Circular References in Corporate Finance

In this section I explain how you can resolve a couple of circular references that arise in corporate models. The most classic circular reference comes from interest expense and interest income that is affected by financing over the course of the year. In an annual model interest can be computed on the average balance. If you don’t make this assumption you are implicitly assuming that all activity for the corporation comes at the very end of the year. Developing a user defined function is not that difficult to resolve the circular reference because no loop is required. The video and files below illustrate how to solve this circular reference.

Don’t Believe People who Give you B.S. About Circular References

My good friend Karnen sent be an article about circular references written by some professor.  This man claimed that you can somehow get around circular references.  What total rubbish.  Interest expense and income affects cash flow. But cash flow affects financing. Unless you make a monthly model there will be a circular reference.

Mechanics of Getting Rid of Circular References

Iteration Button — Problems but maybe not impossible.

Copy and Paste in Corporate Model –> Totally Clumsy

Function — Not too difficult

 

Mechanics of Resolving Circular Reference

 

Circular Reference Exercise 3 – Corporate Modelxlsm.xlsm
Exercise 10 – Target Capital Structure with Function.xlsm