Forecast The Income Statement

Forecasting Income Statement

Revenue-

In most 3-statement models, the revenue forecasting is likely the most essential forecast. There are two primary methods for estimating revenue mechanically:

1. Grow revenues by inputting an aggregate growth rate.

2. Segment level detail and a price x volume approach.

1. Grow revenues by inputting an aggregate growth rate-

Grow revenues by inputting an aggregate growth rate is straightforward. Let’s take an example of ABC company revenue growth last year was 10%. The analyst expected that growth rate to continue throughout the forecast period, revenue would simply be grown at that rate.

2) Segment level detail and a price x volume approach-

A more extensive forecast technique is required if the analyst has a view on price and volume variations across segment. In this situation, the analyst would establish specific volume and pricing assumptions for each section. Rather than forecasting a consolidated growth rate explicitly, the consolidated growth rate is an output of the model based on the price/volume segment buildup in this case.

Cost of goods sold (Cogs)

Make an assumption for a percentage gross profit margin (gross profit/revenue) or a percentage COGS margin (COGS/revenue) and convert it to dollars.

Historical margins serve as a baseline against which the analyst can either straight-line into the projected period or reflect a thesis that derives from a specific point of view (which the analyst develops on their own estimate).

Revenue – Gross Profit = COGS

Operating Expenses (OPEX)

Selling costs, general and administrative expenditures, and research and development costs are all included in operating expenses.

All of these costs are driven by either sales growth or an explicit anticipation of margin changes.

For example, if last year's SG&A margin was 15%, an SG&A projection for next year would simply be to straight-line the prior year's 15% margin. If we expect modifications, we'll normally make a note of it in the margin assumptions.

Depreciation and Amortization (D&A) -

Expenses for depreciation and amortization are normally not included separately on the income statement. Rather, they are embedded within other operating expense categories. However, in order to arrive at an EBITDA forecast estimate, you normally need to forecast D&A. D&A expenses are predicted as part of the balance sheet buildup and linked back into the income statement after the buildup is complete since they are a result of historical and expected future capital expenditures and purchases of intangible assets.

Stock-Based Compensation (SBC)-

Like D&A, stock-based compensation is embedded within other operating expense categories, but the historical amounts can be explicitly found on the cash flow statement. Stock-based pay is often calculated as a proportion of revenue.

Interest Expense-

Interest expense forecasting, like depreciation and amortization, is done as part of the balance sheet buildup in a debt schedule and is based on projected debt levels and interest rates.

Interest expense is determined by the company's debt balances, whereas interest revenue is determined by the cash holdings. Analysts use one of two approaches to calculate interest in financial models.

1. Interest rate x average period debt

For example, if your model is forecasting a $100m debt balance in the end of 2016 and $200m at the end of 2017, at an assumed interest rate of 5%, the interest expense would be calculated as $150m (average balance) x 5% = $7.5m.

2. Interest rate x beginning period debt

Under this approach, you would calculate interest off the beginning of period balance (which is last year's end of period balance) of $100m x 5% = $5m.

Interest Income

While revolver debt is often used to plug a deficit, cash is used to plug a surplus, therefore any excess cash flows predicted by the model will naturally result in larger cash levels on the balance sheet.

As a result, we're dealing with the identical circularity difficulties we're dealing with when forecasting interest income.

The expected cash balances and the projected interest rate earned on idle cash determine interest income. We won't be able to forecast it until both the balance sheet and the cash flow statement are completed. Analysts can calculate interest using either the beginning- or average-period approach, just like interest expense. If you anticipate interest income based on average cash balances, it will be similar to interest expense.

Other non-operating items

In addition to interest income and interest expense, organizations may have other non-operating income and expenses that are not explicitly mentioned on the income statement. Straight-line forecasting is usually the best method for predicting those goods (as opposed to operating expenses, which are usually tied to revenue growth).

Taxes

In most cases, simply straight-lining the tax rate from the previous year is enough. However, there are times where tax rates historically are not indicative of what a company can reasonably expect to face in the future.

Difference between Effective Tax Rate and Marginal Tax Rate?

The effective tax rate is calculated by dividing the actual taxes due (as determined by the tax statements) by the company's pre-tax reported income. The effective tax rate can differ from the marginal tax rate because there is a difference between pre-tax income on the financial statements and taxable income on the tax return.

The marginal tax rate is the rate that is applied on the last dollar of a company's taxable income, based on the relevant jurisdiction's statutory tax rate, which is partly determined by which tax bracket the company falls into (for US corporations, the federal corporate tax rate would be 35 percent ). The reason it's called marginal tax rate is because as you move up in tax brackets, your "marginal" income is what is taxed at the next highest bracket.