Introduction to Financial Statement Modeling
Refresher reading access
Introduction
Financial statement modeling is a key step in the process of valuing companies and the securities they have issued. We begin our discussion with an overview of developing a revenue forecast. We then describe the general approach to forecasting each of the financial statements and demonstrate the construction of a financial statement model, including forecasted income statements, balance sheets, and statements of cash flows. Then, we describe key behavioral biases that can influence the modeling process and strategies to mitigate them. We then turn to several important topics on the effects of micro- and macroeconomic conditions on financial statement models: the impact of competitive factors on prices and costs, the effects of inflation and deflation, technological developments, and long-term forecasting considerations.
Most of the examples and exhibits used throughout the reading can be downloaded as a Microsoft Excel workbook. Each worksheet in the workbook is labeled with the corresponding example or exhibit number in the text.
Learning Outcomes
The candidate should be able to:
- demonstrate the development of a sales-based pro forma company model
- explain how behavioral factors affect analyst forecasts and recommend remedial actions for analyst biases
- explain how the competitive position of a company based on a Porter’s five forces analysis affects prices and costs
- explain how to forecast industry and company sales and costs when they are subject to price inflation or deflation
- explain considerations in the choice of an explicit forecast horizon and an analyst’s choices in developing projections beyond the short-term forecast horizon
2 PL Credit
If you are a CFA Institute member don’t forget to record Professional Learning (PL) credit from reading this article.