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CFA Level II Exam · Integration of Financial Statement Analysis Techniques

Forecasting and Valuation Using Financial Statement Analysis

Updated 7 October 2026 · Fact-checked

Forecasting with statement analysis means using past ratios, growth and cash flow patterns to project revenue, margins, investment and financing. You then turn those projections into free cash flow or earnings for valuation, and into coverage and leverage for credit views. Finally you test how sensitive the answer is to your key assumptions.

Understand Forecasting and Valuation Using Statement Analysis

A forecast is only as good as the analysis behind it. In an item set, you first study the historical statements. You look at growth, margins, asset turnover, leverage and cash conversion. Those ratios tell you what the business has done and what it may keep doing.

Next you project. Most models start with revenue, because costs, working capital and capital spending are tied to it. You then forecast operating margin, tax rate, working capital as a share of sales, capital expenditure and depreciation. The balance sheet must stay consistent with the income statement and cash flow statement. Debt and cash are usually the balancing items.

The projections feed valuation. For a DCF, you compute FCFF or FCFE each year and discount them, with a terminal value after the explicit forecast period. For multiples, you forecast earnings, EBITDA or book value and apply a justified multiple. For credit, you project interest coverage, debt to EBITDA and free cash flow after debt service, and compare them with covenants or thresholds.

Every forecast rests on assumptions, so you test them. Sensitivity analysis changes one input at a time, such as growth or margin, and shows the effect on value. Scenario analysis changes several inputs together, such as a base, best and worst case. Small changes in the terminal growth rate or discount rate often move value a lot, because terminal value is usually a large share of the total.

You must also adjust the statements first. If earnings include one-off gains, or if lease, pension or capitalised cost choices distort comparability, projecting the raw numbers carries the distortion forward. Clean the base year, then forecast.

Key formulas to remember

FCFF from net income
FCFF = NI + NCC + Int(1 − t) − FCInv − WCInv
NCC is non-cash charges such as depreciation. FCInv is capital expenditure net of asset sales. WCInv is the increase in net working capital.
FCFF from EBIT
FCFF = EBIT(1 − t) + Dep − FCInv − WCInv
Use when the vignette gives EBIT and a tax rate.
FCFE from FCFF
FCFE = FCFF − Int(1 − t) + Net borrowing
Discount FCFE at the cost of equity. Discount FCFF at WACC.
Terminal value (Gordon growth)
TV at time n = FCF(n+1) ÷ (r − g) = FCF(n) × (1 + g) ÷ (r − g)
Needs r > g. Discount TV back from time n.
Sustainable growth
g = ROE × retention ratio
Use to check whether forecast growth is consistent with returns and payout.
Credit measures
Interest coverage = EBIT ÷ interest expense; Leverage = Debt ÷ EBITDA
Forecast these under base and downside cases and compare with stated thresholds.
Enterprise value to equity
Equity value = EV − Debt + Cash (and other non-operating assets) − other claims
Subtract non-controlling interest and preferred stock where given.

How to solve Forecasting and Valuation Using Statement Analysis questions

Use the same sequence for any forecasting or valuation question in a vignette.

  1. 1Read the questions first, then scan the vignette and exhibits for the data you need.
  2. 2Check whether the base-year figures need adjustment for one-offs or comparability. If so, adjust before projecting.
  3. 3Identify the driver, usually revenue growth, then apply the stated margin, tax, working capital and capex assumptions to project each year.
  4. 4Compute the cash flow the question needs: FCFF for firm value, FCFE for equity, or coverage and leverage for credit.
  5. 5Match the discount rate to the cash flow: WACC for FCFF, cost of equity for FCFE. Add a terminal value if the model is multistage.
  6. 6Convert to the requested output: equity value, per-share value, or a credit ratio, adjusting for debt, cash and share count.
  7. 7Apply any sensitivity or scenario change asked for, and change only the inputs named.
  8. 8Sense-check the answer against growth, margins and the terminal share of value.

Quickest way: Change-only recalculation

When to use it: Use when a question asks how value or a ratio changes if one assumption moves, as in sensitivity questions.

  1. Find the base-case result already given in the exhibit.
  2. Identify the single line the new assumption affects, such as the margin or the terminal growth rate.
  3. Recompute only the affected cash flow or terminal value, not the whole model.
  4. Take the difference and add it to the base result.
  5. Check direction: higher growth or lower discount rate raises value; higher capex or working capital lowers FCF.

Common mistakes in Forecasting and Valuation Using Statement Analysis

  • Discounting FCFF at the cost of equity, or FCFE at WACC

    Candidates focus on the cash flow arithmetic and forget the matching rule.

    Fix: Write the pairing next to your answer: FCFF with WACC, FCFE with cost of equity.

  • Forgetting to subtract debt and add cash after finding enterprise value

    The DCF output feels like the final answer.

    Fix: Ask whether the question wants firm or equity value. For equity, adjust for net debt and other claims.

  • Projecting unadjusted earnings with one-off gains or losses

    Candidates take the reported base year at face value.

    Fix: Remove non-recurring items from the base year, then apply growth and margin.

  • Using a terminal growth rate at or above the discount rate

    A high near-term growth rate is carried into perpetuity.

    Fix: Keep terminal growth modest and below r. The Gordon formula needs r > g.

  • Treating the increase in working capital as a cash inflow

    Sign confusion with balance sheet changes.

    Fix: An increase in operating working capital uses cash and reduces FCF.

  • Changing several assumptions in a sensitivity question

    Candidates try to be realistic and alter linked inputs.

    Fix: Change only what the question states, and hold everything else at base case.

Worked examples

Example 1

A company has year 1 EBIT of 200 million, a tax rate of 25%, depreciation of 40 million, capex of 70 million and an increase in working capital of 10 million. WACC is 10% and FCFF is expected to grow at 4% a year after year 1. Net debt is 500 million and there are 50 million shares. Q1: What is year 1 FCFF? Q2: What is the firm value? Q3: What is the value per share?

Show the solution
  1. Q1: EBIT(1 − t) = 200 × 0.75 = 150.
  2. FCFF = 150 + 40 − 70 − 10 = 110 million.
  3. Q2: Firm value = FCFF1 ÷ (WACC − g) = 110 ÷ (0.10 − 0.04) = 110 ÷ 0.06 = 1,833.33 million.
  4. Q3: Equity value = 1,833.33 − 500 = 1,333.33 million.
  5. Per share = 1,333.33 ÷ 50 = 26.67.

Answer: FCFF is 110 million, firm value is about 1,833 million, and value per share is about 26.67.

Example 2

Using the same company, the analyst tests a downside case in which the long-run FCFF growth rate is 3% instead of 4%, with year 1 FCFF and WACC unchanged. Q1: What is the new firm value? Q2: What is the new value per share? Q3: By what percentage does firm value fall?

Show the solution
  1. Q1: Firm value = 110 ÷ (0.10 − 0.03) = 110 ÷ 0.07 = 1,571.43 million.
  2. Q2: Equity value = 1,571.43 − 500 = 1,071.43 million. Per share = 1,071.43 ÷ 50 = 21.43.
  3. Q3: Fall in firm value = (1,833.33 − 1,571.43) ÷ 1,833.33 = 261.90 ÷ 1,833.33 = 14.3%.
  4. A 1 percentage point cut in growth cuts firm value by about 14%, and equity value by more (1,333.33 to 1,071.43, about 19.6%) because net debt is fixed.

Answer: Firm value is about 1,571 million, value per share is about 21.43, and firm value falls about 14.3%.

Exam tips

  • Read the question stems first so you know whether you need FCFF, FCFE, a ratio or a sensitivity result before you search the exhibits.
  • Check units and share counts. Vignettes often mix millions and per-share figures.
  • In sensitivity questions, change only the stated input. Leverage magnifies the effect on equity value compared with firm value.
  • Watch for adjustments the vignette hints at, such as one-off items, leases or pensions, before you project.
  • If two answers differ by the debt or cash adjustment, you have probably confused firm value with equity value.

Forecasting and Valuation Using Statement Analysis in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Forecasting and Valuation Using Statement Analysis: frequently asked questions

How do I forecast financial statements for the CFA Level II exam?

You rarely build a full model. The vignette gives growth, margin, tax and investment assumptions, and you apply them to get cash flows or ratios. Practise the arithmetic and know which line each assumption drives.

Which should I forecast first, revenue or costs?

Revenue. Most costs, working capital and capex are linked to it through margins or percentages of sales. Forecast revenue, then derive the rest.

Why is terminal value so important?

In many DCF models it makes up a large share of total value. A small change in terminal growth or the discount rate can therefore change value a lot. That is why sensitivity analysis focuses on these inputs.

What is the difference between sensitivity and scenario analysis?

Sensitivity analysis changes one input at a time to see its effect. Scenario analysis changes several linked inputs together to describe a coherent case such as a downturn.