Creating Custom Functions for Financial Modeling and Analysis in Excel

Excel is a powerful tool for financial modeling and analysis, but you often may require custom functions for complex or specific calculations. By using Excel VBA, you can create UDF functions to streamline calculations, ensure accuracy, and enhance productivity. In this article, we will show how to create custom functions for financial meddling and analysis in Excel.

What Are Custom Functions?

Custom functions, also known as User-Defined Functions (UDFs), are VBA code snippets that allow you to create your formulas in Excel. These functions can be tailored to specific financial calculations and used just like built-in Excel functions.

Getting Started with VBA

To access the VBA editor:

• Go to the Developer tab >> select Visual Basic.
• In the VBA Editor, go to Insert tab >> select Module to create a new module for your code.
• Then, you can insert your respective VBA codes.

Example Custom Functions for Financial Modeling

1. Net Present Value (NPV) Function for Uneven Cash Flows

Excel’s built-in NPV function considers cash flows even. Let’s create a function to handle uneven cash flows.

VBA Code:

Function CustomNPV(DiscountRate As Double, CashFlows As Range) As Double
    Dim NPV As Double
    Dim i As Integer
    Dim Flow As Variant
    Dim DiscountFactor As Double
    
    NPV = 0
    i = 0 ' Start from 0 to correctly handle the first cash flow
    
    For Each Flow In CashFlows
        DiscountFactor = (1 + DiscountRate) ^ i
        NPV = NPV + Flow / DiscountFactor
        i = i + 1
    Next Flow
    
    CustomNPV = NPV
End Function

To use the CustomNPV function, select cell D2 and insert the following formula.

Formula:

=CustomNPV(A2, B2:B5)

Here,

• A2: It’s the discount rate.
• B2:B5: It contains cash flows.

The result will display the NPV based on a 10% discount rate and the uneven cash flow.

The Custom NPV result of -21.037 indicates that, based on the cash flow and discount rate, the present value of the investment is negative, meaning the project or investment would result in a net loss.

2. Compound Annual Growth Rate (CAGR)

CAGR is commonly used in financial modeling to calculate the average growth rate of an investment over time.

VBA Code:

Function CAGR(StartValue As Double, EndValue As Double, Periods As Double) As Double
    CAGR = (EndValue / StartValue) ^ (1 / Periods) - 1
End Function

To use the CAGR function, select cell D2 and insert the following formula.

Formula:

=CAGR(B2, B3, 5)

This formula will return the CAGR as a percentage. Where B2 is the initial value, B3 is the final value, and 5 is the number of years.

The result of 14.87% for the CAGR means that the value has grown at an average annual rate of 14.87% over the 5 years, from the starting value in 1000 to the ending value of 20000. This percentage reflects consistent annual growth, assuming the value increased at a steady rate each year.

3. Interest Coverage Ratio

The Interest Coverage Ratio measures a company’s ability to pay interest expenses on its debt.

VBA Code:

Function InterestCoverageRatio(EBIT As Double, InterestExpense As Double) As Double
    If InterestExpense = 0 Then
        InterestCoverageRatio = "Error: Interest Expense Cannot Be Zero"
    Else
        InterestCoverageRatio = EBIT / InterestExpense
    End If
End Function

To use the InterestCoverageRatio function, select cell D2 and insert the following formula. Drag the formula down to fill the formula for the remaining rows.

Formula:

=InterestCoverageRatio(B2, C2)

This formula returns the interest coverage ratio where B2 is EBIT (Earnings Before Interest and Taxes) and C2 is the interest expense.

The Interest Coverage Ratio indicates the company’s ability to pay its interest expenses, with higher values reflecting stronger financial health. In this case, the ratio ranges from 4.8 to 6.5 over five years, showing the company can comfortably cover its interest payments, though a slight decline in 2022 suggests a need for monitoring.

4. Loan Payment Schedule

This function will calculate the periodic payment for a loan based on constant payments and a constant interest rate.

VBA Code:

Function LoanPayment(Principal As Double, AnnualRate As Double, Months As Integer) As Double
    Dim MonthlyRate As Double
    MonthlyRate = AnnualRate / 12
    LoanPayment = (Principal * MonthlyRate) / (1 - (1 + MonthlyRate) ^ -Months)
End Function

To use the LoanPayment function, select cell D2 and insert the following formula.

Formula:

=LoanPayment(B2, B3, B4)

The function will calculate the monthly loan payment. Where B2 is the loan amount, B3 is the annual interest rate, and B$ is the loan term (months).

This monthly payment amount of 943.56 would be required to fully repay the loan, including both principal and interest, over the given term at the specified interest rate.

Conclusion

User-defined custom functions in Excel can significantly enhance your financial modeling capabilities by allowing you to create tailored calculations that fit your specific needs. VBA can create robust custom functions which will reduce manual errors, and improve the efficiency of your models. You can practice and experiment with these examples to suit your financial analysis requirements.