When starting your projections in a financial model, revenue is the most crucial component. Revenue drives enterprise value as well as many other line items in the model. Therefore, financial analysts must spend time planning and devising the best strategy to approach modeling future revenue streams.
Revenue should be projected by simply assuming a growth rate based on historical financial. Rather, it should be broken down one of several ways. The method depends on the particular company and the information provided in its financial statements.
Here are the four main methods to break down revenue:
- By revenue segment / product line: For companies with multiple products or business segments, breaking down and projecting the individual business lines provides for more accurate projections. For example, Apple is currently experiencing higher growth in iPhones and its service segment than its iPod segment. Once each segment is projected, simply add the revenue streams to calculate total revenue.
- By store count: Companies with large store expansion plans should contain a store growth projection, with the ending store count equal to the beginning store count plus new stores less closed stores. Once the store count is projected, financial analysts can project an average sales per store along with projected growth/declines. Multiplying average sales per store times stores open during the period will yield the total revenue for the period.
- By geography: Some companies are in the midst of expanding globally, or are seeing higher or lower sales growth in certain regions. For these companies, projecting revenue by geography could be the best method. For example, a soda manufacturer with a heavy concentration in the United States may be experiencing higher growth in China.
- Company-specific metrics: When companies break out revenue drivers, such as Monthly Active Users (MAUs), revenue can be projected using a projection of MAUs and average revenue per MAU. This method is similar to the store count method but instead of stores, you use some other revenue driver the company discloses.
Once again, since revenue drives the model, cash flow and value, significant effort and consideration must be spent on those projections. The method selected could have ramifications for the entire projection:
- When projecting by revenue segment, note how gross margins may differ across business line
- When projecting by store count, note how capital expenditure and pre-opening costs move higher
- When projecting by geography, note how the profit margins may be different across regions
Once you’ve completed your revenue projections, compare your output to management’s guidance and analyst estimates. Are your estimates higher or lower? Do you feel comfortable and can you defend your variances? What is the source of divergence? How does your overall outlook of the business and competition impact your assumptions?
The key to being a top financial analyst lies in the ability to not only build a robust model but to derive and defend your assumptions. In our financial analyst courses & boot camps in NYC, we create revenue projections for a public restaurant company using the first method above. We review financial statements, company presentations, and earnings transcripts to determine key revenue and store growth assumptions.