Financial Analysis with Microsoft Excel

Timothy R. Mayes and Todd M. Shank

Published by Dryden Press ISBN: 9 780030 155024

Reviewed by Marjory Forbes and Brian R Doughty

Department of Finance and Accounting
Glasgow Caledonian University

Introduction
The purpose of the book is to integrate financial management and Excel spreadsheet
techniques by encouraging student thinking rather than providing pre-built templates.
The Preface provides background to the use of spreadsheets in the business world. The
text is written for Excel 7.0. No difficulties were encountered when testing with this
with Excel 5.

This is intended to be a supplementary not a primary text and is similar to an

Introductory Financial Management textbook. However, the authors see the depth of
the book on the financial management side as providing potential for use as a primary
text. Emphasis is placed on the self-teaching approach and concentration on the
interpretation of results. Particular mention is given to statistics and management
science tools in this respect, and it is assumed that students will have familiarity of basic
accounting and statistics. The chapters are progressive in terms of financial
management content, and contain objectives and summaries.

The authors anticipate that more interest can be generated from using this book with its
self-teaching/self-paced approach than from a traditional lecture. This is especially true
in the case of non-finance students. The intended audiences are students on first year
undergraduate financial management courses, first year MBA courses, or any course
which is case-oriented with extensive use of spreadsheets

The book begins by introducing spreadsheet basics and moves on through Basic
Financial Statements, Cash Budgets to Capital Budgeting and its attendant risks. Each
chapter is preceded by a list of learning objectives with a summary of the major Excel
functions being discussed at the end of each.

Spreadsheet Basics including mathematical operators and order of precedence are

covered in Chapter 1.

The techniques used to Format Charts are possibly “too heavy” for Spreadsheet Basics
but nevertheless, the principles explained are common to many facilities in charting.
Unfortunately, the instructions leave the reader with a chart dissimilar to the exhibit, in
terms of formatting, and without direction as to how to change it.

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The reader will have spent much time in developing the worksheet before instructions
on saving are given. These should have been placed much earlier in the text to provide
the reader with the opportunity of saving his/her work and coming back to it a later
time.

Conclusion on the Basics

There are many good examples in this chapter which are spoilt by a few inconsistencies
and incomplete instructions. The authors claim that “Programming requires the student
to ... confront many issues...” and that “...the book concentrates on spreadsheet building
skills ... to think and understand”. It is believed that some of these confrontations at
this basic stage will unnerve many students who will be unsure of what to do next
particularly when the instructions do not quite lead them where they expect to be. The
chapter would be good value in a supervised class with the tutor overriding these
problem areas.

The contents of the later chapters are summarised below.

Beyond the Basics

The Basic Financial Statements, Income Statement, Balance Sheet and Cash Flow
Statement using Exhibits as references are built. This requires students to produce an
Income Statement, Balance Sheet and Cash Flow statement. The chapter is well written
introducing students to the essentials of these reports. However it does not address the
issues of terminology. For example, the Income Statement can commonly be referred to
as the Profit and Loss Account, Accounts Payable as creditors and Accounts receivable
as debtors. No definition of these terms is given, regardless. Fiscal Year may also be
termed Tax Year. There is an assumption that students have a familiarity with these
concepts and others e.g. depreciation methods, breakdown of cost of goods sold.

The Cash Budget

The cash budget is described and its use in the planning of short-term borrowings and
timing of expenditures is emphasised. The example used is well stated with the
exception that the opening balance is not given as an assumption at the start and is only
“discovered” in the course of completing the chapter. The problems associated with
determining the short-term borrowing are addressed and consideration is given to
using the cash budget for timing large expenditures.

The chapter develops to cover adding of interest and investment of excess cash, and the
calculations for cumulative investing/borrowing and cumulative interest
income/expense are explained adequately.

The student is not told to adjust the formula for unadjusted cash balance and ending
cash balance to reflect the effects of short-term interest income/(exp.) and Current
Investing. It is most unlikely that novices would be able to resolve this difference on

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their own, making a self-teaching approach difficult. Integration could be better in this
section too.

The problem associated with determining the short-term borrowing is addressed and
the spreadsheet solution of using a logical test (IF statement) to calculate this is
introduced. The description of this statement would probably need some further
explanation and it is likely that only the better students will grasp this immediately.

The chapter on Evaluating Performance with Financial Ratios explains the purpose of
ratios and who would use them. The categories covered are liquidity, efficiency,
leverage, coverage and profitability ratios. Examples are based on the workbook
created for Chapter 2, Basic Financial Statements.

The contents in this chapter are well presented and the explanations and examples are
appropriate. The last section interprets the various ratios to give a company profile.
This involves trend analyses and comparison with industry averages. It stresses that no
ratio can be taken in isolation and that the whole topic is very subjective. A useful ratio
formula summary is given at the end of the chapter.

As far as the Excel implementation is concerned, this is a well presented chapter

although inconsistency between text and illustration again prevailed. Care with the
instructions is also necessary.

Financial Forecasting
Again, progression and integration is achieved by use of the workbook created for
Chapter 2, Basic Financial Statements. The Percent of Sales Method is used for
forecasting of the income statement, forecasting assets on the balance sheet and
forecasting liabilities on the balance sheet.

When forecasting liabilities, current liabilities, long-term liabilities and owner’s equity
are reviewed. Spontaneous sources of financing and discretionary sources of financing
are then introduced. After the forecasting example the balance sheet does not square
and this is used to indicate to the student the need for discretionary financing.

Other forecasting techniques covered are the Trend function, regression analysis and an
assessment of risk by calculating a firm’s beta coefficient using regression analysis. This
section on Linear Trend Extrapolation uses Excel to determine a sales forecast based on
certain mathematical procedures. Students are asked to enter historic data to a new
sheet and then prepare an XY chart. The resulting chart gives rise to a need to
determine a linear trend. The Excel function TREND is used to do this. The student is
then taken through the stages of using Excel to insert the trendline on the chart,
including displaying the straight line equation which Excel generates!

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Regression Analysit is handled without any mathematical exposition. Using a file
supplied by the authors, the student can, with care, create a scatter plot using the chart
wizard. A few anomalies were encountered. The student is invited to enter the
regression line on the chart.

Break-even and Leverage Analysis

This chapter considers decisions that managers make regarding the cost structure of the
firm which in turn impact on methods of financing the firm and pricing the firm’s
products. Variable and fixed costs are introduced and are presented graphically.
Break-even point is defined specifically as the unit sales required for earnings before
interest and taxes to be equal to zero i.e. operating break-even point. A simple example
is given in which the contribution margin per unit and percentage is introduced. The
example lends itself to “what if” questions but this is not provided and would assist in
emphasising interpretation skills.

Other Break-even Points covered are the sales units required to earn a given level of
income before interest and tax, but is not really a break-even point. A cash break-even
point is also calculated by eliminating any non-cash expenses from the fixed costs,
notably depreciation. Nothing is required in Excel at this stage but some
implementation might have enhanced integration.

Under Leverage Analysis Business Risk and Financial Risk are defined before
calculations are performed for the degree of operating leverage, the degree of financial
leverage and the degree of combined (Total) leverage for Spuds and Suds, (i.e. not the
original workbook).

The Time Value of Money

This looks at general formulas for future value and present value of a single amount, for
annuities and the NPV and IRR for streams of uneven cash flows. The problem of non-
annual compounding periods is mentioned. The inverse nature of the relationship
between FV and PV is stated. There is a good manual example of annuities and the
distinction between regular and deferred annuities is made. NPV is well covered.
However, PVF or FVF components of formula are not highlighted and there is no
mention of financial tables which students could use to check figures manually.
Discounting, and opportunity costs are not explicitly defined. At times, the terms
discount rate and interest rate are used interchangeably but this convention is not
explained.

In solving for ‘yield’ in uneven cash flow streams, an illustration of manual calculation
would prove useful. The theoretical weaknesses of IRR are inadequately covered, but is
elaborated on in the Chapter on Capital Budgeting.

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The section on non-annual compounding periods is short on manual examples and
answers to calculations are not given for students to receive feedback on their
understanding.

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Valuation and Rates of Return
The concepts of value, risk-return trade-off and CAPM, share valuation and bond
valuation are dealt with and in general the chapter explains the material very well.
However, definitions are lacking at times e.g. time to maturity, beta, principal, par
value. Value Line is not explained. With respect to share valuation, it is not totally clear
which formulas are the Constant Growth Model and which are the Gordon Model.
However, manual examples of the Gordon Model are very clear. There is a good
discussion on how to convert terms from annual to semi-annual for bond valuation.

Self-teaching for this chapter may prove difficult due to the challenging nature of the
topic. Once again, problems exist which have occurred in earlier chapters and are
largely avoidable - such as incorrect range details, no use of function wizard and
incomplete instructions.

The Cost of Capital section includes hurdle rates, WACC and its components, marginal
WACC and flotation costs. This chapter is well covered, and uses a new set of examples.

Capital Budgeting
This chapter covers payback, discounted payback, NPV, PI, IRR and MIRR along with
sensitivity analysis and producing an optimal capital budget. Overall, this chapter
covers the theory well, using Supreme Shoe Company as the illustration.

Under NPV, it is stated that all positive NPV projects must be accepted, which is correct
if there is no capital rationing, but this assumption is not stated at this point in the text.

Risk, Capital Budgeting and Diversification

This the final chapter and uses a new set of data viz. the Freshly Frozen Fish company.
Statistical concepts are reviewed e.g. continuous and discrete probability distributions,
expected values, variance/standard deviation and risk-adjusted discount rates,
portfolio risk, return and diversification. The chapter focuses on populations where the
distribution is discrete and known, but alternatives for samples where probability
distribution are unknown are referred to. Complex theory and formulas are presented
well.

Certainty equivalence is reviewed, and Decision Trees and Monte Carlo Simulation are
covered although not requiring Excel work. Again, it is assumed students know the
basics and some areas could provide more explanation e.g. Finding the NPV form
Decision Trees, and definitions e.g. utility function, diversification (it is defined, but at
the end of the chapter).

In the Excel models some assumptions/explanations regarding formula would help.

Having said that, in places, the Excel instructions might help some students understand
the finance theory more easily.

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Conclusions on FAME
Financial Management coverage was comprehensive and progression was achieved.
The extent of interpretation was appropriate. Overall the integration of financial
management concepts with Excel skills worked well.

The book is appropriate for its intended audience. However, if the audience includes
non-finance students but with the assumption that these students will have a basic
knowledge of accounting and statistics, then these students may need greater assistance
when working through the book.

On occasion, American terms are used without footnotes to provide English

equivalents. Footnotes could also have been used for definitions or references which
are assumed to be known by the student.

Some chapters do take two to three hours to complete and any course would need to
allow time for this when integrating the book into an existing programme.

It is recommended that the book it is suitable as a supplementary text, with tutor

support, as students may have difficulties using it as a primary text on a self-taught
basis.

Marjory Forbes and Brian R Doughty

Department of Finance and Accounting
Glasgow Caledonian University