14 (FS&A) - Financial Statement Modeling Flashcards
Bottom-up Analysis
Financial analysis that starts with the study of an individual company or the reportable segments of a company.
Top-down Analysis
Financial analysis that starts with expectations about a macroeconomic variable, often the expected growth rate of nominal GDP.
Hybrid Analysis
Financial analysis that incorporates elements of both top-down and bottom-up analysis.
Between bottom-up, top-down, and hybrid analysis, which is the most common and why?
Hybrid Analysis. This is because by using elements of both an analyst can highlight inconsistencies between each approach.
What is “growth relative to GDP growth” revenue forecasting?
When one forecasts revenue for a company based on a modeled relationship between GDP and company sales growth. Company revenue growth is forecasted based on an estimate for future GDP growth.
What is “market growth and market share” revenue forecasting?
When one forecasts revenue for a company by first, estimating industry sales (market growth), and then company revenue is estimated as a percentage (market share) of industry revenue.
Economies of Scale
An economic situation in which a company will have lower costs and higher operating margins (because of lower costs) as production volume increases. In other words, as production volume increases, costs fall and operating margins rise.
Economies of scale should exhibit a positive correlation between sales volume and margins, thus increasing profitability the larger the company becomes in terms of volume.
How to identify if a company has economies of scale?
When companies with large amounts of revenue have lower COGS and SG&A as a proportion of revenue than smaller companies.
What is the best way to forecast COGS?
Because COGS is so closely related to revenue, future COGS is usually estimated as a percentage of future revenue. Expectations of changes in input prices can be used to improve COGS estimates.
Are SG&A costs variable or fixed?
They can be both. Different components of SG&A have different characteristics.
R&D and corporate overhead components of SG&A are likely to be stable (i.e. more fixed in nature) over the short term. Whereas, the selling and distribution costs will tend to increase with increased revenue (i.e. variable).
What are the two primary factors of gross interest expense?
- Amount/level of debt outstanding (i.e. gross debt)
- Market interest rates
Statutory Tax Rate
v.
Effective Tax Rate
v.
Cash Tax Rate
Statutory Tax Rate - Percentage tax charged in the country where the firm is domiciled.
Effective Tax Rate - Income tax expense as a percentage of pretax income on the income statement.
Cash Tax Rate - Cash taxes paid as a percentage of pretax income.
What are the five major behavioral factors that affect analyst forecasts?
- Overconfidence bias
- Illusion of control bias
- Conservatism bias (i.e. Anchoring)
- Representativeness bias
- Confirmation bias
Overconfidence Bias
When an analyst puts too much faith in one’s own work. Analysts may underestimate their forecasting errors.
Illusion of Control Bias
When an analyst has a false sense of security in one’s forecasts. To mitigate against this, one should seek outside opinion or only put stock/focus on variables with known explanatory power.
Conservatism Bias (aka Anchoring Bias)
When an analyst only makes small adjustments to their prior forecasts when new information becomes available.
Representativeness Bias
When an analyst tends to classify data based on past information and known classifications.
Confirmation Bias
When an analyst tends to only look for information that confirms prior beliefs and ignores data that contradicts them.
Describe approaches to balance sheet modeling.
When building a forecast model, many balance sheet items flow from the forecasted income statement items.
Net income less dividends declared will flow through to retained earnings.
Working capital items can be forecast based on their historical relationship with income statement items (i.e. turnover ratios).
Property, plant, and equipment (PP&E) on the balance sheet is determined by depreciation and capital expenditures (capex). One approach to estimating PP&E is to assume it will be equal to its historical average proportion of sales so that PP&E will grow at the same rate as revenue. However, by having an understanding of the company’s operations and future plans and incorporating this information into her model, an analyst can make more accurate projections of a company’s future capital needs. Forecasts may also be improved by analyzing capital expenditures for maintenance separately from capital expenditures for growth. Historical depreciation should be increased by the inflation rate when estimating capital expenditure for maintenance because replacement cost can be expected to increase with inflation.
Return on Invested Capital (ROIC)
Why is ROIC preferred over ROE?
A return on both equity and debt.
ROIC is preferable because it allows comparisons across firms with different capital structures (i.e. it adjusts for total return and not just return on equity).
What does it mean if a company has a higher ROIC than its peers?
When considering a company’s competitive environment, what can lead to higher ROIC and strong financial performance?
A higher ROIC indicates the company is likely exploiting some competitive advantage in the production and sale of its products/services.
Higher ROIC can be the result of favorable competitive conditions within Porter’s 5 Forces.
Companies have a higher ROIC when they have:
- More pricing power when the threat of substitutes is low and switching costs are high.
- More pricing power when the intensity of industry rivalry is low.
- More pricing power (and better earnings) when the bargaining power of suppliers is low.
- More pricing power when the bargaining power of customers is low.
- More pricing power (and better earnings) when the threat of new entrants is low.
When considering a company’s competitive environment, what can lead to higher ROIC and strong financial performance?
Higher ROIC and better financial performance can be the result of favorable competitive conditions within Porter’s 5 Forces.
Companies have a higher ROIC and better financial performance when they have:
- More pricing power when the threat of substitutes is low and switching costs are high.
- More pricing power when the intensity of industry rivalry is low.
- More pricing power and earnings potential when the bargaining power of suppliers is low.
- More pricing power when the bargaining power of customers is low.
- More pricing power and earnings potential when the threat of new entrants is low.
What can increase COGS?
An increase in the input costs of a good/service.
When can mitigate the increase in COGS from a rise in input prices?
If the company has hedged the risk of the input price increase with derivatives or contracts for future delivery.
