Reading 38: Introduction to Financial Statement Modeling

Book 2: FSA

Steps to create a Sales-Based Pro Forma Company Model

1.) estimate rev growth based on market growth and market share, a trend growth rate, or growth relative to GDP

2.) Estimate COGS based on a % of sales or on a more detailed method

3.) Estimate SG&A as either fixed, growing with revenue, or using some estimation technique

4.) Estimate financing costs using interest rates, debt levels, and the effects of any large anticipated changes in capex or financial structure

5.) Estimate income tax expense and cash taxes using historical effective rates and trends, segment information for different tax jurisdictions, and anticipated growth in high- and low-tax segments, taking into account changes in deferred tax items

6.) Model the balance sheet based on items that flow from the income statement through working capital accounts

7.) Use D&A and maintenance and growth capex to estimate capex and net PP&E on the balance sheet

8.) Use completed pro forma income statement and balance sheet to construct a pro forma cash flow statement

Overconfidence Bias

having too much faith in one’s one work

Illusion of Control Bias

overestimating what an analyst can control

What are examples of Illusion of Control

seeking expert opinions to justify one’s forecast

making a model more complex

Conservatism Bias/Anchoring

making only small adjustment to the model after new information has been made public

Representativeness Bias

the tendency to judge the probability of something based on a typical example

Base-Rate Neglect

underweighting the actual probability of an event and using anecdotal observations to constitute the probability of an event

Confirmation Bias

seeking out information that only affirms their opinion

Porter’s Five Forces

threat of substitutes

threat of new entrants

bargaining power of customers

bargaining power of suppliers

intensity of rivalry

when is the intensity of rivalry high

many competitors, undifferentiated products, fixed costs are high, barriers to exit are high, industry growth is slow

Inflection Point

instances in the future that will not be like the past

What is the appropriate forecast horizon?

the holding period