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Questions and Answers
Pam Jones, CFA, creates pro forma financial statements for a company she is analyzing. In developing the income statements, she needs to forecast growth for the selling, general, and administrative (SG&A) line item. Her forecasted number will most likely be driven by:
Pam Jones, CFA, creates pro forma financial statements for a company she is analyzing. In developing the income statements, she needs to forecast growth for the selling, general, and administrative (SG&A) line item. Her forecasted number will most likely be driven by:
- inflation forecasts for fixed SG&A, and sales growth for variable SG&A. (correct)
- sales growth for fixed SG&A, and inflation forecasts for variable SG&A.
- sales growth for both fixed and variable SG&A.
Which of the following measures will an analyst most likely use to develop a forecasted capital structure mix for a company he is reviewing?
Which of the following measures will an analyst most likely use to develop a forecasted capital structure mix for a company he is reviewing?
- Debt-to-equity ratio. (correct)
- Working capital.
- Current ratio.
A company's days sales outstanding (DSO) is equal to 42 days. With current revenues of $20 million and 8% forecasted growth, accounts receivable on the pro forma balance sheet will be closest to:
A company's days sales outstanding (DSO) is equal to 42 days. With current revenues of $20 million and 8% forecasted growth, accounts receivable on the pro forma balance sheet will be closest to:
- $2,301,370.
- $2,684,320.
- $2,485,480. (correct)
Which of the following scenarios may an analyst use to forecast sales growth for a company in the next fiscal year?
Which of the following scenarios may an analyst use to forecast sales growth for a company in the next fiscal year?
Current year balances for working capital accounts are $8 million for accounts payable, $13 million for inventory, and $10 million for accounts receivable. If the former is forecasted to grow 3% and the latter two line items are forecasted to grow 4%, an analyst will estimate a working capital total closest to:
Current year balances for working capital accounts are $8 million for accounts payable, $13 million for inventory, and $10 million for accounts receivable. If the former is forecasted to grow 3% and the latter two line items are forecasted to grow 4%, an analyst will estimate a working capital total closest to:
In forecasting revenue for the next year, an analyst is most likely going to exclude which of the following situations from his forecasted number?
In forecasting revenue for the next year, an analyst is most likely going to exclude which of the following situations from his forecasted number?
A top-down revenue forecast is most likely to be based on expected:
A top-down revenue forecast is most likely to be based on expected:
Based on growth strategies outlined by the company's CEO, an analyst forecasts overall growth of 5%. With inflation forecasted by economists at 3%, an analyst will likely forecast capital expenditures related to maintenance to grow by what percentage next year?
Based on growth strategies outlined by the company's CEO, an analyst forecasts overall growth of 5%. With inflation forecasted by economists at 3%, an analyst will likely forecast capital expenditures related to maintenance to grow by what percentage next year?
Sandra Page, CFA, is preparing a pro forma balance sheet for a company. Page is planning to incorporate several ad hoc additions into her forecast that are not currently accounted for on the company's recently published balance sheet from the prior year. Which of the following items will Page most likely need to add?
Sandra Page, CFA, is preparing a pro forma balance sheet for a company. Page is planning to incorporate several ad hoc additions into her forecast that are not currently accounted for on the company's recently published balance sheet from the prior year. Which of the following items will Page most likely need to add?
In creating a forecast for capital spending devoted to maintenance projects, an analyst will often start her analysis by looking at a company's:
In creating a forecast for capital spending devoted to maintenance projects, an analyst will often start her analysis by looking at a company's:
Revenue for ABC Company will close the year at $15 million. In projecting next year's revenue, the CFO assumes nominal GDP growth of 3% and company revenue growing 15% faster than GDP. Projected revenue next year will be closest to:
Revenue for ABC Company will close the year at $15 million. In projecting next year's revenue, the CFO assumes nominal GDP growth of 3% and company revenue growing 15% faster than GDP. Projected revenue next year will be closest to:
Current-year sales for ABC Co. are $20 million. Although Annie Mann, CFA, forecasts overall growth of 5% heading into next year, she would like to further refine her estimates by assigning the following probabilities based on actions she thinks the competition may take:
Growth
Probability
6 percent
30%
5 percent
20%
4 percent
50%
Using these probabilities, what is Mann's forecasted sales total for next year?
Current-year sales for ABC Co. are $20 million. Although Annie Mann, CFA, forecasts overall growth of 5% heading into next year, she would like to further refine her estimates by assigning the following probabilities based on actions she thinks the competition may take:
| Growth | Probability |
|---|---|
| 6 percent | 30% |
| 5 percent | 20% |
| 4 percent | 50% |
Using these probabilities, what is Mann's forecasted sales total for next year?
Using a baseline revenue amount of $6 million for A Co., an analyst estimates that next year's revenue will grow by 3%. If the forecasted gross margin is equal to 65%, forecasted cost of goods sold (COGS) will be closest to:
Using a baseline revenue amount of $6 million for A Co., an analyst estimates that next year's revenue will grow by 3%. If the forecasted gross margin is equal to 65%, forecasted cost of goods sold (COGS) will be closest to:
A company's CFO plans to spend $45 million on capital expenditures in the next year. These expenditures will be funded through cash held in the company's bank accounts ($30 million) and $15 million coming from a planned debt issuance at the end of the current year. An analyst forecasting the capital structure of the firm will project which of the following?
A company's CFO plans to spend $45 million on capital expenditures in the next year. These expenditures will be funded through cash held in the company's bank accounts ($30 million) and $15 million coming from a planned debt issuance at the end of the current year. An analyst forecasting the capital structure of the firm will project which of the following?
In estimating sales for future years, an analyst will most likely account for which of the following potential assumptions?
In estimating sales for future years, an analyst will most likely account for which of the following potential assumptions?
An analyst forecasts average selling prices for each product and service a company provides, as well as expected sales volumes. Using these estimates is an example of which type of revenue forecasting?
An analyst forecasts average selling prices for each product and service a company provides, as well as expected sales volumes. Using these estimates is an example of which type of revenue forecasting?
Which of the following represents a benefit to an analyst incorporating scenario analysis into her forecasting?
Which of the following represents a benefit to an analyst incorporating scenario analysis into her forecasting?
An analyst is most likely to forecast summary measures for a company, rather than forecasting specific financial statement items, when:
An analyst is most likely to forecast summary measures for a company, rather than forecasting specific financial statement items, when:
An analyst is using an historical base rate convergence approach to estimate the growth rate of a company in an established industry. If the analyst forecasts sales growth for this company of 4% next year, it is most likely because:
An analyst is using an historical base rate convergence approach to estimate the growth rate of a company in an established industry. If the analyst forecasts sales growth for this company of 4% next year, it is most likely because:
An analyst would like to use historical results as a baseline to prepare his forecasted financial statements for the next year. Which of the following types of companies are appropriate for this type of approach?
An analyst would like to use historical results as a baseline to prepare his forecasted financial statements for the next year. Which of the following types of companies are appropriate for this type of approach?
An analyst attends a management call where the CEO projects revenue and operating expense growth of 4%-6% next year, respectively. Understanding the natural tendency of management when communicating these numbers, an analyst will most likely project which of the following?
An analyst attends a management call where the CEO projects revenue and operating expense growth of 4%-6% next year, respectively. Understanding the natural tendency of management when communicating these numbers, an analyst will most likely project which of the following?
Forecasting a fixed growth rate is most appropriate for estimating:
Forecasting a fixed growth rate is most appropriate for estimating:
A company has a market share of 5% and sales of $16 million. If overall industry sales are forecasted to grow 4% and the company's market share is expected to increase to 6%, expected sales for the company will be closest to:
A company has a market share of 5% and sales of $16 million. If overall industry sales are forecasted to grow 4% and the company's market share is expected to increase to 6%, expected sales for the company will be closest to:
Flashcards
What drives SG&A growth forecast?
What drives SG&A growth forecast?
Driven by inflation forecasts for fixed SG&A and sales growth for variable SG&A.
What is the debt-to-equity ratio?
What is the debt-to-equity ratio?
A measure of leverage (solvency) used to forecast capital structure.
How do you calculate forecasted accounts receivable?
How do you calculate forecasted accounts receivable?
Multiply days sales outstanding by forecasted revenue, divide by 365.
What is important in scenario analysis?
What is important in scenario analysis?
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What to exclude in revenue forecasting?
What to exclude in revenue forecasting?
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What is a top-down revenue forecast?
What is a top-down revenue forecast?
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How to forecast maintenance capital expenditures?
How to forecast maintenance capital expenditures?
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What ad hoc item to add to pro forma balance sheet?
What ad hoc item to add to pro forma balance sheet?
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How to create a forecast for capital spending?
How to create a forecast for capital spending?
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How to project next year revenue?
How to project next year revenue?
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Forecast capital structure of the firm
Forecast capital structure of the firm
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What should you account for in estimating sales?
What should you account for in estimating sales?
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What is forecasting average selling prices?
What is forecasting average selling prices?
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What are the benefits of incorporating scenario analysis?
What are the benefits of incorporating scenario analysis?
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When do you forecast summary measures?
When do you forecast summary measures?
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When should I utilize historical data
When should I utilize historical data
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What is a GDP growth forecast?
What is a GDP growth forecast?
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What is historical base rate convergence approach?
What is historical base rate convergence approach?
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What should you project when looking at revenue growth?
What should you project when looking at revenue growth?
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What is the best method to forecast fixed rate?
What is the best method to forecast fixed rate?
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Study Notes
Forecasting SG&A Growth
- When forecasting growth for the Selling, General, and Administrative (SG&A) line item in pro forma financial statements, consider that fixed SG&A is more influenced by inflation, while variable SG&A is more directly correlated with sales growth
- Therefore, inflation forecasts should drive the estimation of fixed SG&A, and sales growth should drive the estimation of variable SG&A
Forecasting Capital Structure Mix
- Analysts use the debt-to-equity ratio to forecast a company's capital structure mix
- A firm's capital structure includes liabilities and equity on its balance sheet
- The debt-to-equity ratio measures leverage (solvency)
- Working capital and the current ratio are not suited for forecasting a firm's capital structure
Calculating Forecasted Accounts Receivable
- The formula to calculate forecasted accounts receivable involves multiplying days sales outstanding (DSO) by forecasted revenue, and then dividing by 365
- With current revenues of $20 million and 8% forecasted growth, the forecasted revenue will be $21.6 million
- If the DSO is 42 days, the forecasted accounts receivable would be $2,485,480
Scenario Analysis for Sales Growth
- To forecast sales growth using scenario analysis, probabilities for each scenario must be between 0% and 100%
- The sum of all probabilities has to equal 100%
Estimating Working Capital
- To estimate working capital, accounts payable have to grow by 3%, and inventory and accounts receivable by 4%
- The forecasted working capital is calculated as accounts receivable + inventory - accounts payable
Revenue Forecasting Exclusions
- When forecasting revenue, exclude nonrecurring items, as they aren't sustainable
- Gains from remeasuring subsidiary financial statements aren't predictable due to exchange rate changes and should be excluded
- The sale of aged fixed assets and early losses from new products shouldn't be excluded when forecasting revenue
Top-Down vs. Bottom-Up Revenue Forecasts
- Top-down revenue forecasts rely on macro variables like GDP growth
- Bottom-up forecasts use company-specific factors such as prices, volumes, and sales at existing and new outlets
Forecasting Capital Expenditures
- When inflation is forecasted at 3% and overall company growth at 5%, maintenance-related capital expenditures are typically forecasted to grow by the inflation rate
Incorporating Items into Pro Forma Balance Sheet
- Contingent gains (e.g., lawsuits) are incorporated as a receivable on the balance sheet with a gain on the income statement but only when the gains are almost certain
- Exchange rate fluctuations and market value changes of equity securities aren't considered ad hoc, and are generally excluded from pro forma balance sheets
Approach to Forecasting Capital Spending
- When forecasting capital spending for maintenance projects, analysts often start by reviewing historical depreciation expenses - this indicates the age and condition of existing assets
- Prior-year sales and current year balances of gross property, plant, & equipment do not provide as much insight
Projecting Revenue
- The CFO assumes nominal GDP growth of 3% and company revenue growing 15% faster than GBP
- Use the formula : 3% x (1 + 0.15) = 3.45% × $15 million in revenues × 1.0345 = $15,517,500
Refining Estimates
- The weighted average probability of the three scenarios is equal to 4.8% (6% × 30%) + (5% × 20%) + (4% × 50%); $20,000,000 × 1.048 = $20,960,000
Projecting Cost of Goods Sold
- If the analysts estimates that next year's revenue will grow by 3% and the baseline is $6 million, next year's revenue will be $6,180,000
- To find COGS use: $6,180,000 x 35% = $2,163,000
Projecting Capital Structure
- A new debt issuance will lead to an increase in the debt-to-equity ratio which increases financial leverage
- Cash flow from investing activities decreases, given the outflow of $45 million for capital expenditure
Estimating Sales
- Projecting Tax rate changes and fixed cost reductions due to new negotiations will not impact sales totals
- A new product launch from a competitor will impact sales
Revenue Forecasting
- A bottom-up approach to revenue forecasting includes the analysis of an individual company
- Includes forecasting selling prices and expected sales volumes
Scenario Analysis
- Scenario analysis accounts for the reality that unforeseen changes and be positive or negative impacts on financial statements
When to forecast summary measures
- If summary measures are relatively stable over time, an analyst is most likely to forecast summary measures for a company, rather than forecasting specific financial statement items
Projecting the historical base rate
- Forecasted sales growth of 4% would make sense under this approach if the industry average were expected to be similar
Forecasting financial statements
- If an analyst would like to use historical results as a baseline to prepare his forecasted financial statements for the next year, mature-stage companies are appropriate for this time of approach
Management tendencies
- Management will often project lower revenue growth and higher operating expense growth
Forecasting a fixed growth rate
- Fixed growth rates are more appropriate for administrating expenses
- Cost of goods sold and selling expenses have more variable aspects
How forecasted sales are impacted
- With company sales of $16 million and market share of 5%, sales for the industry are equal to $320 million ($16 million / 0.05). If overall industry sales are forecasted to grow 4%, industry sales will be equal to $332,800,000. With a forecasted market share of 6%, the company's forecasted revenue will be $332,800,000 × 0.06 = $19,968,000
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