Before joining the KPMG Australia valuation team, Ruby Liu has over 11 years of commercial and training experience from a statistics tutor at the University of Queensland, an authorised trainer for project finance courses, head of KPMG Sydney modelling team, to head of corporate finance at TransGrid.

Her experience covers financial model build and audit, corporate finance, project finance, and infrastructure valuation.

She is currently committed herself in infrastructure value enhancement and joined the KPMG Australia valuation team. She is keen to help her clients to further understand key value drivers of their assets and improve both value growth and dividend yield.

WHY DID RUBY SELECT THE TOPIC AND WHY IS SHE PASSIONATE ABOUT IT?

Through my career I have seen many companies continue to use the acquisition (deal) model as their operational model post financial close. This is not the correct purpose for which it was built in the first place, and can potentially create a significant risk of errors.

The “re-purposed” models ultimately cause internal frustrations and even incorrect management decisions into the future.

I am therefore taking this opportunity to share my views on the differences between models created for a particular transaction (“Deal Model”) and ones used in an ongoing manner for business operations and management (“Operational Model”), with the goal of encouraging robust discussions of this topic and improving the usage of both model types.

TOPIC AND CONTEXT IN NO MORE THAN 3 SENTENCES

It is important to understand the differences between a Deal and Operational Model, as they are fundamentally designed to meet two different purposes.

As such this article seeks to answer the questions:

(i)               What is a deal model;

(ii)               What is an operational model; and

(iii)              When and how should each be used.

IF YOU HAD TO TEACH THIS TOPIC IN A CLASS TO SCHOOL KIDS WHAT KEY TIPS WOULD YOU GIVE THEM TO FOCUS ON

Before one tries to understand when and how two tools should be applied in practice, it is important to fully understand the purpose of the tools and the design logic behind them.

What is a Deal Model?

A Deal Model is designed specifically for a transaction. The purpose of the model is to represent the performance forecast of a project, a company, or a portfolio of assets in a “simplified” version, which then assists management in making an informed investment decision at a point in time.

A Deal Model usually has the following characteristics:

• Is designed to be (at least should be) used for a singular transaction – i.e. to facilitate a particular transaction to reach a financial close;

• Will be amended multiple times within a short timeframe (both functional and structural changes during the negotiation process of a deal);

• Will be more focused on cash flows primarily instead of accounting treatment or how the numbers will be presented or disclosed in balance sheet; and

• Are often audited as Investment Committee, Banks, and sometimes governments will rely on the model audit report to ensure the model’s integrity.

What is an Operational Model?

An Operational Model is designed for a business to manage its ongoing operations where they make either tactical or strategic decisions.

An Operational Model usually has the following characteristics:

• Will be used repeatedly by the company’s internal finance team on a regular basis for example monthly, quarterly or annually;

• Will be amended multiple times within a long timeframe (driven by changes within the business or reporting requirements from the Boards);

• Will be focused on both cash and accounting; and

• Are often unfortunately not audited independently and left to the internal teams to ensure a “peer” review is undertaken at the very least. In some cases, even a peer review is not done until a material error is identified, then an independent model audit might be called upon when it is often either too late or in a panic.

WHAT PRACTICAL STEPS CAN PEOPLE TAKE NOW TO LEARN MORE

Now we understand the key differences between a Deal Model and an Operational Model, we should ensure each type of model is used for its designed purpose.

Based on my experience, almost every Deal Model will be amended many times during a transaction, and it is difficult to determine how that change will manifest at the outset of the transaction. Therefore, the modeller should try to allow maximum model structural flexibility at the beginning of the build.

In addition, although practitioners tend to focus more on cash flows analysis, accounting is still important in a Deal Model. The level of detail is not required to the extent that we need to cross check with the accounting standards, but the balance sheet MUST balance as an integrated three-way financial model (which is included in almost every deal model).

Regarding an Operational Model, the first focus in my opinion, should be aligning the business to reality as much as possible.

In my experience often Deal Models are used as Operational Model post the transaction and include outdated business assumptions or cash flows waterfall logic.

Those models could provide incorrect analysis, which causes inaccurate strategic decision making.

Therefore, it is important to consult internal finance teams and other key stakeholders before developing an Operational Model in order to understand:

• The purpose of the model whether this be for simply tracking purposes, scenario and what-if analysis, for meeting any bank covenant, or board reporting requirements;

• Who is responsible for the maintenance and review of the model on a regular basis;

• What is the current business situation the model tries to represent and how this might change;

• What internal control procedures are in place to ensure that the model remains both accurate and fit for purpose; and

• What are the required model outputs?

Unlike developing a Deal Model, it is critical to do a detailed model specification before building an Operational Model.

WHERE ARE GOOD PLACES (LINKS) TO FIND OUT MORE ON THE TOPIC

We have found that there are very few discussions on the differences and uses of the Deal and Operational Models, which is one of the reasons we chose this topic. It would be good to hear from others who can contribute to the conversation.

HOW IMPORTANT IS THIS SKILL IN THE CONTEXT OF LEARNING FM?

Deal and Operational Models are two of the most commonly used financial models in business today. Understanding both of these models and their purpose will help people better utilise the skills and models for enhanced decision making and value creation.

HOW DOES ALL THIS DISRUPTION, AI AND AUTOMATION TALK IMPACT THIS TOPIC

I personally do not think the current technology disruptions will impact the deal modelling. In a deal environment, bespoke analysis is needed to be completed quickly where the structure can change overnight.

Excel is still the best software for developing Deal Models due to its flexibility and affordable initial cost investment – i.e. I cannot foresee a consortium investing $1m in an artificial intelligence (“AI”) or sophisticated business intelligence (“BI”) system for an early feasibility assessment of a potential investment opportunity.

On the other hand, operational modelling could be impacted by the current evolving technologies (e.g. AI, machine learning, and automation).

Excel still has strong advantages compared to other BI software, but I can see large Operational Models being transferred into different BI systems, especially those that need to process large datasets (e.g. daily transactions, etc.).

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