Financial Statement Projections

Revenue projections are based sometimes on historical growth if a mature or cyclical company or more on market intelligence and judgment if a fast-growing company.

Revenue = price x quantity. 

Break them out. Maybe you have a good handle on future unit sales or prices. Does the company have the power to pass through future cost increases? Is the sector expanding capacity, which may pressure prices? 

For a restaurant chain, if average revenue per store were stable, and we knew the number of new stores they planned to open, we can project revenue. 

COGS projections - what percent of COGS is fixed v. variable? Variable costs go up in line with their % of unit volume, but fixed costs stay the same unless capacity is expanded. What are the Capex plans? D&A is a component of COGS. 

Break out COGS as detailed as possible. Two-thirds of a chemical manufacturer’s COGS is energy. What is the outlook for natural gas prices? An aircraft engine maker sources metals. Are miners expanding or shrinking capacity (impacts prices)?

SG&A expenses are projected as a % of revenue (e.g. hard key 15%, then make the expense projection = 15% x projected revenue), however, a portion is a fixed cost and will not increase in line with revenue. 

Interest income and expense are projected based on debt and cash balance projections. Is there debt coming due, and if/when rolled over, will rates be higher or lower? 

Other income/expense is hard to project unless there is a recurring trend. If not, project zero. 

Income tax expense is projected as a % of pre-tax income, based on past rates as long as constant. Be mindful of future use of “net operating loss” (NOL), which reduces tax rates. 

Cash is the one item on the balance sheet that will be linked FROM the cash flow statement (beg of yr cash + net cash flow = end of yr cash).

Accounts Receivable. In an assumption sheet, you will hard key DSOs based on trends. If 30 days, then the AR balance will be = 30/360 * revenue projection

The same methodology applies for Inventoryand Accounts Payable, except you would multiply by the COGS projection instead of revenue

Other Asset. Discern if there are trends or not. These could be hard keyed or tied as a % of revenue.

Goodwill is not amortized. It sits there unless there is an impairment, which one cannot project. 

Amortization: Financing fees from acquisitions can be amortized, but not investment banking fees (to be discussed in the LBO section). You can project this for past expenses, but rarely do you project future acquisitions, unless maybe if you work in corporate development as an in-house banker. 

For example, Property, Plant & Equipment (PP&E)

Gross PP&E = beg balance + CAPEX – asset sales

Capex projection: Discern historical CAPEX (from cash flow statement) as a % of revenue.

Asset sales projection: Discern trends and read the notes. Often you will project $0. 

Depreciation expense (from historical cash flow statement) is projected as a % of gross PP&E historically. Add each year’s projected depreciation to the accumulated depreciation balance.

Net PP&E = gross – accumulated depreciation.

Liabilities

Accounts payable projection: If there are 40 days in payables the equation is 40/360 * COGS projection

Accrued liabilities and other: Discern trends and express them either as absolute hard keyed value or as % of COGS.

Debt: Read the debt schedule in the filings. Is there any debt coming due? 

Shareholders’ Equity:

Retained earnings projection = beg balance + net income (after dividends)

All changes in Balance Sheet Accounts must be run through the cash flow; otherwise, the balance sheet totals will not balance. All Non-cash items in the income statement must be added back/deducted from the operating cash flow.

Operating Cash Flow equals the sum of….

· Net Income is taken from the income statement

· Depreciation and Amortization are taken from the income statement

· Add back/deduct any other non-cash expenses/income from the income statement (examples are non-cash interest expense, any non-cash restructuring charges, amortization of capitalized accounts, etc.)

· Changes in working capital including:

• Current Assets = previous period       balance – current period balance
• Current Liabilities = current period       balance – previous period balance

·   Changes in other assets/other liabilities

• Other Assets: previous period       balance – current period balance
• Other Liabilities: current period       balance – previous period balance

Cash Flow from Investing Activities equals the sum of….

· Capital Expenditures which are outflows

· Acquisitions which are outflows

· Sale of Assets which are inflows

Cash Flow from Financing Activities is driven by debt and the interest schedule, which integrates the cash and debt balance sheet accounts, interest expense and interest income on the income and the cash flow statements. An increase in debt or equity is a cash inflow.

Ending Cash Balance = Beginning Cash Balance + Cash Flow during Period

Create a section just for debt and interest, all tranches. The notes to financial statements contain information on amortization, maturity, and rates. 

Ending debt balance = beg balance + drawdowns – amortization, pay downs, or maturing debt that is not rolled over

Interest expense projection = average debt balance x interest rate

After projecting each debt tranche in the separate table, and link the beginning and ending balances to the balance sheet. Link the interest expense to the income statement’s interest expense. Link projected interest income to the income statement’s interest income because a cash balance earns interest.