[PDF] Financial Modeling Growth Rate Logic - Wall Street Training

105641_2WST_Financial_Modeling_Assumptions.pdf Wa ll S t . T r a i n i n g i s a r e g i s t e r e d s e rv i c e m a r k o f H L C a p it a l P a r t n e r s , L t d . Hamilton Lin, CFA W a ll S t. T r a i n i ng President + 1 ( 212
) 537
- 663

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P r o v i d i n g f i n an c i a l t r a i n i n g t o W a l l S t r eet®WALL ST FINANCIAL STATEMENT MODELING

JUSTIFYI

N G G R O W TH RATES AND M AR G I N

ASSUMPTIONS

RUN - RA TE , N O N - D I S T R E S S E D , G O I N G C O N C E RN E N T I T Y S A L E S / R E V E NU E G R O W T H Instead of just assuming a 10% growth rate, base your assumptions on the following:

· Historical trends (calculate CAGR, historical growth rates, average of historical growth rates, i.e. last 3 years)

· Specific growth initiatives (why use 15% growth if never grew past 10%? Unless specific growth plans)

· Industry growth and trends

· Build-up analysis

I t i s no t un c o mm o n t o h a v e d e c l i n i n g g r o w t h r a t e s ( s t il l g r o w t h , a l b e i t a t a s l o w e r p a ce ) i n t h e p r o j ec t i o n p e r i o d a s on e c a nn o t g r o w a t 15 % o r 20 % f o r e v e r . S i n c e w e kno w t h a t t h e p a s t i s a P E R F E C T i n d i c a t o r o f t h e f u t u r e , t h e m o r e n u m b e r o f h i s t o r i c a l y e a r s i n yo u r a n a l y s i s t h e b e t t e r w h e n j u s t i f y i n g y o u r p r o j e c t i o n i n pu t s . S e n s i t i z e y o u r p r o j e c ti o n s f o r " B a s e C a s e " o r " M g m t C a s e " , " O p t imi s ti c" o r " A g g r e ss i v e" a nd "P e s s i mi s ti c" o r " D o w n s i d e" c a s e s ! F UND A M E N T A L S A L E S / R E V E NU E G R O W T H RA TE B U I L D - U P E X A M P LE

S Wal-Mart (Retailer):

· Econometric / regression analysis of sales vs. GDP and/or population growth (leave to statisticians) '

· Sales / square foot / type of store; this allows you to capture: o Number of stores (and growth in number of stores) o Type of store (i.e."upgrading" a smaller neighborhood store to a super-center) o Same store comp sales (critical to retail) o Size in sq. foot per store (stores get larger on average due to space efficiencies or expansion) C o c a - C o l a ( B e v e r a g e ):

· Geographic:

o US: more mature, saturated market è slower growth

o Asia: rapid growth è get each person in China to drink 1 Coke per year è extra billion + cans sold!

· Product Type and Demographic Changes

o syrup vs. power vs. food o carbonated vs. non-carbonated

§ Coke recently purchased Vitamin Water

§ Growth in carbonated staggering as consumers become more health conscious § Imagine a Vitamin Water vending machine next to every Coke vending machine worldwide

§ Might cannibalize own product to a certain extent, but someone else would do that for you anyway!

E X P E N S E S · COGS, % of Sales and SG&A, %of Revenue: similar to Sales / Revenue growth justification o Historical trend, usually want to see these decline over time due to economies of scale Wa ll S t . T r a i n i n g i s a r e g i s t e r e d s e rv i c e m a r k o f H L C a p it a l P a r t n e r s , L t d . Hamilton Lin, CFA W a ll S t. T r a i n i ng President + 1 ( 212
) 537
- 663

1 www.wallst-training.com

i nf o @ w a ll s t - t r a i n i n g . c om www.wstselfstudy.com TRAININGwww.wallst-training.com P r o v i d i n g f i n an c i a l t r a i n i n g t o W a l l S t r eet®WALL ST T R A I N I

NGwww.wallst-training.com

P r o v i d i n g f i n an c i a l t r a i n i n g t o W a l l S t r eet®WALL ST FINANCIAL STATEMENT MODELING

JUSTIFYI

N G OTHER

ASSUMP

T IONS RUN - RA TE , N O N - D I S T R E S S E D , G O I N G C O N C E RN E N T I T Y D E P R E C I A T I O N E X P E N S

E · Ideal detailed build-up approach (absent actual projections from company internal accounting system)

o Depreciate existing Net PPE based on estimated remaining useful life of each separate asset o Useful life inputs can be found on any MD&A; remember, land is not depreciated

o Depreciate new Capital Expenditures based on estimated weighted average useful life of all (new) assets

· % of Revenue: fair approach if historical % of Revenue has been fairly constant and consistent; should result

i n s i m i l a r n u m b e r s W O R K I N G CA P I T A L

· Use concept of Cash Conversion Cycle and Days Outstanding formulas for non-service based entities

o Days Inventory Outstanding: Inventory * 365 / COGS o Days Receivable Outstanding: AR * 365 / Revenue o Days Payable Outstanding: AP * 365 / (COGS+SG&A) · % of Revenue (usually 1% - 2% or base on historical percentages) · % of Change in Revenue (usually 1% - 2% or base on historical percentages)

· 30 or 60 Days Working Capital changes

o Calculate Working Capital requirement: take Total Operating Expenses (usually, COGS+SG&A, do not i n c l u d e D & A o r i n t e r e s t ) a nd d i v i d e b y e i t h e r 12 ( 30
d a y s o r 1 m o n t h ) o r 6 ( 60
d a y s o r 2 m o n t h s )

o Take the difference each year è that is your Change in Working Capital (usually a cash flow out)

o Rationale: when a company is sold, a minimum working capital requirement is usually part of the t e r m s h e e t; t h i s i s t h e w o r k i n g c a p i t a l r e q u i r e d t o r u n a nd s u s t a i n t h e bu s i n e ss a nd d a y - t o - d a y o p e r a t i o n s , e l s e t h e ac q u i r o r w o u l d h a v e t o i n j e c t m o r e c a p i t a l i n t o t h e bu s i n e ss , r a i s i n g t h e i m p li e d pu r c h a s e p r i c e CA P I T A L E X P E ND I T UR E S · Next fiscal year estimate is usually supplied by management in any MD&A · For subsequent years, CapEx can be estimated as follows: o Keep constant each year o $ change (based on historical CapEx if relevant) o %age change (based on historical CapEx if relevant)

o Average of last 3 years (usually CapEx grows each year, so for a "normal" trend, this projects a decline)

· We don't think it's ideal to use the following approaches:

o % of Revenue è in theory, Revenue lags CapEx; while you may get a stable trend, it's reverse logic

o % of D&A è in theory, D&A is a function of a very precise, identifiable CapEx calculation; avoid this

o % of Net or Gross PPE è in theory, PPE is a function of CapEx; avoid this method for sure! . Wa ll S t . T r a i n i n g i s a r e g i s t e r e d s e rv i c e m a r k o f H L C a p it a l P a r t n e r s , L t d . Hamilton Lin, CFA W a ll S t. T r a i n i ng President + 1 ( 212
) 537
- 663

1 www.wallst-training.com

i nf o @ w a ll s t - t r a i n i n g . c om www.wstselfstudy.com TRAININGwww.wallst-training.com P r o v i d i n g f i n an c i a l t r a i n i n g t o W a l l S t r eet®WALL ST T R A I N I

NGwww.wallst-training.com

P r o v i d i n g f i n an c i a l t r a i n i n g t o W a l l S t r eet®WALL ST FINANCIAL STATEMENT MODELING

JUSTIFYI

N G OTHER

ASSUMP

T IONS RUN - RA TE , N O N - D I S T R E S S E D , G O I N G C O N C E RN E N T I T Y D E F E RR E D T A X A S S E T S & L I A B I L I T I E S ( D T A & D TL ) · Deferred taxes only occur due to temporary differences in taxes that will reverse

· Permanent differences in taxes result in immediate increase / decrease to effective tax rate (vs. statutory rate)

· DTAs arise primarily due to NOLs (Net Operating Losses) o Future benefit to be used to offset future taxes o Calculated as Net change in NOL x Future estimated statutory tax rate · DTLs arise primarily due to difference between book (GAAP) and tax depreciation o GAAP depreciation assumes straight-line (pro-rata) over life of asset o TAX depreciation assumes accelerated depreciation over life of asset (in USA, MACRS applies)

o Thus, in the early years of an asset's life, a larger depreciation expense results in lower Taxable Income and

t h u s , l o w e r t a x e s ; t h i s r e v e r s e s i n t h e l a t e r y e a r s ; i f a c o m p a n y k ee p s a d d i n g t o i t s a ss e t b a s e , s o m e t i m e s t h i s r e s u l t s i n a p e r m a n e n t c h a ng e a n d i n c r e a s e s R e t a i n e d E a r n i n g s , a no n - P & L i m p a c t

· Other temporary differences include: FMV step-up in mergers, pension and OPEB recognition among others

· Other permanent differences include life insurance premiums and payouts among others · Temporary differences are reconciled in M1 schedule for US corporations' tax returns