Company Analysis: Forecasting

Question 1

What are financial statement forecasts used for?

Answer 1

Valuation and investment recommendations.

Question 2

What are the four key forecast objects?

Answer 2

• Financial statement lines with clear drivers
• Financial statement items without clear drivers
• Summary measures
• Ad hoc items

Question 3

What is a primary advantage of forecasting drivers?

Answer 3

Explanatory value and forecast accuracy.

Question 4

What is a disadvantage of forecasting drivers?

Answer 4

Numerous drivers that are difficult to forecast as a group.

Question 5

What should forecasts be based on?

Answer 5

Information that is readily available and reasonably frequent and recurring.

Question 6

What is the simplest forecasting method?

Answer 6

Using actual past results as the starting point.

Question 7

When is using historical results as a forecasting method most appropriate?

Answer 7

For companies and industries that are noncyclical or in the mature stage.

Question 8

What does historical base rate convergence assume?

Answer 8

A forecasting object will converge to an industry average or median growth rate.

Question 9

Why might management guidance be useful in forecasting?

Answer 9

Management has internal and industry information that is unavailable to the public.

Question 10

What is the drawback of using management guidance?

Answer 10

It is rarely presented as a point estimate, often given as a range.

Question 11

What is an analyst discretionary forecast?

Answer 11

A catch-all for any other forecasting approach than the three previously discussed.

Question 12

What factors determine the appropriate forecast horizon?

Answer 12

• Investor’s or portfolio manager’s time horizon
• Whether the industry is cyclical
• Specific company changes

Question 13

What is the focus of top-down revenue forecasts?

Answer 13

Expectations about a macro variable, often nominal GDP growth.

Question 14

How does an analyst model company revenue growth relative to nominal GDP growth?

Answer 14

By projecting company growth will exceed or lag GDP growth.

Question 15

What is the starting point for bottom-up revenue forecasts?

Answer 15

An individual company or its reportable segments.

Question 16

What are examples of bottom-up drivers?

Answer 16

• Average selling prices (P) and volumes (Q)
• Product line or segment revenues
• Capacity-based measures
• Return- or yield-based measures

Question 17

What should analysts avoid including in a revenue forecast?

Answer 17

Nonrecurring items.

Question 18

What is the formula for forecasting cost of sales (COGS)?

Answer 18

Forecast COGS = (historical COGS / revenue) × estimate of future revenue.

Question 19

What does a decrease in market share indicate about gross margins?

Answer 19

It puts pressure on the company’s gross margins.

Question 20

How can small changes in COGS impact profitability forecasts?

Answer 20

COGS is typically a large portion of a company’s costs.

Question 21

What type of expenses are SG&A considered to be?

Answer 21

Less sensitive to changes in sales volume.

Question 22

What three balance sheet items comprise working capital forecasts?

Answer 22

• Accounts receivable
• Inventories
• Accounts payable

Question 23

What is the formula for calculating days sales outstanding (DSO)?

Answer 23

DSO = 365 / receivables turnover.

Question 24

How is inventory days on hand (DOH) calculated?

Answer 24

DOH = 365 / inventory turnover.

Question 25

What is the formula for days payable outstanding (DPO)?

Answer 25

DPO = 365 / payables turnover.

Question 26

What must an analyst consider when forecasting capital investments?

Answer 26

Tangible and intangible assets.

Question 27

How can we forecast inventory turnover?

Answer 27

Forecast inventory turnover can be calculated as forecast COGS / forecast average inventory or forecast inventory as DOH × (forecast COGS / 365) ## Footnote COGS stands for Cost of Goods Sold, and DOH stands for Days on Hand.

Question 28

What does Days Payable Outstanding (DPO) represent?

Answer 28

DPO is calculated as 365 / payables turnover ## Footnote Payables turnover is the ratio of total purchases to average accounts payable.

Question 29

How can we forecast accounts payable?

Answer 29

Accounts payable can be forecast as DPO × (forecast COGS / 365) ## Footnote This relates the number of days payable to the cost of goods sold.

Question 30

What are the two categories of capital expenditures for accurate forecasting?

Answer 30

Capital expenditures should be divided into: * Maintenance * Growth ## Footnote Maintenance capital expenditures are necessary to maintain existing assets, while growth capital expenditures are aimed at expanding the business.

Question 31

What is the starting point for forecasting maintenance capital spending?

Answer 31

Historical depreciation is usually the starting point for forecasting maintenance capital spending ## Footnote This provides a baseline for estimating future expenses.

Question 32

What must be accounted for when estimating maintenance expenditures?

Answer 32

Expected inflation rate must be accounted for when estimating maintenance expenditures ## Footnote Replacement costs typically increase with inflation.

Question 33

How can depreciation and amortization be forecasted?

Answer 33

Depreciation and amortization can be forecast using net book value of property, plant, and equipment and the estimated useful life of the assets ## Footnote This provides a systematic approach to estimating future depreciation expenses.

Question 34

What factors should analysts consider when forecasting a firm's capital structure?

Answer 34

Analysts should consider: * Leverage ratios (e.g., debt to assets, debt to equity) * Borrowing requirements due to planned capital expenditures * Management's target capital structure * Debt covenant ratios ## Footnote These factors help assess the company's financial strategy and risk.

Question 35

What is the purpose of scenario analysis in forecasting?

Answer 35

Scenario analysis examines the sensitivity of net income to changes in assumptions ## Footnote This includes varying assumptions such as economic conditions, competition, and technological changes.

Question 36

True or False: Forecast financial statements should rely on a single point estimate.

Answer 36

False ## Footnote Multiple scenarios provide a range of estimates, enhancing the robustness of forecasts.

Question 37

What is the end result of performing scenario analysis?

Answer 37

The end result is to develop a range of estimates using multiple scenarios ## Footnote This approach allows analysts to better understand potential outcomes and risks.