fsa 12: introduction to Financial Statement Modeling

What is a sales-based pro forma model?

forecasting model where future financial statement items are projected primarily based on expected sales growth

What are the major steps in constructing a pro forma income statement?

• Forecast revenue

• Forecast COGS

• Forecast operating expenses

• Forecast non-operating items

what are the four main drivers of revenue growth and their meanings?

Driver	Meaning
Volume	Selling more units
Price/mix	Charging more or selling premium products
FX	Currency movements
Acquisitions	Buying businesses

what is organic growth and formula

Revenue growth from:

• Volume changes

• Price/mix changes

(1+Volume Growth)×(1+Price/Mix)−1

what are the six ways to forecast costs?

Item	Common Forecast Method
COGS	% of sales
SG&A	% of sales
Admin expenses	Growth rate or % of sales
D&A	% of fixed assets
Capex	% of sales

how to forecast operating profit

EBIT = revenue - operating expenses

What are the major non-operating items forecasted in the model?

• Interest expense = Debt ×Interest Rate

• Taxes

• Shares outstanding

What items are needed to forecast an income statement?

• revenue

• COGS

• SG&A/operating expenses

• depreciation and amortisation

• EBIT

• interest expense

• taxes

• shares outstanding

• net income /EPS

What items are needed to forecast a cash flow statement?

• Net income

• Capex

• Depreciation

• Working capital changes

• Dividends

• Debt activity

What are the main behavioral biases in financial forecasting, and how can analysts mitigate them?

Behavioral Bias	Meaning	Example in Forecasting	Mitigation
Overconfidence	Excessive belief in forecasting ability	Analyst is too certain forecasts are accurate	Track forecast errors, use scenario analysis, widen confidence intervals
Illusion of Control	Belief that more complexity/data improves accuracy	Building overly detailed models with immaterial inputs	Focus on key variables, keep models simple and flexible
Conservatism (Anchoring)	Insufficiently adjusting forecasts after new information	Small revisions despite major new evidence	Regularly reassess assumptions, encourage team review
Representativeness	Assuming recent trends will continue	Extrapolating temporary strong growth indefinitely	Use long-term averages/base rates, not just recent performance
Confirmation Bias	Seeking evidence that supports existing views	Ignoring negative information that contradicts forecast	Look for opposing evidence and alternative scenarios

What are Porter’s Five Forces?

1. Threat of substitutes

2. Industry rivalry

3. Bargaining power of suppliers

4. Bargaining power of buyers

5. Threat of new entrants

how is the explicit forecast horizon chosen?

• Investment style (holding period of the strategy)

• Industry cyclicality (must cover a full cycle / mid-cycle normalisation)

• Company events (M&A, restructuring, major projects)

• Data reliability (uncertainty limits how far you can forecast)

• Firm standards (some models use fixed horizons)

how to forecasting beyond the explicit period

After the forecast horizon, value is captured using a terminal value.

Two main methods:

• Perpetuity growth model (FCF grows at a constant long-term rate)

• Exit multiple approach (apply EV/EBITDA or similar multiple)

Key rule for terminal value

The final forecast year must be:

• “Normalized” (mid-cycle), not a boom or recession year

Otherwise valuation will be distorted.

How long-term forecasts are simplified

• Normalize revenue growth (GDP-level or market-driven)

• Stabilize margins (gross/operating margins converge)

• Use steady assumptions for capex, tax, and working capital