Lessons
on Conducting
Financial Analysis and Writing Memos
1.
The Memorandum
The first part of your completed analysis will be a short memo
(preferably no more than one page); but note that the memo will be the last thing that you actually do.
In writing the memo you should keep in mind that you are generally a lowerlevel analyst who is making an initial recommendation to your supervisor or to someone in a higherlevel position. Your job is to tell him/her what is most important in the most concise way possible. Write the memo so that if the reader is satisfied after skimming it, he/she has not missed something vital to the acceptance or rejection of your recommendation.
The memo should be brief, yet cover all the pertinent information. For example, if the analysis is conducted on whether we should buy a piece of equipment or not, the first or second sentence of the memo should present your decision, yes or no, along with the implications of your decision (stock price up by 20%, or a decrease in cash flows).
Your decision, of course, is based on many facts, interpretations, and guesses. All of this does not belong in the memo. Only very important pieces of additional information should be included. For example, suppose the analysis directs you to use 12% as the discount rate. When you use 12%, the NPV is positive indicating the equipment should be purchased. But, being the thorough analyst that you are, you used your spreadsheet to easily see the results with a 15% discount rate (which you think is a better reflection of the cost of capital based on information in the case). With a 15% discount rate, the NPV is negative, indicating the equipment should not be purchased. This information is very relevant to the ultimate decision maker and should be in the memo.
The memo should specifically refer only to the important supporting documentation for your decision. Graphs or tables, which summarize the results under various assumptions, can be most enlightening for the reader's quick review of all of your work. If you have a graph, tell the reader in the memo (e.g., see graph on the following page) and alert him/her that other supporting documents of lesser importance are also included.

2. Supporting Documentation
Documentation chosen to support the decision in the memo should be based on what you think a reader might want to know without having to call you to explain something. The selection process requires you to become somewhat of a mindreader. "Now, if I were reading this for the first time, what might I want to see included?" Granted, this is not an easy thing to accomplish, but it becomes easier with practice.
Besides determining what is important, you must also determine the priority of its importance. The documentation should not be attached in the order in which you constructed it. Instead, it should be arranged in an order in which an interested reader would want to see it.
For example, suppose you performed the following analyses in the order given:
(1) Calculated the cost of capital under several assumptions.
(2) Calculated the cash flows for a capital budgeting project under several assumptions.
(3) Calculated the NPVs for each combination of cost of capital and cash flow assumptions.
Your reader is most interested in your decision (go with the project or not) in the memo. In the memo you probably told him/her that your result was based on running several NPVs under different assumptions. The reader is probably interested in the results of some of these particular NPV calculations. He/she should be able to turn the page to see a table or graph which describes these in a summary form. A quick glance may satisfy your reader.
If your reader is not satisfied and wants to know more, he/she may wish to see each completed NPV calculation. Therefore, your summary sheet should tell the reader which exhibits (that follow) contain which results. Exhibit A may be cost of capital of 10% with cash flow assumptions 1, 2, and 5. Exhibit B may be cost of capital of 10% with cash flow assumptions 1, 2, and 3. And so on. If your reader is satisfied with Exhibits A  Z, then he/she will stop there.
If your reader is not satisfied and wants to know more, he/she may wish to see how you derived the costs of capital. The summary sheet should direct the reader to the documents which illustrate these calculations.
So, the documentation must be present to answer all of the reader's questions and be put in an order that the reader is most likely to want it.
Each table, graph, or analysis must be written for a very busy executive who does not have time to try to figure out what your abbreviations mean, where this strange number came from, etc. In other words, idiotproof your work. A person unfamiliar with finance should at least be able to tell what is going on, although they may not know why or how to interpret it.
One last thing is required for me, but is not required in the business world. I want the formulas behind each spreadsheet construction you do. If you have 5 pages with the same programming (e.g., NPV), but different assumptions (e.g., different costs of capital and cash flow assumptions), only give me 1 copy of the formulas. Attach these at the extreme back of your case.

3. Checklist for
Final Report
The following items should generally be found in a good analysis and cover memo. Before you turn in your work, check these items.
Memorandum
Signature or initials by your name.
State your recommendation by the end of the first paragraph and explain why you are making the recommendation.
Recognize the scenarios are all possibilities. Your recommendation must be sound given all the possibilities. Remember, the decision maker
doesn't=t know what will happen in the future any more than you do. The decision must be the right one given all possible outcomes.
Include a small table and/or graph to illustrate all the scenarios.
Use several small paragraphs rather than one long one.
Single space the memo.
Do not use abbreviations except when defined in the memo.
Keep memo as short as possible to deal with the
issue(s).
Refer to attached spreadsheets.
Refer to yourself as
"I" and to the decision and/or company as "our."
Use a spell checker.
Do not refer to the obvious as a revelation, e.g., higher revenues lead to higher
NPVs.
Spreadsheet
Orient the attached landscape spreadsheets such that the headings point left.
Put a detailed, descriptive title on the spreadsheet so that a person could go straight to the spreadsheet and know what it contains. Clearly identify the scenario. Highlighting a line on the spreadsheet to differentiate scenarios is not sufficient.
Format spreadsheet figures. Use the $ format for top figure, all subtotals, and grand totals. Use the same number of digits after the decimal point. For example, if you are using whole dollars, do not have some figures in dollars and cents.
Use complete words, rather than abbreviations.
Include computergenerated cell formulae at the end of the materials turned in.
Clearly label assumptions in a table on the spreadsheet so that important ones can be changed for different scenarios.
Minimize the number of spreadsheet pages by placing all relevant work on the main spreadsheet.
Use notation consistently for subtraction and addition. If you use parentheses to show negatives or subtraction, use them in all cases.
Ensure it is clear how numbers relate to one another.
Use a font which is big enough to read but not so big you have to use many spreadsheets to do one task.

4. Example of Memo
June 26, 2012
TO: John C. Butterfield, V.P. of Finance
FROM: Dorla A. Evans, Treasurer
SUBJECT: Recommendation on the Indonesian Field
I have evaluated the costs and benefits of drilling the Indonesian Field. As always, oil drilling decisions are fraught with uncertainty. The data suggest, however, that the likely return is worth the risk. I show below that additional seismic tests can significantly reduce the risk. I recommend we complete the seismic tests then base our decision upon its outcome.
Without the seismic tests, the expected net present value (NPV) is $40 Million with an initial investment of $112 Million. The possible NPVs and their associated probabilities of occurring are shown below:
Probability 
NPV 
.10 
$140 Million 
.15 
$ 95 Million 
.50 
$ 50 Million 
.15 
$ 5 Million 
.10 
$(40) Million 
My analysis indicates the project has a 90% chance of having a positive NPV. The wide distribution of NPVs is caused by the uncertainty in the amount of oil captured in the rock structure.
We can reduce the uncertainty by running further seismic tests in the area. The tests would cost around $120K. Based on what we know about the accuracy of these seismic tests, I believe we would find the following outcomes:
Positive Seismic Test 
Negative Seismic Test 
Probability 
NPV 
Probability 
NPV 
.25 
$150 Million 
.10 
$ 5 Million 
.50 
$100 Million 
.40 
$(35) Million 
.25 
$ 50 Million 
.50 
$(75) Million 
Supporting spreadsheets are attached.
Please let me know your decision on the seismic tests and/or project acceptance. If you have any questions, please do not hesitate to ask.  
