Hi Financial Modeller,

Circular reference issue in building a financial model is widely known, especially when it comes to interest expense and debt balance.

If we search the key word: “to resolve circular reference in financial model” on Google and Youtube, we will find many financial modelers develop many ways and teach us on how to resolve this issues, including using Macro and/or build a UDF.

I could say, this is totally WASTE OF TIME. We don’t need them all, and the whole this effort is not necessary, if in the projection, for example, for interest expense and debt, we include the projection/forecast about WHEN the debt will be paid during the year.

If there is people saying that we can’t forecast that, then I will ask BIG why? How come we boldly forecast other stuffs into 5-7 years but when it comes to when the debt will be paid during the year, we said, we can’t? Sound quite inconsistent.
Once we project the timing of the debt repayment, then we don’t need all those stuffs to kill the circular reference. The idea is CASH FLOW statement should be resolved first, before we are going to build the BALANCE SHEET.
In real business and corporate finance, there is NO SUCH THING called CIRCULAR REFERENCE. This is LOGICAL ERROR. Talking about business, it is really about CASH FLOWS, and then CASH FLOWS drives everything in the business. Since mostly CASH FLOWS come from mainly, in normal activity, core business-related activities, from revenues, then INCOME STATEMENTS is the first focus by the financial modelers. And INCOME STATEMENTS will give the business, either positive cash flows or negative cash flows along the way.
What is then IMPORTANT, build the CASH FLOWS as much as we can. In this Cash Flow Statement projection, we should forecast, amount, timing, etc. about all accounts related to balance sheet, as much as we can from gathering the data and management expectation.
Once CASH FLOWS resolved, then we should not have the circular reference to resolve.
Hope this helps.
Jakarta, October 2019

Leave a Reply

This site uses Akismet to reduce spam. Learn how your comment data is processed.