Forecasting the Income Statement Main categories to forecast – Revenues – Operating expenses Cost of goods sold Selling, general, and administrative expenses – R&D – Marketing expenses – Other/non-recurring expenses and income (if forecastable) Restructuring costs One-time charges Non-recurring income – Depreciation and amortization (part of COGS or SG&A, but separated here to highlight the fact that this is a separate forecast) – Interest expense/income – Shares outstanding 1

Forecasting revenues There are many ways to forecast growth rates in revenues. – Company guidance – but you should justify why you believe the company. You should give examples of instances when the company met/exceeded/underperformed its forecast. You want to adjust this number according to their performance – Macro approach – you can look at the forecast growth rate of the industry and/or economy and make adjustments depending on how your company is positioned within the industry – Forecast using units and prices – Revenues = price X quantity. This means getting forecast information on the units (e.g., # of subscriptions, # of physical units, etc) and prices – You can use any of these, or a combination of these applied to the segments to forecast revenues, depending on the information you have. 2

Forecasting operating expenses Operating expenses (COGS and SG&A) tend to be have a stable relationship with revenues. These items tend to be forecast as a % of revenue – An exception will be if COGS has volatile components such as fuel or commodities (metals, agricultural products) that account for volatility in COGS. In these cases, you want to make adjustments depending on the forecasts for these inputs. Your company’s 10-K will be a good starting point to find this out. – If R&D or marketing is an important activity within your company, and if you have separate information to forecast these items, you should try to do it. – You should make adjustments to incorporate new information about the company. Examples include new financial information from the latest 10-Q, 10-K, or 8-K; new equipment that will make production more efficient and/or cheaper; new acquisitions that will change production processes; new information about their competitor/s 3

Forecasting operating expenses (continued) – Please be realistic about your assumptions. Gains in efficiency don’t happen overnight. – You should forecast the line item and use the margins as a way of checking your assumptions. (Will be discussed in conjunction with the Excel example in class) 4

Forecasting other/non-recurring expenses and income You don’t need to forecast one-time charges (or gains) from prior statements – Unless the company predicts that these expenses will continue over the next year or so of your forecast period Dirty surplus components are not forecastable. You can assume they are zero over the forecast period. You can incorporate charges you anticipate will occur in the future You can make assumptions for smaller line items (e.g., they can be fixed (or changing) in your forecasts 5

Forecasting shares outstanding Will depend on information you have about – Share repurchases – New share issuance – Stock options exercise 6

Forecasting interest expense Will depend on two things: – The forecast size (in terms of total assets) of your company – the future capital structure of your company. To figure this out you will need information on What the company says about debt (are they going to issue more debt? Are they going to pay down debt?) New share issuances Share repurchases You can calculate future debt (short-term and long-term) as a percentage of total assets. You will need to have an estimate of the interest rate (you can divide interest expense by total debt as rough approximation) To calculate the interest expense, apply the interest rate to the total debt forecast. 7

Forecasting depreciation and amortization Will depend on the following – The forecast size (in terms of total assets) of your company – the forecast level of additions to PP&E. This will depend on the rate at which PP&E is forecast to grow. You can check how this has been growing historically, and make adjustments depending on what the company says about its future plans – The average life of PP&E (= average PP&E/depreciation ) 8