Assumptions in financial statements

Building financial models really starts when we begin making assumptions about what's going to happen to the business over time. In particular, in order to get to future assumptions, we're going to have to start by examining what's happened historically. I'm in the 02_05_Begin Excel file. Now, what we have here are a set of assumptions ranging from assumptions related to TAM, Target Addressable Market, to Income Statement Assumptions and Balance Sheet Assumptions. And these are really key assumptions that we're going to need to take from what's happened historically to what's happened in the future in order to forecast where this business will be going. Now, each of these assumptions is going to be built on our historical data initially. 

So, for example, looking at Revenue Growth. This revenue growth of 5.1% can come from the balance sheet. So, if we wanted to understand what 2015 Revenue Growth is, it's simply going to be the difference between our 2015 Revenue and our 2014 Revenue all divided by 2014 Revenue. Revenue Growth for 2015 was 7.77%. And we can look at this across our entire five year period. What we see for this particular firm, is that Revenue Growth varies significantly anywhere from mid-double digits down to low single declines in revenue growth. 

Similarly, we'll need to make assumptions about what COGS looks like, what SGNA look like, what Depreciation and Amortization look like and what Interest Rates look like. We'll do this based on historical figures from the financial statements. That's why, before we can even get to building the assumptions, we need to have an iron clad set of financial statements in place. We're going to have the same factors impacting our balance sheet. Whether it's Net Receivables based on days, whether it's Inventory, CAP Backs, or Equity Issuance and Debt Issuance, we're going to need to make similar assumptions over time in order to understand what will happen to this firm. 

Finally, and perhaps most difficult of all, we're going to have to make assumptions about what will happen to the market over time. Now, in theory, our targeted address we'll market can be broken down into two components. How much bigger the pie gets, and then how much bigger our piece of the pie gets. We've made an initial statement that in 2014 our piece of the pie grew one percent, while the pie itself grew by seven percent. In theory, this should be tied to our Revenue Growth. In practice, there will often be some difference between what we calculate as the Market Share growth and our piece of the pie's growth versus what actually happens with our top line. Even still, we'll want to go through and make projections based on what's happened over time. Now, in our particular case we can't pull these items directly from the financial statements, but we will have to pull them from other data sources. So, perhaps as an example, we have a four percent change in the market over time in 2015, and a two percent increase in our share of the market. These should tie directly to the level of Revenue Growth. At this point, you should be prepared to go through and begin building out assumptions for your own three statement financial model.