Circular references 1

How do they arise?

● Net interest expense is a function of opening and closing

debt and cash balances
● Closing balances are a function of surplus cash
- With surplus cash dependent on the net interest expense

● Effectively, net interest depends on itself (the circularity)

Net
interest
Surplus
cash

Opening &
closing
balances
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 Options for the circular reference

● Break the circularity

- Use last year’s debt & cash balances
- Slightly less accurate
- Breaks the circularity

● Model scheduled debt repayments

- Not all surplus cash is applied to debt repayment
- Not quite as easy to test debt capacity
- Doesn’t help with calculating interest on the cash balances

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 The circular reference

● The other option

- It’s an optimisation problem
- You can use “iteration” (an advanced version of goal seek) to
solve it

● Turn “iteration” on
- File > Excel options > Formulas > Iterative calculation [on]

● It comes with a serious health warning

- It’s not usually good practice
- Goal seek won’t work any more
- Error tracking and auditing functions stop working
- If you (by mistake) create a second circular reference on top of the
first, you won’t be able to trace it and could spend hours finding
the problem (the voice of bitter experience)

● You have been warned!

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 The circular reference

● The other option

- It’s an optimisation problem
- You can use “iteration” (an advanced version of goal seek) to
solve it

● Turn “iteration” on
- File > Excel options > Formulas > Iterative calculation [on]

● It comes with a serious health warning

- It’s not usually good practice
- Goal seek won’t work any more
- Error tracking and auditing functions stop working
- If you (by mistake) create a second circular reference on top of the
first, you won’t be able to trace it and could spend hours finding
the problem (the voice of bitter experience)

● You have been warned!

5
 The circular reference

● Do you want to be a dark side modeller?

● Dark side modellers should:
- Only allow themselves one circular reference e.g. around debt or
cash balances
- Create the deliberate circular reference as the very last step in
your model build, then turn iteration on
- Then Excel will warn you about accidental circular references as
you build your model
- Write a note for the poor ignorant Jedi Knight who picks up your
model later, and doesn’t know it’s got a deliberate circular
reference in it

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 Summary: the circular reference

● A common problem in these kinds of models

- When you want to apply surplus cash to debt repayment

● Iteration can be useful

- It finds a mathematical solution to the optimisation problem for you

● It comes with a serious health warning!

- Subsequent error tracking becomes very difficult

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