CFA Level I · CFA Level I Exam

Introduction to Financial Statement Modeling: formula sheet

Full chapter guide

Key formulas

Balance sheet identity: Assets = Liabilities + Equity; Must hold in every forecast period. If it fails, a link is broken.
Retained earnings roll-forward: Ending RE = Beginning RE + Net income − Dividends; Main link from the income statement to the balance sheet.
PP&E roll-forward: Ending net PP&E = Beginning net PP&E + Capex − Depreciation; Assumes no disposals or impairments.
Cash roll-forward: Ending cash = Beginning cash + CFO + CFI + CFF; Ending cash feeds the balance sheet cash line.
Working capital cash effect: Increase in operating assets = cash outflow; increase in operating liabilities = cash inflow; Applies to non-cash working capital items such as receivables, inventory and payables.
Driver-based forecast: Forecast item = Driver ratio × Base (e.g. receivables = days sales outstanding × sales ÷ 365); Ties balance sheet items to income statement drivers.
Growth rate method: Sales(t) = Sales(t-1) × (1 + g); g can be historical, GDP-linked or guided by management.
Market share method: Revenue = Market size × Market share; Forecast both the market and the share. Share must be between 0% and 100%.
Price and volume method: Revenue = Volume × Average price; Combined growth = (1 + volume growth) × (1 + price growth) - 1, not the simple sum.
Bottom-up build: Revenue = Σ (units × price) across products, segments or stores; Add up the parts. Same-store sales plus new-store sales is a common split.
COGS from gross margin: COGS = Revenue × (1 − gross margin); Equivalent to forecasting COGS as a percentage of revenue.
Days sales outstanding: Receivables = DSO × Revenue ÷ 365; Use the same day-count (365 or 360) as the source data.
Days inventory on hand: Inventory = DIH × COGS ÷ 365; Inventory is based on COGS, not revenue.
Days payables outstanding: Payables = DPO × COGS ÷ 365; Also based on COGS (purchases if given).
Net working capital change: ΔNWC = change in (receivables + inventory) − change in payables; An increase is a cash outflow.
PP&E roll-forward: Ending net PP&E = Beginning net PP&E + Capex − Depreciation; Ignores disposals and impairments unless given.
Straight-line depreciation: Depreciation = (Cost − Salvage value) ÷ Useful life; Apply to the gross depreciable base.
Interest expense: Interest = Interest rate × Debt balance; Beginning balance avoids circularity; average balance is more precise.
Operating margin effect: Operating income = Revenue − COGS − SG&A − Depreciation; Fixed costs create operating leverage.
Probability-weighted value: Expected value = Σ (probability of scenario × value in scenario); Probabilities across scenarios must add up to 100%.
Sensitivity analysis rule: Change one input; hold all others constant; record change in output; Shows which input drives the result most. Ignores correlation between inputs.
Scenario analysis rule: Change several inputs together in a consistent set (base, best, worst); Captures linked inputs. Results depend on how well the scenarios are defined.
Real growth approximation: Real growth ≈ nominal growth − inflation; Exact: (1 + nominal) ÷ (1 + inflation) − 1. Use it to check whether revenue growth is real or just price.

Quick revision

A model turns assumptions into projected income statement, balance sheet and cash flow.
Start by defining the purpose and scope, then gather data and build the forecast.
Top-down starts from the market or economy and works down to the company.
Bottom-up builds from company units, such as price times volume by product or location.
Hybrid combines both, often using one to cross-check the other.
Forecast revenue first, since costs and working capital depend on it.
Variable costs move with revenue; fixed costs do not move with it in the short run.
Working capital forecasts often use days of sales, inventory and payables.
Capex forecasts should be consistent with growth plans and depreciation.
Overconfidence and anchoring can make forecasts too narrow or too close to past figures.
Scenario analysis tests a model under different sets of assumptions.
Models are only as reliable as their inputs, so state limits and revisit assumptions.

Common mistakes

Forecasting costs or balance sheet items before revenue. Fix: Remember the order: understand the business, forecast revenue, then costs, working capital, capex and financing.
Treating depreciation as a cash outflow. Fix: Add it back in CFO. It lowers net income and net PP&E but not cash directly.
Adding volume growth and price growth to get revenue growth. Fix: Compound: (1 + volume growth) × (1 + price growth) - 1. Better still, compute the new volume and price and multiply.
Mixing up top-down and bottom-up. Fix: Ask where the forecast starts. Economy or industry first is top-down. Company units or segments first is bottom-up.
Forecasting inventory and payables from revenue. Fix: Receivables use revenue. Inventory and payables use COGS.
Reporting the working capital balance instead of the change. Fix: Subtract the prior-year balance and then apply the sign to cash flow.
Calling a test sensitivity analysis when several inputs change together. Fix: Count the inputs. Only one changing at a time is sensitivity. A coherent set of changes is scenario.
Saying scenario analysis gives the single most likely outcome. Fix: Scenarios show a range of possible outcomes. Only with assigned probabilities can you compute an expected value.

Exam tips

Know the order of build steps and the reason revenue comes first.
For link questions, trace net income, retained earnings, CFO and cash in that order.
Expect sign questions on depreciation and working capital; check the direction before choosing.
Remember that a balancing balance sheet checks mechanics, not assumption quality.
With 90 seconds per question, use the quick trace rather than building full statements.
Identify the starting point of the forecast. That one clue usually decides top-down versus bottom-up questions.
Expect a hybrid answer when the question mentions both industry data and company segments.
In calculations, grow each factor first and then multiply. Do not add growth rates.