.

Customer Lifetime Value

Keeping your customers happy and coming back for more is an essential strategy for any
business. Still, many companies are short-sighted and focus on one-off purchases from new
buyers rather than repeat purchases from existing customers.
Hanging on to repeat customers and nurturing that relationship can be extremely lucrative,
considering that repeat customers generally spend 67% more than new customers.
One metric in particular can help companies understand the value of existing buyers: customer
lifetime value.
Customer lifetime value (CLV) is the amount a customer can be expected to spend on a
company‘s services or products during their entire relationship or lifetime.
CLV is essentially calculated as follows:
Average Value of a Sale (x) Number of Transactions (x) Retention Time Period (x) Profit
Margin
Customer lifetime value (CLV), also called lifetime value (LTV), refers to the profit margin
that a company can expect to earn during its business relationship with a customer.
Keeping this metric in mind helps companies take a longer view and shift their focus from
simple transactions to the extended value of repeat business.
Of course, it‘s crucial to find new customers so that your company can grow, but for your
business model to be sustainable, it‘s also imperative to bolster the lifetime value of existing
customers.
Unfortunately, many companies dismiss, ignore or underappreciate this metric because it can
be tricky to define and calculate. What‘s more, data shows that 44% of companies are
focused on acquiring new customers while just 18% are committed to retention. If you‘re in
the latter group, it‘s time to step it up and really focus on the customer lifetime value.
Keep in mind that just a 5% increase in customer retention can boost your profits by more
than 25%, so it‘s clearly well worth the effort.
Why Is Customer Lifetime Value Important?
Customer lifetime value (CLV) is a crucial metric as it allows companies to understand the
value of retained customers. If the success rate of selling to an existing customer is 60-70%
and to a new customer is 5-20%, it makes a ton of sense for companies to try to increase their
CLV any way they can.
Let‘s take a look at the five most significant reasons why CLV is so important.

It can help boost profit: Increasing customer retention rates by just 5% has been shown to
increase profits by 25% to 95%. This, at least in part, is because existing customers are 50%
more likely to try out new products and statistics show they spend 31% more than new
customers.

Thus, repeat customers increase your average CLV because customer retention can improve
not only the number of sales per order but also sales over time. Since you spend only once to
acquire a customer and customer retention costs less than the acquisition cost, your customer
lifetime value can increase and translate into more profit.
It can lower customer acquisition costs (CAC): Companies that interact with and nurture
their customers will enjoy higher profit margins and lower CAC. It‘s actually an expensive
proposition for companies to go out and constantly try to find new customers. If acquiring a
new customer can cost between 5% and 25% more than hanging onto an existing one, it
makes all the sense in the world to take care of your current ones.
It can help you maintain a steady cash flow: If you‘re getting repeat sales from existing
customers, that will create a very nice, regular cash flow. When you know you have money
coming in, it‘s easier to reinvest it back into your business. When you know people will be
coming back for more, you know you have a steady flow of cash to work with.
It can increase customer loyalty and retention: CLV allows companies to identify their
most valuable customers and offer them personalized rewards and incentives. At the same
time, you can build strong relationships with new customers and retain them through stellar
customer support, attractive loyalty programs, and other lucrative incentives to win their
loyalty and long-term business. When you have repeat customers, you get more sales, good
reviews, and referrals.
It can allow you to target your ideal customers: Understanding customer lifetime value
can give you a better idea of what kind of customers spend the most money on your business.
It allows you to segment your audience according to their CLV. Then you can use look-alike
modelling to adapt your acquisition strategy to the target audience matching your customers
with the highest CLV. From there, you can work to increase your customer lifetime value
further.
Customer Lifetime Value Formula
There are multiple ways to calculate CLV. We‘re going to look at two possibilities here, one
using the ARPU and churn that we mentioned above and one using other metrics. The
formula you use will depend mainly on the data you have available.
The first method is to divide ARPU by the churn rate:
Customer lifetime value = ARPU / Churn Rate
A second method for calculating CLV is by using the following formula:
Customer Lifetime Value = Average Value of a Sale x Number of Transactions x Retention
Period x Profit Margin

Keep reading for some real examples.

Example CLV Calculation

Let‘s look at two examples so we can understand CLV better.
You already know your company has a churn rate of 10% and an ARPU of $30. Using the
first formula, we get:

30 / 0.10 = $300
The average customer lifetime value for your company would be $300. Let‘s use the other
formula.
Your company sells menswear. The average sale is $75, and the average customer shops with
you 4 times per year for 3 years. You know that your profit margin is 20% after taking into
account overhead, the cost of goods sold, marketing expenses, and administrative costs.
Using our formula, CLV would be calculated as follows:
$75 x 4 x 3 x 20% = $180
Your company‘s average customer lifetime value is $180, and you can now use this
information to predict cash flow. You can also figure out how many customers you‘ll need to
acquire and retain if you‘re going to achieve your target profitability.

Cost per click: Pay-per-click is one of the many tactics that you can use to strengthen your
marketing campaign. It's important to track the cost of each marketing tactic you deploy
throughout your campaign, so you meet budgetary requirements and evaluate the
performance of your team effectively. However, it's also feasible for the accounting
department to know the cost of your paid search campaign to see if it's an indicator of the
marketing team's success.

Cost per click, formally known as pay per click, measures how much you get paid when a
user clicks on your advertisement displayed within a search engine. In other words, the cost
per click gets measured by how many users have an interaction with your brand in the form of
ads. Since you'll be getting paid by the advertiser for your ad's performance, you need to
make sure that the ad redirects to your landing page that solicits the user to respond to your
call-to-action (CTA). Some of the ad types you can use include text, image, video, social
media and shopping.

Increases the chance of boosting profits

A lead searches for what they want to buy on a search engine to find the lowest price and
highest quality, so placing your ad with the highest searched result creates interest and
improves the probability of your target audience to go to your website, along with ending up
in the buying process. You'll need to check the functionality of your website for it to navigate
your customers through the buying stage smoothly.

Easy to manage spending costs

You can make a quick decision on when to start and stop campaigns, so you'll know how
much you paid through the duration your ads ran on the search engine and make adjustments
to your ads campaign to be within budget. Also, you can run an ad campaign for as long as
you want and you have no upfront cost, which can have enormous growth potential.

Accessible performance metrics

You can see the performance of your ads as the user clicks on them, which can determine
how much you want to spend for the quarter or the year depending on your marketing budget.
You can also find out who's clicking on your ads, and you have the option of adjusting your
keywords and adding a promotion that incentivizes leads to go to your website.

Improves exposure opportunities

You can attract your target audiences and new audiences to your product with quality ad
campaigns, and cost per click campaigns present you the opportunity to apply remarketing
tools that can drive the user back to your website based on their search history. The
association with your brand and the search gives familiarity with the user, so they'll know to
search for your company again in case they want to make a purchase.

How to calculate cost per click

Take a look at the steps to calculate cost per click for your business:

1. Identify the ad campaign you're calculating.

2. Determine the total cost per click.
3. Find out the number of users click on the ad.
4. Divide the cost per click by the number of clicks to get your calculation.

1. Identify the ad campaign you're calculating

It's advised that you run multiple ad campaigns using different keywords to see which one
isthe most searchable. This way, you'll know the numbers behind your brand's impact and
youcan note the demographics that showed up on your searches, which can lead to a
separate marketing campaign if you can see a different target audience consistently
interacting with your website.
Determine the total cost per click
The average price per click shows up when you search for available keywords that you want
to use for your ad campaign. The cost can vary depending on the number of companies
bidding for the keyword. It notes the competition you'll have with others in using it.

However, we want to look out for the total cost of each click to begin finding the average
amount for the campaign. We'll say that the total cost per click is $19.90 to make this
calculation.

Find out the number of users click on the ad

Monitor the number of users that clicked on your ad on a daily, weekly, monthly and even
annual basis to check on the progress you have with engaging with your target audience. Ad
reports can be handed out to marketing managers and be a factor in the marketing budget
allocated by the executive team for the following year. We'll say that a weekly ad campaign
with a $19.00 cost per click received 20 clicks.

Divide the cost per click by the number of clicks to get your calculation

The last step is to divide your total cost per click over the number of clicks you received for
the campaign. The number can either be a decimal or a whole number, which symbolizes the
total that comes out to be less or more than $1 per click. Using the example from above, the
average cost per click is $.95 per click.

Conversion Rate

The conversion rate is an online marketing KPI measuring the ratio of a website‘s visitors to
conversions. A conversion doesn‘t necessarily have to be a sale or transaction, but could also
include successful downloads or newsletter sign-ups. Conversion rate optimization is a
central aspect of online marketing and search engine optimization, as an improved conversion
rate can have a significant impact on lead generation, and therefore sales and revenue.

Conversion Rate Definition

The conversion rate describes the relationship between visits/clicks on a website to

conversions. A conversion is the process of a potential customer becoming an actualcustomer.
Conversions can consist of purchases or downloads.

How to Calculate the Conversion Rate

The conversion rate can be calculated in two ways. One method of calculating the conversion
rate includes all recorded visits to a website, therefore including automated page impressions
by bots, and repeated page impressions from the same user. This calculation is less accurate,
unless a logfile analysis is used so that visits by search engine bots can be excluded.

Conversion Rate = (Number of Conversions x 100%) / (Number of Visits) Here‘s an example:

A marketing professional sells eBooks on their website. In the first week after the sales
launch, the website gains 100,000 page views and his eBook is downloaded a total 100 times
which means:

Conversion Rate = (100 x 100%) / 100000 = 0.1%

For a more accurate calculation of the conversion rate, the page views in the formula need to
be replaced by unique visitors or sessions, meaning a visitor is only counted once even if they
visit the site multiple times. Cookies are usually used to identify visitors, making it possible
to exclude multiple visits by the same user.

More accurate conversion rate = (number of conversions x 100) / (number of unique visitors)

For this calculation, a particular period of time is selected and only one conversion per unique
visitor per day is calculated. The total number of page views doesn‘t matter for the
calculation.

Bounce rate

In internet marketing/business terminology, bounce rate is associated with the analysis of

traffic to a company‘s webpage. The rate (always a percentage) indicates the percentage of
visitors that come to the site and leave versus those who come and view multiple pages.
Formula for Bounce Rate
The formula for calculating bounce rate is given below:

There are a number of different aspects to consider when making a website that will keep
users around to check out more than one page. At the top of the list are:
Effective communication
With any website, the primary objective is to pass along the most pertinent information about
the company and what is being sold or offered. Effectively communicating things such as
contact information, all available products/services, prices, etc., is critical if the company
wants to get visitors to view more than one page, thereby making the company more
successful.
Aesthetics
Stimulating colours and interesting graphics, organized in a neat and orderly way, are far
more likely to attract and keep viewers. The key is to make sure that in the aim to be
aesthetically pleasing that the site doesn‘t become overburdened with too many flashy,
confusing graphics, texts, or colours.
User accessibility
Neither the two other aspects on this list – nor any of the other aspects for a successful
website – matter if the site isn‘t user-friendly. Fast loading speeds, clearly labelled links, and
even things such as audio clips to read out the names of the links, are all important. Enabling
viewers to easily find and access whatever part of the site they‘re interested in encourages
them to stick around.
A Good Bounce Rate
There are a number of variables that determine what a good or bad bounce rate is. They
include the industry, business type, products/services sold, and how saturated the marketplace
is for companies in the industry or that sell the same or similar goods/services.
The way to determine the best rate for a certain company is to research the standard-to-above
average rates for similar companies or companies within the same market space that seem to
be making a decent profit.
Again, what is a good or ideal rate for one type of company in a given city may be
completely different for a similar company in a different area. However, the rule of thumb
with bounce rates is as follows:
Anything below 20%: An extraordinarily low bounce rate!
20% – 40%: The ideal goal range for pretty much every company41% – 75%: The range that
most sites actually fall into
75%+: The danger zone for bounce rates
 UNIT V
Forecasting – time series and exponential smoothing – purchase order processing –
production order quantity model – acceptance sampling – material requirement
planning – Quality control charts – Lot sizing methods – Project management
Exponential Smoothing for Time Series Forecasting
Exponential smoothing is a forecasting method for univariate time series data. This method
produces forecasts that are weighted averages of past observations where the weights of older
observations exponentially decrease. Forms of exponential smoothing extend the analysis to
model data with trends and seasonal components.

Statisticians began developing exponential smoothing back in the 1950s. Since then, it has
enjoyed a very successful presence among analysts as a quick way to generate accurate
forecasts in diverse fields, particularly in industry. It‘s also used in signal processing to
smooth signals by filtering high-frequency noise.

In this post, I show you how to use various exponential smoothing methods, including those
that can model trends and seasonality. These methods include simple, double, and triple
(Holt-Winters) exponential smoothing. Additionally, I help you specify parameter values to
improve your models. We‘ll work through example data sets and make forecasts!

Benefits of Exponential Smoothing

By adjusting parameter values, analysts can change how quickly older observations lose their
importance in the calculations. Consequently, analysts can tweak the relative importance of
new observations to older observations to meet their subject area‘s requirements.

In contrast, the moving average method weights all past observations equally when they fall
within the moving average window and it gives observations outside the window zero weight.
Like the Box-Jenkins ARIMA methodology, statisticians refer to exponential smoothing as
an ETS model because it models error, trend, and seasonality in time series data.
Time Series Analysis Introduction
Time series analysis tracks characteristics of a process at regular time intervals. It‘s a
fundamental method for understanding how a metric change over time and forecasting future
values. Analysts use time series methods in a wide variety of contexts.

Area Examples
Business Manufacturing output, sales, prices
Economics GDP, stock market, and other indicators
Social Sciences Population trends, political changes
Medicine Disease, birth, and death rates
Physical Sciences Climate and environmental changes

In this post, I cover the basics of time series analysis. I‘ll define this type of data, explain
what we can learn from it, and touch on more advanced methods that I will explore in future
posts. For this introduction, I focus on using time series plots to highlight what you can learn
from these data.

Time Series Data

A time series is a set of measurements that occur at regular time intervals. For this type of
analysis, you can think of time as the independent variable, and the goal is to model changes
in a characteristic (the dependent variable).

For example, you might measure the following:

Hourly consumption of energy
Daily sales
Quarterly profits
Annual changes in a country‘s population

Each of these examples tracks a single metric at regular time points. Use subject-area
knowledge to choose the appropriate time interval that allows you to answer your research
questions.

Compared to Panel Data

Panel data contain observations of multiple characteristics measured over time for the sameset
of subjects, such as people, businesses, or countries.

For panel data, you need a time value and an additional characteristic to identify a particular
observation. For example, if you have panel data that tracks sales for a group of companies
over time, you‘ll need a time value and a company identifier to find an individual
observation.

Time series data are a sub-type of the broader class of panel data. These series only track a
single characteristic. Consequently, you only need the time value. For example, for the
annual number of breast cancer cases time series, you just need to know the year to identify
the observation.

Compared to Cross-Sectional Data

Cross-sectional data describes a set of people, items, companies, etc. at a single point in time.
The goal is to determine the differences between the subjects at one time. For example, a
cross-sectional study might assess wages by education level to understand the impact of
education. Time does not play a role in this type of analysis.

Goals of Time Series Analysis

Time series analysis seeks to understand patterns in changes over time. Statisticians refer to
these patterns as the components of a time series and they include trends, cycles, and
irregular movements. When these components exist in a time series, the model must account
for these patterns to generate accurate forecasts, such as future sales, GDP, and global
temperatures.
In addition to these patterns, time series models typically incorporate the fact that time flows
in one direction. Past events can influence future observations but not the other way around.
Additionally, events close together in time often have a stronger association than more distant
observations. While these ideas are obvious to us, statisticians had to build them into how
these models work.

Like all data, time series data contain random fluctuations. This randomness can obscure the
underlying patterns. Smoothing techniques cancel out these fluctuations to more clearly
unveil the trends and cycles. In other posts, I cover the modelling and smoothing techniques.

Simple Exponential Smoothing (SES)

Use simple exponential smoothing for univariate time series data that do not have a trend or
seasonal cycle. Analysts also refer to it as single exponential smoothing. It‘s the simplest
form of exponential smoothing and a great place to start!

Simple exponential smoothing estimates only the level component. Think of the level
component as the typical value or average. This method updates the level component for each
observation. Because it models one component, it uses only one weighting parameter, alpha
(α). This value determines the degree of smoothing by changing how quickly the level
component adjusts to the most recent data.

Alpha values can range from 0 to 1, inclusive. Lower values produce smoother fitted lines
because they give more weight to past observations, averaging out fluctuations over time.
Higher values create a more jagged line because they weigh current data more highly, which
reduces the degree of averaging by the older data.

Double Exponential Smoothing (DES)

Double exponential smoothing can model trend components and level components for
univariate times series data. Trends are slopes in the data. This method models dynamic
gradients because it updates the trend component for each observation. To model trends, DES
includes an additional parameter, beta (β*). Double exponential smoothing is also known as
Holt‘s Method.

As with alpha, beta can be between 0 and 1, inclusive. Higher values place more weight on
recent observations, allowing the trend component to react more quickly to changes in the
trend.

Forecasts for this method change at a constant rate equal to the final value of the trend
component. A popular extension for this method adds a dampening component to the
forecasts, causing the forecasts to level out over time to avoid overly optimistic long-term
forecasts.

In the example below, we‘re using double exponential smoothing to model monthly computer
sales. As you can see in the chart, the time series data have a trend. I‘ve allowed the software
to estimate the level (0.599) and trend (0.131) smoothing constants from the data to optimize
the fit.

The forecasts (green diamonds) increase at a rate equal to the final trend estimate. Notice how
the prediction intervals widen with subsequent forecasts.
Triple Exponential Smoothing (Holt-Winters Method)

Triple exponential smoothing can model seasonality, trend, and level components for
univariate time series data. Seasonal cycles are patterns in the data that occur over a standard
number of observations. Triple exponential smoothing is also known as Holt-Winters
Exponential Smoothing.

This method adds in the gamma (γ) parameter to account for the seasonal component. For this
method, you must specify the period for the seasonal cycle. For example, these lengths
include the following: weekly (7), monthly (12), or quarterly (4).

In triple exponential smoothing, seasonality can be multiplicative or additive. Multiplicative

seasonality has a pattern where the magnitude increases when the data increase. Additive
seasonality reflects a seasonal pattern that has a constant scale even as the observations
change.
In the example below, we‘re using triple exponential smoothing to model daily food sales.
The time series plot displays an upward trend and a weekly seasonality.

Purchase order process: In today‘s global workforce, a slow purchase order process can
cripple your business. Manual purchase order processing and archaic systems hamper the
purchase order process and do more harm than good. Relying on a manual purchase
order process with emails and spreadsheets is like using a bank account with no ATM
access. A great way to overcome this challenge is by automating your procurement process.
Digitalization makes clunky processes work like a charm. Still not convinced? Here‘s a
free e-book that talks about the importance of procurement automation.

In the technological era, it would be wise to take advantage of a cloud-based solution like
kiss flow for purchase orders. Because it would help you to track POs end-to-end. But
before we delve deeper into a procurement system for successful PO management, let‘s take
a look at the current state of purchase order management, and figure out its major flaws.

Purchase orderprocess flow

The purchase order process consists of several compliance checkpoints and approval/input
tasks to ensure timely PO processing. Here are the most common purchase order process
steps:

Create a purchase order

Send out multiple requests for quotation (RFQ)

Analyse and select a vendor

Negotiate contract and send PO

Receive goods/services

Receive and check invoice (3-Way Matching)

Authorize invoice and pay the vendor

Record keeping

Purchase order closure

Example:

To understand a PO process, consider this real-life example. Jeni, an HR Manager is looking

out for new laptops to onboard new joiners. She creates a PR, which auto flips and
becomes a PO, thanks to procurement software like Kiss flow. The purchase order has
information on the number of laptops, the specifications, and the time she needs them.
Based on the PO, a Request for Quote (RFQ) is sent to the suppliers to get the quotes.
Based on the quotes received, their quality, and estimated delivery time, a vendor is
selected. Post selection of the vendor, he/she is contracted and the PO is shared. The
vendor delivers the laptops requested, Jeni receives them and verifies the products. Post this,
Sathish, Accounts Manager from the Finance team performs 3 -way matching with the
help of Kiss flow Procurement Cloud and then pays the vendor if
there aren‘t any discrepancies. The records for the transaction are kept safe, and the PO
will be now marked as closed.

The pain points of manual purchase order processes

Manual purchase orders are costly, inefficient, and time-consuming to maintain. There
are too many documents required to process a single purchase order.

Acquiring, storing, and sending them through the approval loop while ensuring they don‘t get
lost or damaged along the way is extremely tedious.
According to a recent APQC study, manual PO processing can cost organizations as much
as $506.52 per purchase order. A great way to reduce this cost is by automating your
procurement process. We have broken this down into simple actionable steps and put
them together in our free e-book.
Here are some of the disadvantages of a manual purchase order process:

Lacks visibility

Spikes organizational expense

Drags PO processing cycle

Depends on human intervention

Has process bottlenecks and compliance issues

Involves an endless loop of emails and people

Is cumbersome, inaccurate, and error-prone

Benefits of a digital PO system

Here are six reasons why every organization needs a procurement solution with a
purchase order management system. Digital purchase order systems can:

Enhance efficiency in PO management, with no lost or delayed POs

Improve PO processing speed

Accelerate purchase order approvals

Streamline order and stock management

Improve the vendor-buyer relationship

Prevent procurement fraud

Production Order Quantity Model Definition:

An economic order quantity technique applied to production orders.

Production Order Quantity Model Explanation:

A generation arranging model with stochastic interest, consistent faulty rate and limit
imperative is created to examine the generation issue of a chocolate milk producer. The model
is demonstrated to have an ideal arrangement under the given conditions. An ideal creation
plan is set up for the firm, which is demonstrated to be better than the present generation
plan. The affectability investigation performed on the ideal arrangement gives helpful bits of
knowledge on the stock control and limit prerequisite choices of the firm. The distinction
between these two techniques is that the EPQ model accept the organization will deliver its
very own amount or the parts will be transported to the organization while they are being
created, in this manner the requests are accessible or gotten in a steady way while the items
are being created. While the EOQ model accept the request amount arrives total and
following requesting, implying that the parts are created by another organization and are
prepared to be sent when the request is put.
Quality control

Quality control charts depict measures of quality for processes or for products. They show the
deviation, if any, from the set, ideal standards or specifications for a product or a process.
The Importance of Quality Control Quality control is an extremely important activity for any
business that is engaged in manufacturing products. If a company‘s products are produced
with uneven quality, it can negatively impact the company‘s sales.
For example, consider a company that makes and sells bottled beverages. Now think about
what might happen if a production machine that affixes the caps to the bottles gets a little bit
out of whack, so that it begins affixing approximately one-third of the bottle caps in such a
way that it becomes nearly impossible, or at least extremely difficult, for consumers to
remove the cap from the bottle. It doesn‘t take too many instances of an occurrence such as
that before the company begins to lose a lot of customers.
Therefore, companies set rigorous specification standards for both manufacturing processes
and for the finished products that they produce. They then set in place quality control
procedures. One of the procedures is commonly to take random samples and create quality
control charts that reveal how much deviation exists from the specification standards for a
product.

Understanding Quality Control Charts

Quality control charts can be created and used to examine either a single variable or multiple
variables related to the desired quality of a product or process. For example, a toy
manufacturing company may wish to use quality control charts to monitor
(1) the smoothness of the edges of the toy and
(2) the fit of the toy‘s packaging.

A quality control examination will use random samples of the population to be examined,
comparing actual specifications found in the collected samples to the stated, ideal
specifications. Typically, a quality control chart will show a centre line that represents the
ideal specification for whatever quality variable is being studied. The chart will also usually
include upper and lower quality control lines that represent acceptable, relatively insignificant
levels of deviation from the desired specification. Plotted on the chart will be the results of
random samples drawn for the quality control study.
As long as the samples show deviations that are only within the range bordered by the upper
and lower quality control lines, then that indicates good quality control, that products are
being produced with the desired level of uniform quality. It is referred to as being ―in
control.‖
However, if the results show many samples with plot points above or below the upper or
lower quality control lines, respectively, it indicates significant variation in product or
process quality that needs to be addressed. Wide variations from specifications indicate being
―out of control.‖
Uses of Quality Control Charts
While the use of quality control charts is most frequently associated with manufacturing
processes and manufactured products, they can be applied to many other things as well.
Following are some other potential applications for the use of quality control charts.
Employee Retention Rates
Finding, hiring, and training new employees is an expensive and time-consuming process for
a company. Therefore, it is to a company‘s advantage to retain good employees as long as
possible. A quality control chart can be constructed that compares a company‘s
actual employee turnover rate to its desired rate. If the chart reveals an excessively high
turnover rate, then the company can do further investigation to find the cause(s) of the high
turnover rate, and then make changes designed to reduce the rate.
Returns on Investments
Quality control can also be applied to examine returns on your investments, checking the
extent to which individual investments in your portfolio either outperform or underperform
compared to your expected investment returns.
Wide variations in investment results, either up or down, may indicate that your
current investment portfolio carries a higher degree of risk than the risk level that you are
comfortable with. Outperforming and underperforming investments can also be examined for
common characteristics that may help you identify future investments that offer a higher
probability of obtaining maximum profits.

E-commerce websites
Quality control charts can be used to monitor the processes and functionality of an e-
commerce website. For example, anyone engaged in such a business would do well to
monitor the number of instances where there is some type of glitch in the website‘s operation
that causes a customer to abandon the process of making a purchase. By monitoring the
quality of the website‘s operational performance, any problems or issues that arise can be
quickly addressed before they lead to a substantial decline in revenues.

Acceptance sampling
Let‘s imagine that a consumer receives some lots of products from a supplier. A sample of
parts from the lot is taken and the number of defective items counted, if there is. If the
number of defective items is low, the entire lot will be accepted, but if the number of
defective items is high, the entire lot is rejected. Deciding on accepting a good-quality lot and
rejecting a poor-quality lot is referred to in quality as acceptance sampling.
Acceptance sampling is a statistical technique utilized in quality control, allowing a
manufacturer to determine the quality level of a batch of products from a specific production
run by selecting a predetermined number for testing. The quality of the sample selected during
sampling becomes the quality level for the entire group of products.
The primary objective of acceptance sampling is to determine the quality level of a batch
with a specified degree of statistical certainty without having to test every single unit of that
batch. After completing the sampling exercise or testing, the manufacturer decides whether to
accept a lot or reject it based on how many of the predetermined number of samples passed or
failed the test.
The concept of acceptance sampling was originally applied by the U.S. military to the testing
of bullets during World War II and became very popular throughout that time and beyond.
The concept was developed by Harold Dodge, a veteran of the Bell Laboratories quality
assurance department, who was acting as a consultant to the Secretary of War.
Why Sampling?
Random sampling is conducted for the following reason:
Sensitive of Products: Comprehensive testing might damage the product or make it unfit for
sale in some way. An example is testing a food or pharmaceutical products. This is an
especially important point to consider when testing method is a destructive one.

Cost & Time: Inspecting too many products at a reasonable cost or within a reasonable
timeframe poses another challenge. Much time is spent in the course of testing and more
inspectors might be needed which amounts to more cost.
Cumbersomeness of Lot Size: It is practically unrealistic to test every single product of a
particular lot of very large size at the same time due to the level of cumbersomeness of the
batch which makes handling quite difficult.

Acceptance Sampling Methods

The following are two methods listed below:

Singular Sampling: This is the simplest which involves testing a single unit at random, per
say X units produced (sometimes called an (n, c) plan). The acceptance isthereafter evaluated
based on the number of defective units say, C, found in the sample size, say, N.

Multiple Sampling: This method involves multiple sampling, which relies on severalsuch (N,
C) evaluations. This method of sampling is more costly, but may be more accurate.

When Acceptance Sampling should be used

Since acceptance sampling relies on statistical inference made from a small sample, thus not
as accurate as more comprehensive measures of quality control, it should only be used when
so many products are made that are impractical to test a large percentage of its units; or when
inspection of a unit would result in its destruction or render it unusable.
Material Requirements Planning

Material requirements planning or MRP is a computerized system that allows manufacturers

to plan, manage, and control their inventories more efficiently. It, thus, helps them schedule
the manufacturing per bills of materials and deliver the right product at the right time and the
best possible price.
This manufacturing decision-making process compares existing raw materials and
components required to produce goods with the production capacity based on the demand
forecasts. Besides helping understand inventory levels, the system lets producers optimize
labor requirements. Its purpose is to enhance the productivity of a business and reduce
superfluous inventory while maintaining the supply-demand cycle.

Examining existing inventory levels and the manufacturing capacity of a unit is critical to
production. The first stage in the process is to determine what to manufacture to develop the
inventory. MRP then examines the current market demand to determine the volume. The next
step is to figure out quantities of raw materials and components required to produce finished
goods. Finally, the unit plans the production (based on the bill of materials), cost, and
delivery of products. Overall, it leads to efficient production and inventory optimization
while satisfying the demand.
MRP Inputs, Objectives, And Benefits
Material Requirement Planning Examples

Let us consider the following material requirements planning examples to get an in-depth
insight into the concept:

Example #1

Sharon, the proprietor of a clothing store, creates and sells a wide range of clothes. In a short
time, her shop became well-known among the local ladies. However, when she began
accepting online orders, operating the store became more difficult. Despite her best efforts,
she could not deliver the products on time as she struggled to keep track of the demands. As a
result, she produced more similar clothes based on the variety of demand resulting in excess
production and further losses.

Her friend Lisa, who was more into using technology to solve business challenges, suggested
using the material requirements planning system. Sharon did so and prepared a bill of
materials to understand the type, quantity, and delivery time. The computerized system did all
computations and let her know how to maintain the demand and supply chain.

Example #2

MRP enables firms to make well-informed decisions about inventory management,

production planning, and delivery of finished goods. Using an outdated system, however, may
cause manufacturing issues during supply chain disruptions.
For instance, the COVID-19 epidemic halted the import of raw materials and components,
affecting the manufacture of products worldwide. As a result, manufacturers have little
choice but to switch to advanced software or integrate modern functions to deal with such
incidents. One method is to optimize raw material management and leverage diverse systems
to cut costs while developing responsive supply chains.

Pros and Cons

Here are a few advantages and disadvantages of the material requirements planning process:

Pros

Assesses the volume beforehand

Balances the demand and supply chain
Enhances the productivity
Guarantees customer satisfaction
Helps in product customization
Maintains inventory levels
Turns complex manufacturing processes into simple
Minimizes overhead costs
Delivers products on time
Prevents wastage of inventories and stocks
Provides a time estimate for production and distribution
Reduces lead timesCons
Expensive to deploy and complicated to use
Incorrect data can provide inaccurate demand estimate
Needs proper training and regular maintenance
Requires accurate data
Wrong inputs can delay production and shipment

What are the basic steps of MRP?

The basic steps of MRP are as follows:
Determining the product type
Calculating demand and setting volume
Identifying required raw materials and components
Checking existing inventory levels
Examining the manufacturing capacity
Planning production
Scheduling delivery

How does MRP help?

MRP assists the producer in analysing several parameters to develop demand forecasts. It
enables a company to understand the type and quantity of a specific product, estimate
inventory, schedule manufacturing, and ensure that finished goods arrive at the appropriate
location at the right time and at the lowest possible cost to meet the market demand.
Lot sizing procedures: The material planner (who is the person in charge of placing the
order) must decide how large the order should be, as placing numerous orders each month
could be very costly as well as inventory holding costs. Their decision should be made to find
an appropriate trade-off between the costs to find a viable financial solution. This
optimization problem is called ―lot sizing‖. As more and more constraints are added to the
equation such as quality control or perishability, it becomes quite thorny. In this article, we
will present how lot sizing is done as of today and review the lot sizing techniques available
to industrial companies to plan their purchases of raw materials and components.

Material Requirements Planning: the first step before computing lot sizes

Determining adequate lot sizes is needed to maintain acceptable inventory and service levels.
Minimum order quantities demanded by suppliers often blow-up inventory levels especially
for items with long inventory turn cycles. To determine the lot size that will minimize the
costs, industrial companies use Materials Requirements Planning (MRP).

Materials Requirements Planning (MRP) is a software-based solution used by every

Enterprise Resources Planned (ERP) system whose purpose is to:

Ensure the availability of materials, components, and products for planned production and for
customer delivery, Maintain the lowest possible levels of inventory, Plan production, delivery
schedules, and purchasing activities.

MRP is especially suited for manufacturing environments where the demand of many
materials and components depends on products with external requirements.

Demand for end products is independent.

Demand for components depends on end products, which is why we call it dependentdemand

The three major inputs of an MRP system are:

the master production schedule, which expresses how much of each material is required and
when it is required the product structure records, also known as the Bill of Material Records
(BOM), contains information on every item or assembly required to produce the end products
the inventory status records which contains the status of all materials in inventory After
running the Material Requirements Planning, industrial companies know the following:

What items are required for the production

How many of them are required?

When are they required (i.e. when they will be consumed in production)

However, they must now decide when to order what quantity of the desired material in order
to minimize costs, which is when lot sizing comes into the equation.

2. What are the different methods applied to determine optimal lot size?

The different lot sizing techniques implemented across industrial companies can be
categorized into static, periodic, or dynamic. Static lot sizing consists of placing a fixed order
quantity or ordering exactly the amount that is needed to cover forecasted
demand. Periodic lot sizing groups together the requirements that lie in a determined period.
For dynamic lot sizing, the cumulative forecasted demand throughout the entire time horizon
is taken into account to determine the optimal order quantities. As time progresses and the
production requirements for the new time horizon adjusts, the previously developed planned
orders might be adapted.

Static lot sizing procedures

Static lot sizing methods consist of ordering a fixed quantity or the exact number of
requirements for the date needed.

Fixed Order Quantity: This method involves ordering a fixed quantity when the reorder point
is reached. The quantity often depends on the supplier-specific constraints.
Economic Order Quantity: This formula was developed in 1913 by Ford W. Harris which
results in an order quantity that minimizes the total holding costs and ordering costs.
The formula is the following: Q= (2DS/H)0,5where:
Q = Quantity to be ordered
D = Demand in units (typically on an annual basis) S = Order cost (per purchase order)
H = Holding costs (per unit, per year)

Lot for Lot (L4L): It consists of ordering the exact amount that matches the net requirement
for each period.

Single Lot: It entails ordering the total requirement for the defined period in one go.

Static lot sizing procedures are easy to automate but do not provide much flexibility as a high
demand variability could result in high inventory holding costs. The Lot for Lot procedure
stands out as an exception as inventory is minimized which on the other hand results in
extremely high ordering costs.

Periodic Lot sizing procedures

Periodic lot sizing groups several requirements within a time interval together to form a lot.
Periodic lot sizing procedures are effective when used with cheap items when inventory costis
low.
Period of Supply (POS): A period of supply such as 3 weeks is specified, for which the net
requirements across that period are ordered together each time.

Period Order Quantity: It consists of applying the EOQ model to a subset of the entire period
under consideration at a time, where the demand is translated into the average requirement of
each subset period.

Dynamic lot sizing procedures

Dynamic lot sizing considers the effect of cumulative needs across time to determine the best
order quantities. As time advances and new production requirements for inbound materials
are known, previously developed planned orders may end up changing. This could also be the
result of forecast variability.

In the examples for each technique provided at the end of this article, we oversimplify the
situation for ease of comprehension, by assuming perfectly forecasted requirements which in
reality is often not the case.

Least Unit Cost (LUC): An order size is determined such that the demand for the next ―n‖
periods will be met, where ―n‖ minimizes the average cost per unit.

Least Total Cost (LTC): In this heuristic technique the optimal solution corresponds to the
order plan where the order costs approximate the carrying costs.

Part Period Balancing (PPB): This method represents a variation of the LTC approach. It
converts the ordering cost to its equivalent in part periods, ―the economic part period (EPP)‖,
by dividing the ordering cost by the cost of carrying one unit for one period. When ―the
cumulative parts period‖ which corresponds to the excess inventory x the number of weeks
that it is carried, exceeds the EPP, we take it as the optimal lot size.

Silver Meal (SM): Silver and Meal developed this heuristic in 1973, which determines the
average cost per period. It first considers a lot that covers the demand for a period and
calculates the costs. It then increases the lot size to cover the requirements for another period
and calculates the average cost for that period. One period is added at a time until the average
cost per period increases, after which the process stops.

3. How lot sizing optimization should be done today?

Many could think it would make more sense to only apply dynamic lot sizing procedures as
static and periodic procedures allow a lower level of flexibility resulting in unnecessary high
levels of inventory or too many orders.

Still, many industrial companies continue to use static and periodic lot sizing techniques like
EOQ because of their simplicity to implement, although supplier constraints such as
minimum order quantities or rounding values are not considered in the original formula. This
implies that an optimum is difficult to reach, especially in terms of costs, resulting in
financial hidden losses tied in the order planning processes (Nydick 1989).

For dynamic lot sizing techniques, every method could perform well depending on the
environment and type of material (Collier 1980). Some methods still managed to stand out as
academic studies have shown that the Silver Meal (SM) represents the best trade‐off between
cost‐effectiveness and robustness (Jeunet 2000) and the Wagner Whitin (WW) algorithm
performs best for the dynamic lot sizing problem and is often used as a benchmark for simpler
heuristic techniques (Baciarello 2013, Beck 2015).

However, if these methods perform well in academic studies, there are some clear real- world
limitations, as for example, the Silver-Meal is not easily expandable to include real- life
constraints such as minimum order quantities or multiple quantity discounts (Benton 1996).
Furthermore, the Wagner Whitin (WW) algorithm is not used in practice as it is not available
on ERP systems due to its complexity and difficulty to implement (Bahl 2009).

Given the increased adoption of data analytics into business decision-making, the problem
has to be solved algorithmically in order to realize substantial savings as it allows for more
flexibility to integrate all the constraints relative to the complex lot sizing problem (Kulkarni
2019). The UMSOPQVAD provides good results integrating most supplier constraints but
requires a high level of data requirement in order to perform well and does not consider
material perishability

Project management

Project management is the use of specific knowledge, skills, tools and techniques to
deliver something of value to people. The development of software for an improved
business process, the construction of a building, the relief effort after a natural disaster,
the expansion of sales into a new geographic market—these are all examples of
projects.

All projects are a temporary effort to create value through a unique product, service or result.
All projects have a beginning and an end. They have a team, a budget, a schedule and a set of
expectations the team needs to meet. Each project is unique and differs from routine
operations—the ongoing activities of an organization—because projects reach a conclusion
once the goal is achieved.
The changing nature of work due to technological advances, globalization and other factors
means that, increasingly, work is organized around projects with teams being brought
together based on the skills needed for specific tasks.

THE 5 STAGES OF THE PROJECT PLANNING PROCESS

The life cycle of a project has five stages.

Stage 1: Visualizing, selling, and initiating the project

An effective way to get buy-in for a project or idea is to link it to what is important to the
person or group you are approaching and demonstrate that you are openly soliciting their
input. By doing so, they can help shape the concept.

Stage 2: Planning the project

Assuming the project concept and feasibility have been determined, the plan-do-check-act
(PDCA) cycle (see figure below) is directly applicable to project planning and management.

Stage 3: Designing the processes and outputs (deliverables)

When the project is approved, the project team may proceed with the content design along
with the persons or items needed to implement the project.

The design process includes defining:

Measurements
The monitoring method
Status reporting protocols
Evaluation criteria
Design of the ultimate processes and outputs
Implementation schedules

Stage 4: Implementing and tracking the project

The project design team may also implement the project, possibly with the help of additional
personnel. A trial or test implementation may be used to check out the project design and
outputs to determine if they meet the project objectives.
Result.
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results may also be communicated to interested parties. The implementation team makes any
course corrections and trade-offs that may be necessary and are approved.

Stage 5: Evaluating and closing out the project

The implementation team officially closes the project when the scheduled tasks have been
completed.

Usually evaluations are done to determine:

Objectives met versus objectives planned

Actual tasks and events scheduled versus planned
Resources used versus planned resource usage
Costs versus budget
Organizational outcomes achieved versus planned outcomes; any unplanned outcomes
Effectiveness of project planning team (optional)
Effectiveness of implementation team (optional)
Team‘s compilation of project documents, evaluations, and lessons learned

The project is then officially closed out. Participants are recognized for their contributions,
and the team disbands.

For some projects, many organizations find value in a post-implementation assessment of the
outcomes achieved from implementing the project. This may occur several months after
project completion.

PROJECT OUTPUTS VS. OUTCOMES

Frequently the project management terms ―outputs‖ and ―outcomes‖ are used as if their
meanings were interchangeable; however, they are not.

Outputs are defined as what the project produces. Project outputs may be an improved
process, installation of a new machine, a benchmarking study, etc. Outputsof the project team
process itself may be project plans and supporting documents, status reports, and the like.
Outcomes are defined as the effects that the implementation of the project has on the overall
organization and should support the strategic direction of the organization. Outcomes may
consist of measurable improvements in customer satisfaction, profits or cost containment,
improved market position and market penetration, etc. For ease of understanding, outcomes
are usually expressed as dollar values.