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.

Practice Question 1

How are industry growth rates typically incorporated in a top-down revenue model?

A. Ignored, as they are considered irrelevant.
B. Used as the main driver of revenue projections.
C. Integrated along with other macroeconomic factors.
D. Applied only to specific product lines.

Correct Answer: B

Practice Question 2

What is the primary focus of a bottom-up approach to modeling revenue?

A. Macro-economic trends.
B. Individual product or service lines.
C. Overall industry growth.
D. Market share analysis.

Correct Answer: B

Practice Question 3

In a top-down revenue model, what type of data sources are typically utilized?

A. Detailed company-specific data.
B. Aggregated financial statements.
C. Industry reports and economic indicators.
D. Customer-level data.

Correct Answer: C

On the other hand, a bottom-up revenue model relies on detailed company-specific data.

Practice Question 4

What does "granularity" refer to in the context of bottom-up revenue modeling?

A. The simplicity of the model.
B. The use of industry averages.
C. The level of detail and specificity in the model.
D. The overall complexity of the revenue analysis.

Correct Answer: C

Practice Question 5

Time-series approaches are considered:

A. top-down.
B. bottom-up.
C. hybrid.

Correct Answer: B

However, time-series analysis can be a tool used in top-down approaches.

Practice Question 6

In a bottom-up revenue model, what type of data sources are typically utilized?

A. Detailed company-specific data.
B. Aggregated financial statements.
C. High-level industry reports.

Correct Answer: A

On the other hand, industry reports and economic indicators are utilized in a top-down approach.

Practice Question 7

In a bottom-up revenue model, what are the key drivers of revenue?

A. Company-specific factors and product-level details.
B. Overall industry growth rates.
C. Market share percentages.

Correct Answer: A

On the other hand, industry reports and economic indicators are utilized in a top-down approach.

Practice Question 8

What is the primary focus of a top-down approach to modeling revenue?

A. Individual product or service lines.
B. Overall industry trends and macroeconomic factors.
C. Market share analysis.

Correct Answer: B

On the other hand, industry reports and economic indicators are utilized in a top-down approach.

Practice Question 9

An IT company's market share stands at 10% of a $1bn market in 2013. The overall industry is expected to grow at a rate of 1%. The company expects that its innovative products coupled with aggressive marketing will allow it to increase its market share by 5% each year. What will its revenues be for the year of 2017?

A. $104.6 million.
B. $126.5 million.
C. $119.3 million.

Correct Answer: B

The market size will be 1,000m x (1.01)⁴ = $1,040.6m. The company's market share will be 10% x 1.05⁴ = 12.16%. The annual revenue in 4 years will be 1,040.6 x 12.16% = $126.5m.

Practice Question 10

Which approach is considered to be "top-down"?

A. market growth and market share.
B. time series.
C. return on capital.

Correct Answer: A

In this approach the analyst starts from the top - growth in a particular market.