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Forecasting Basics – The Income Statement

November 10, 2016

By Frank Luengo, Sonora Foods Ltd. 

In a previous post I talked about how you can organize your income statement to facilitate ratio analysis.

The same income statement format can be used for common margin ratios as well as forecasting. The first step is to common size your income statement to gain understanding of all the different components of revenue and expenses relative to top line sales. Consider the following fictitious income statement:

In the right column I have taken each line item value and divided it by top line sales to create a percentage value. Right away you get ratios such as EBITDA margin and net profit margin as well as each expense as a percentage of sales. If you take a time series of several income statements (monthly, quarterly, or annually, depending on your needs) you can see what the trends are for each of these values.

With your knowledge of the business and your understanding of emerging cost trends you can now make reasonable assumptions about each cost component in the future. Where possible you will then need to supplement your forecast with projected changes in operating budgets and input costs.

So, for example, if you expect revenues of $380 in the next reporting period, you can estimate that your cost of sales will be $190, or 50% of sales.

You will need to be cautious of some costs which can be “chunky” and will not move smoothly with sales. A couple of examples are depreciation, which depends on possibly irregular capital expenditures, and general and administrative costs, which are fixed in the short term but variable in the long term.

Once you have a reasonable forecast, you will need to use this income statement to help forecast your balance sheet. I will show an example in a future post.

This article was written by Frank Luengo, originally published on Frank’s Vault.