How to Forecast the Income Statement
Forecasting the income statement is a key part of building a 3-statement model because it drives much of the balance sheet and cash flow statement forecasts.
In the following guide, we address the common approaches to forecasting the major line items in the income statement in the context of an integrated 3-statement modeling exercise.
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Before any forecasting can begin, we start by inputting historical results. The process involves either manual data entry from the 10K or press release, or using an Excel plugin through financial data providers such as Factset or Capital IQ to drop historical data directly into Excel.
Here is Apple’s 2016 income statement:
Common issues when inputting historical income statement data
When inputting historical income statement data, several issues are usually encountered:
Deciding the level of revenue (sales) detail
Some companies report segment- or product-level revenue and operating detail in footnotes (which roll up into the consolidated income statement). For example, while Apple provides a consolidated “net sales” figure in the income statement, the footnotes provide sales by product (iPhone, iPad, Apple Watch, etc.).
If it’s important that the final model includes a scenario analysis — for example, what if iPhone unit sales are better than expected, but the iPhone average selling price is worse than expected? — a detailed historical segment breakout is useful to provide a foundation for forecasts. Otherwise, relying on the net sales line on the income statement is sufficient.
Line item classification
Not all companies classify their operating results the same way. Some companies will aggregate all operating expenses into one line, while others will break them into several line items. If our model will be used to compare performance across other firms, the classifications need to be apples-to-apples and often require us to make judgments on how to classify line items and whether to hunt for more detailed breakdowns in the financial footnotes.
For example, notice that Apple’s 2016 income statement above contains a line called “Other income/(expense), net” of $1,348 million. This line aggregates interest expense, interest income and other non-operating expenses, as we can see in Apple’s 10K footnotes:
Since 3-statement financial models need to forecast future interest expense based on debt levels and interest income based on future cash levels, we needed to identify and use the more detailed breakout provided in the footnotes.
Companies prepare their historical income statement data in line with US GAAP or IFRS. That means income statements will not contain financial metrics like EBITDA and Non GAAP operating income, which ignore certain items like stock-based compensation. As a result, we often have to dig in footnotes and other financial statements to extract the data needed to present income statement data in a way that’s useful for analysis.
Putting it all together
Below is an example of how to input Apple’s historical results into a financial model:
If you compare it with Apple’s actual income statement (shown previously) you’ll notice several differences. In the model:
- Other income is broken out to explicitly show interest expense and interest income.
- Depreciation and amortization as well as stock based compensation is explicitly identified in order to arrive at EBITDA.
- Growth rates and margins are calculated.
Notice the adherence to several financial modeling best practices including:
- Formulas are colored black and inputs are blue.
- The model presents data from left to right (unfortunately companies report results from right to left).
- Decimal places are consistent (two for per-share data, none in Apple’s case for operating results).
- Negative numbers are in parentheses.
- Expenses are all negative (not all models follow this convention — the key here is consistency).
Thanks for putting together a great article. I’m sure I’ll have more questions.
Do you use Net interest expense in debt schedule or interest expense?
Hi everyone, I have a question, does anyone know if Apple have capital /Financing leases? Because I couldn’t find it in the companies 10k. I search the note but I only find operating. Also, how I can I derive PP&E if I only have commercial paper. I mean Proceeds from/(repayments… Read more »
What’s the forecasted EBIT based on the information below?
Cost of goods sold: 32,000