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Forecasting Income Statements

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Corporate Finance I: Measuring and Promoting Value Creation

University of Illinois at Urbana-Champaign

4.8 (427 ratings) | 10K Students Enrolled

Course 1 of 7 in the Financial Management Specialization

In this course you will learn how to use key finance principles to understand and measure business success and to identify and promote true value creation. You will learn how to use accounting information to form key financial ratios to measure a company’s financial health and to manage a company's short-term and long-term liquidity needs. You will also learn how to use valuation techniques to make sound business investment and acquisition decisions. Finally, you will learn how to incorporate risk and uncertainty into investment decisions and how to evaluate the performance of existing investments. Upon successful completion of this course you will be able to: • Understand how companies make investment decisions that create value for shareholders • Use accounting statements to measure the financial health of a company • Forecast and manage a company’s short- and long-term liquidity needs • Measure the contribution of a new project or acquisition to shareholder value • Incorporate risk into investment decisions using the appropriate discount rates • Evaluate the performance of a company or divisions of a company This course was previously entitled Financial Evaluation and Strategy: Corporate Finance. The course received an average rating of 4.7 out of 5 based on 177 reviews over the period of September 2015 through August 2016. A detailed breakdown of ratings and reviews received for the prior version of the course, which is identical in content to the current course, is provided in the course orientation page. This course is part of the iMBA offered by the University of Illinois, a flexible, fully-accredited online MBA at an incredibly competitive price. For more information, please see the Resource page in this course and onlinemba.illinois.edu.

Skills You'll Learn

Corporate Finance, Project, Finance, Mergers And Acquisitions (M&A)

Reviews

4.8 (427 ratings)

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JF

Feb 04, 2019

Great course! I felt that I learned quite a bit. My undergrad is Finance and I feel that this course covered more topics and in more depth than my previous university studies.

FX

Feb 04, 2019

The finance series are some of the best business classes I have taken. Professor Almeida does a fantastic job in teaching Corporate Finance. Highly recommended!

From the lesson

Module 2: Financial Planning

In Module 2, we will learn models that allow us to forecast and manage a company's short-term investments such as capital expenditures. We will forecast the future financial statements of a real world company and learn how to figure out how much external financing the company will need. We will then use real world examples to learn how short-term investments in working capital determine a company's need for short-term financing.

Forecasting Income Statements8:32

Taught By

Heitor Almeida
Professor of Finance, Stanley C. and Joan J. Golder Chair in Corporate Finance

[MUSIC]

To answer the question we just posed, we will need to do financial forecast.

That's what we just talked about, and the first

financial statement we're going to be thinking about is the income statement, so

now we're going to learn how to forecast an income statement.

The model we're going to use is what we call a percentage-of-sales model.

So in the percentage of sales model,

all the key variables are going to be growing at the same rate as revenue.

So everything is going to remain a constant proportion of revenue,

with certain exceptions.

There are some variables that we cannot use this assumption for

other variables we can.

So that's what we're gonna be talking about now.

It's a very common forecasting model.

Obviously, it's not the only one, and

it works better in some situations than others, but it's going to allow

you to illustrate what it takes to forecast a financial statement.

In this case, the income statement.

So this is the income statement for PepsiCo,

as we said we're going to start with December 2014 financial statements.

So these were the audited numbers that PepsiCo reported at the end of

the fiscal year in 2014, and

then we're going to be thinking about what's gonna happen next as we go forward.

What's going to happen to revenues, costs, and ultimately,

what's going to happen to the company's profitability.

That's what we are looking at.

The income statement ultimately gives you information about profits.

That's what we learned in module one, so

we're gonna be thinking about future profits.

So how do we use these model?

So we have here our revenue forecast for 2015.

As we just talked about, we're going to use revenue growth rates from capital IQ.

From 2015, revenues are expected to grow at a negative rate, so

PepsiCo revenues are actually going to decrease.

So they're going to decrease from 66.7 billion to 63.7 billion.

You can check that this is a 4.4% decline.

And now the question is, what is going to be the cost in 2015?

And I want you to think that about yourself, and try to solve that.

So try to figure out what is going to be the forecast for

cost of goods sold in 2015.

So here is the answer.

So we start from revenue.

The idea of this model is we start from the top of the income statement revenue,

and then we use the same assumption to forecast the other items.

So really what it boils down to is that

COGS in 2015 is going to be growing at the same rate as revenue.

So notice it's 4.4 here, 4.4 there.

So it's really very simple.

The other way to think about it is that,

the company's going to keep the same fraction.

So here you have the fraction in 2014

COGS were $30.9 billion revenue were

$66.7 billion, so that is a fraction.

And what's gonna happen in 2015 is that,

the company PepsiCo is going to keep the same fraction of COGS.

So COGS is going to decrease to $29.5 billion.

So that's the assumption we use, and of course, it's more reasonable,

it's reasonable in some cases, it's less reasonable in other cases, but

that's how you would use a percentage of sales model.

So what we do is we go back in the income statement.

So you would go back here in the income statement and just using a spreadsheet,

or you will probably be doing this in a spreadsheet.

It's not practical to forecast income statement on pencil and paper, but

that's literally what you'll be doing, is just writing the numbers.

So you have revenue here.

That we came up with, and then you keep forecasting the other numbers.

So we figured out that COGS is gonna be this value.

SG&A we're going to use the same assumption.

They're going to be growing at the same rate as revenue.

We're going to have the same fraction, it's the same thing.

So you can check that, that is the answer we're going to get.

So SG&A in 2015 is going to be 24.5 billion.

And now, we come to this item, Others.

So I want to talk about this a little bit.

In every real world financial statement,

there are going to be items that we are not sure about.

So what are these others?

And in some cases, you can do additional research.

In other cases, it might even be difficult to find out exactly what this item is.

So think about, we are trying to forecast future financial state.

So the key question is, what's going to happen in the future?

Is this item going to be a recurring item?

Is it going to grow?

So there are several assumptions you could work with here.

So a common assumption when you have these other items is just to assume that

they are one-time items.

That there are no recurring, so

whatever is happening in 2014 is not gonna keep happening in future years.

So that means you would just add a zero to those lines.

So that's what we have here in this slide.

We have all the non-operating income.

The question is, are they recurring items or are they one-time?

Here, we're going to assume that they are one-time items, and

that they're not gonna happen again in future years.

Again, of course, it's an assumption.

Every time we forecast a financial statement, we are making assumptions.

The assumptions could be more or less reasonable, and it really is the job of

the financial manager to try to come up with as good assumptions as possible.

Then we have interest statements.

When you think about interest statements, it's very clear that we

should not forecast interest of payments as a constant fraction of revenue.

The amount of interest that a company pays is going to depend on how much debt

the company has.

So PepsiCo, in this case, has $29 billion in debt in 2014.

You can check the slide with the balance sheet that is coming out in a few slides.

So PepsiCo has $29 billion in debt.

That means that your interest payment is gonna be whatever interest rate you're

paying times the amount of debt that you have.

So if you do this calculation using our assumption, again,

there is the important slide with all the assumptions we're using.

Interest expense is 4% of total debt that means PepsiCo is going to be paying

a 1.15 billion interest payment every year.

And then, we're going to assume a constant tax rate.

So the tax rate is not going to change in future years.

And really,

these are all the assumptions we needed to forecast the entire income statement.

So here are some of the numbers that we wrote down ourselves.

And we can do it for every little cell here.

So here you have the interest, for example.

Taxes, we are assuming a constant tax rate.

And what that means is you can forecast all the items.

With all the non-operating income, we are using the same assumption we used above.

Which is to set them to zero, so effectively we are assuming that

this is a one-time expense that is not going to happen again in the future.

So that is the answer,

that is our forecast of PepsiCo's future income statement.

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