Convergent Financial Models

Overview

When a financial forecast is performed, the excess income or loss is either assumed to be returned to the shareholders or relegated to a balance sheet plug. If the excess value is a loss, this will increase the borrowings of the firm. It is inaccurate to assume that the borrowings would occur at the end of the period. That is, the forecasted interest expense will be lower than what could be expected, because the borrowings would occur sometime during the period in question and interest expense will have accrued.

ON the flip side, any excess value that is not returned to shareholders can be invested in assets that would also return some income.

A convergent model will attempt to forecast a more accurate number by assuming that whatever excess income or loss will generate some interest or expense during the period. That is once the first round of forecasting is complete, the modeler will go back and add back some interest as income or expense, and then recalculate the balance sheet.

Of course, when adding back income or expense, this will generate a new set of borrowings or investments (althoug a smaller order of magnitude). The analyst could continue to compute several rounds of corrections until the numbers converge, although typically it is only material to compute a single round (if that)

Calculated Values

Sample Model