• 104 05/12/2020

    A stock purchase agreement is the primary transaction document for a stock acquisition. The purpose of the stock purchase agreement is to confirm the price paid for the securities sought, to control risk to the degree possible and to provide a roadmap for the hold period. 

    The two most important variables in any investment are price and risk. It is said that the best way to control risk is through price, but that assumes you know precisely what you are buying and how you are protected in the event that there is a misrepresentation about the assets acquired or liabilities assumed. 
    For this reason, the bulk of this document deals with identifying variables that could put the investment at risk, and detailing how the parties can protect themselves in the event that they are exposed to loss. Beyond price, parties should be aware of three primary concepts:
    1. Representations and Warranties
    2. Covenants
    3. Indemnification
    As the PDF available for download will explain, these three items focus on the assurances and promises made so that the parties can comfortably enter into a transaction, and the protections available to them in the event of a breach.
    PDF Commentary:
    The purpose of this document is to provide an outline of the stock purchase agreement with some context to make the document easier to digest. 
    On the pages that follow, each primary section of the purchase agreement (referred as an article) will be introduced with simple language (no legalese). Beneath each introduction you will find links that provide additional detail on the article described (this portion of the document is a work in process; more links will be added in the future). 
    This approach facilitates an introduction to this document in as few as five pages. It also provides a framework that can be revisited when a particular topic or concept requires review without having to navigate a dense legal document.  

  • 103 05/05/2020

    Interest expense is a period expense, so it appears in each period on your income statement in a financial model. Per most credit agreements, however, interest is only paid on a quarterly basis. Consequently, in a monthly financial model you will have periods with interest expense on the income statement without a corresponding cash outflow for interest paid. (Template available for download at the bottom of this post.)

    To reconcile this timing difference, add a line item titled “Accrued Interest” to you balance sheet under current liabilities. This will pull from the supporting debt schedule, which will be amended as follows. First, add three line items just below the formula for Ending Principal Balance:

    1. Interest Expense
    2. Interest Accrued
    3. Interest Paid

    Interest Expense in a Monthly Financial Model

    Next, calculate interest expense for each period (see image). This will be similar to the approach used to project interest expense in a model with annual periods with two exceptions:

    1. There is no need to take an average of the principal balance.
    2. The interest rate needs to be adjusted to reflect the period of time.

    Interest Expense in a Monthly Financial Model

    Then calculate interest accrued on the line that follows. This is the line item that will link to the balance sheet to project accrued interest. To complete this calculation sum interest expense in the current period with interest accrued in the previous period, and then subtract interest paid in the current period (see image).

    Interest Expense in a Monthly Financial Model

    Finally, in the last step related to the debt supporting schedule, we will calculate interest paid using the =IF() and =MOD() functions. The =MOD() function is a great way to confirm if the month is divisible by three, which makes it easy to identify a quarter (=MOD() video explanation). When the formula identifies a quarter end period it will return the sum of the previous three months of interest expense (see image). 

    Interest Expense in a Monthly Financial Model

    Interest expense will link to the income statement in precisely the same way it does in an annual model, and now the Interest Accrued line item can link to Accrued Interest on the Balance sheet. 

    Interest Expense in a Monthly Financial Model

    The final step is to add a line item to the cash flow statement under changes in working capital. Title it “Accrued Interest” and subtract the current period from the prior period to reflect a cash outflow when the current balance declines from one period to the next. 

    Interest Expense in a Monthly Financial Model

    You may notice that the cash outflow on the cash flow statement is equivalent to -$25,000 in period 3/31/2021, which does not match interest paid of $37,500 on the debt schedule. This is due to the fact that $12,500 of interest expense is included in net income, the first line on the cash flow statement. 

    Download: Link to Monthly Three Statement Model Template

    Note: FASB requires that this sum be included in cash flow from operations. It should never be included under cash flow from financing activities. 


  • 102 05/04/2020

    The most common error I see in financial models as it relates to growth rates is to divide an annual growth rate by 12 to arrive at the monthly growth rate. In this post we will explore the correct way to convert growth rates for all periods.

    There is also an Excel template available for download that will make this calculation for you so that you can check your math (the calculator will apply the conversion to annual, quarterly and monthly periods).

    The correct approach is to apply exponents, and we can explain why this is the correct approach with a simple explanation. When a value grows by 5% from one period to the next you multiply the value by 1.05. If this were to occur for 12 consecutive periods the multiplication pattern would repeat.

    The simplest way to explain this is to solve for the value that when multiplied by itself 12 times returns (1 + the Annual Growth Rate). So for an annual growth rate of 5% we would take the approach that follows.

    Convert Annual Growth Rate to Monthly Growth Rate

    And since we are solving for (1 + Growth Rate), we subtract 1 from the outcome:

    Convert Annual Growth Rate to Monthly Growth Rate

    Formulas for Each Period Follow:

    Annual To Monthly: (1 + Growth Rate)^(1/12)-1

    Annual to Quarterly: (1 + Growth Rate)^(1/4)-1

    Quarterly to Monthly: (1 + Growth Rate)^(1/3)-1

    Quarterly to Annual: (1 + Growth Rate)^(4)-1

    Monthly to Quarterly: (1 + Growth Rate)^(3)-1

    Monthly to Annual: (1 + Growth Rate)^(12)-1


    Convert Annual Growth Rate to Monthly Growth Rate



Models are:
A) really boring
B) pretty sweet
C) super important
D) somewhat easy
E) kind of hard
F) fun
G) all of the above



*Answers a, b, c, d, e, f and g are all correct.