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Part One
Developing Corporate Finance Models
Chapter 1
Introduction
1.3.1 Step 1: Defining the Problem the Model Will Solve: The Fundamental Business Question

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Financial modelling is used, as we mentioned previously, in order to solve various problems. The first step of the process includes teams or individuals asking the right questions at the start of the problem-solving process. This is sometimes hard to believe as it often seems that people are trying to solve a problem before they have properly defined it. Asking the right questions helps break down the problem into simpler constituents.

For example the commercial manager of the company requests the financial analyst to present the impact on the bottom line results of the company of a New Product Development (NPD). Let us say that the costs of the whole NPD process are available and can be largely funded through government subsidy. In order to tackle the problem the financial analyst needs to ask the following questions:

1 What will be the forecast sales volume of the new product per year?

2 What will be the unit price?

3 What will be the credit terms?

4 What will be the inventory needs of the product?

5 What will be the payment terms of the suppliers of the raw materials?

6 What will be the incremental variable and fixed cost per year for the proposed production?

7 When is it anticipated that the governmental subsidy for the initial investment costs will be received?

The problem, then, can be broken down as per Exhibit 1.2:


Exhibit 1.2 Breaking down a business problem into simpler constituents


Financial Forecasting, Analysis and Modelling

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