Financial Statement Forecasting in Equity Valuation: formula sheet

Key formulas

Top-down revenue

Company revenue = Industry sales × Market share

Industry sales come from macro and industry forecasts such as GDP growth.

Bottom-up revenue

Company revenue = Σ (units × price) across products, stores or segments

Example: number of stores × average sales per store.

Market share check

Implied share = Company revenue ÷ Industry sales

Use it to test whether a bottom-up forecast is plausible.

Growth-rate forecast

Revenue(t+1) = Revenue(t) × (1 + g)

For n years: Revenue(t) × (1 + g)^n if g is constant.

Market share model

Revenue = Market size × Market share

Market size and share must use the same period and the same market definition.

Market size growth

Market(t+1) = Market(t) × (1 + market growth)

Market growth is often tied to nominal GDP growth, which includes inflation.

Price and volume model

Revenue = Volume × Average price

Average price is revenue per unit, which can change with product mix.

Combined price-volume growth

Revenue growth = (1 + volume growth) × (1 + price growth) − 1

The sum of the two growth rates is only an approximation.

Segment revenue

Total revenue = Σ segment revenue

Forecast each segment with its own drivers, then add.

Gross margin

Gross margin = (Revenue − COGS) ÷ Revenue

COGS % of sales = 1 − gross margin.

Operating margin

Operating margin = (Revenue − COGS − SG&A) ÷ Revenue

Use after other operating items if given.

Cost forecast with fixed and variable parts

Total cost = Fixed cost + (Variable cost per unit × Units)

Grow the fixed cost for inflation, not for volume.

Degree of operating leverage (DOL)

DOL = % change in operating income ÷ % change in sales = Contribution margin ÷ Operating income

Contribution margin = Revenue − Variable costs. Valid for small changes within the relevant range.

Operating income change

% change in operating income ≈ DOL × % change in sales

The size of the effect grows with fixed costs.

Net PP&E roll-forward

Ending net PP&E = Beginning net PP&E + Capex − Depreciation

Ignores disposals and impairments. Add or subtract them if the question gives them.

Straight-line depreciation

Annual depreciation = (Cost − Salvage value) ÷ Useful life

Many models instead use depreciation as a percentage of beginning gross PP&E or of sales.

Receivables

Receivables = Sales × DSO ÷ Days in year

Use the day count the question gives, usually 365.

Inventory

Inventory = COGS × DIO ÷ Days in year

Use COGS, not sales.

Payables

Payables = COGS × DPO ÷ Days in year

Strictly, payables relate to purchases, but COGS is the usual simplification unless purchases are given.

Change in net working capital

ΔNWC = Ending operating NWC − Beginning operating NWC

Operating NWC excludes cash and debt. A positive ΔNWC is a cash outflow.

Debt roll-forward

Ending debt = Beginning debt + New borrowing − Repayment

Check whether repayment is made at year end or during the year.

Interest expense

Interest = Interest rate × Average debt (or Beginning debt)

Use the basis stated in the question. Average debt is more accurate but creates circularity.

Share count roll-forward

Ending shares = Beginning shares + Shares issued − Shares repurchased

Use the weighted average share count for EPS.

Operating cash flow link

CFO = Net income + Depreciation − Increase in operating NWC

Add other non-cash charges if given.

Ending cash

Ending cash = Beginning cash + CFO + CFI + CFF

This is the figure that goes on the forecast balance sheet.

Probability-weighted value

Expected value = Σ (probability of scenario i × value in scenario i)

Probabilities across the scenarios must sum to 100%.

Sensitivity (percentage change)

Sensitivity = % change in value ÷ % change in input

Change one input only; compare the results across inputs to rank the drivers.

Rule: sensitivity vs scenario

Sensitivity = one variable at a time; Scenario = several variables together

This is the core distinction tested.

Quick revision

• Forecasts feed valuation models, so errors in forecasts flow straight into value.
• Top-down starts with the economy and industry, then moves to the company.
• Bottom-up starts with company or segment details and aggregates upward.
• Market share model: company revenue = market size × market share.
• Revenue forecasts should be checked against capacity, industry growth and competitors.
• Fixed costs do not move with sales in the short run, so higher operating leverage means operating income is more sensitive to sales.
• Variable costs usually scale with revenue; forecast them as a percentage of sales unless there is a reason not to.
• Capex and depreciation must be consistent with the forecast growth in PP&E.
• Working capital forecasts are often based on days ratios such as receivable days, inventory days and payable days.
• Scenario analysis changes several inputs together; sensitivity analysis changes one input at a time.
• Common pitfalls: overconfidence, anchoring on past results, ignoring competitive response and projecting trends too far.
• Check that the three statements stay consistent after every change.

Common mistakes

• Reversing top-down and bottom-up. Fix: Top-down starts at the macro or industry level. Bottom-up starts at the company's own units.
• Forgetting that a bottom-up forecast can overstate sales. Fix: Remember it may ignore market limits. Check the implied market share against the industry.
• Adding volume growth and price growth to get exact revenue growth. Fix: Use (1 + volume growth) × (1 + price growth) − 1 when the question wants an exact figure.
• Applying the market growth rate to the company's revenue when share is changing. Fix: Forecast market size and share separately, then multiply.
• Forecasting every cost as a constant percentage of sales Fix: Hold only variable costs at a % of sales. Grow fixed costs separately.
• Growing fixed costs with sales volume Fix: Fixed costs change only with inflation or stated steps, within the relevant range.
• Treating an increase in working capital as a cash inflow. Fix: Remember that cash is tied up in receivables and inventory. An increase in operating NWC reduces cash flow from operations.
• Applying DIO and DPO to sales instead of COGS. Fix: Receivables use sales. Inventory and payables use COGS, unless the question says otherwise.
• Calling a one-variable test a scenario analysis. Fix: Count the inputs changed. One input held alone is sensitivity; a linked set is a scenario.
• Treating the worst case as the worst possible outcome. Fix: Remember that cases are chosen plausible outcomes. Real outcomes can fall outside them.

Exam tips

• Identify the starting point first; it settles most classification questions.
• Expect short calculations: industry sales × share, or units × price. Do the arithmetic once and check the units.
• Questions on reasonableness often hinge on implied market share.
• Remember the process order: understand the business, forecast revenue, then costs and investment, link statements, test scenarios.
• With no penalty for wrong answers, always answer; eliminate the option that reverses the definitions.
• Read which driver the stem gives. Most items supply the inputs, so your job is to combine them correctly.
• Watch the difference between percentage points of share and percent change in share.
• If a question asks for a judgment, look for the option that links the forecast to market growth, capacity or competition.