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Subject 1. Income Statement Modeling: Revenue PDF Download

Analysts can use different approaches to forecasting revenue for an individual company.

Top-down approaches usually begin at the level of the overall economy. Forecasts can then be made at more narrowly defined levels, such as sector, industry, and market for a specific product, to arrive at a revenue projection for the individual company.

  • In a growth relative to GDP growth approach to forecasting revenue, the analyst forecasts the growth rate of nominal GDP and industry and company growth relative to GDP growth. An analyst may conclude that a company's revenue will grow at a rate of 150 bps above the GDP growth rate, or in relative terms, the company's revenue will grow at a 10% rate faster than the GDP growth rate.

  • In a market growth and market share approach to forecasting revenue, the analyst combines forecasts of growth in particular markets with forecasts of a company's market share in the individual markets. For example, assume a company is expected to maintain a 5% market share for a given product. If the product market is expected to grow to be $1.5 billion in annual revenue next year. The target company's revenue is expected to be $75 million ($1.5 billion x 5%).

The opposite of top-down forecasting is the bottom-up approach. It starts with a micro view of the business that is built up to estimate revenues. It allows an analyst to quickly see how minor changes in assumptions can affect revenues. It also requires an in-depth knowledge of a company's revenue drivers.

Examples of bottom-up approaches:

  • Time series. The forecasts are based on historical growth rates or time series analysis.
  • Return on capital. The forecasts are based on balance sheet accounts. For example, a bank's interest revenue may be calculated as loans multiplied by the average interest rate.
  • Capacity-based measure. The forecasts, for example, in retailing, are based on same-store sales growth and sales related to new stores.

Hybrid approaches include elements of top-down and bottom-up approaches.

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