G describe how ratio analysis and other techniques can be used to model and forecast earnings.

Question 1

Sensitivity Analysis

Answer 1

What if questions?

Ex: What will be the effect on net income if sales increase by 3% rather than the estimated 5%?

Question 2

Scenario Analysis

Answer 2

Based on specific scenarios (a specific set of outcomes for key variables), will yield a range of values for financial statement items.

Question 3

Simulation

Answer 3

Probability distributions of key variables are selected and a computer is used to generate a distribution of values for outcomes based on repeated random selection of values for the key variables

Question 4

Ratio analysis and pro forma financial statements relationships

Answer 4

Ratio analysis prepared pro form financial statements

Pro forma financial statements provide estimates of financial statement items for one or more future periods

Question 5

Relationship: COGS, common-size income statement, a forecast of financial results

Answer 5

A forecast of financial results that beings with an estimate of a firm’s next-period revenues might use the most recent COGS, or an average of COGS, from a common-size income statement.

On a common-size IS, COGS is calc as = %of revenue. If the analyst has no reason to believe that COGS in relation to sales will change for the next period, the COGS percentage from a common-size income statement can be used in constructing a pro forma income statement for the next period based on the estimate of sales.

If no change takes place from prior period, analyst may choose t incorporate the operating profit margin from the prior period into a pro forma income statement for the next period. Beginning with an estimate of next-period sales, the estimated operating profit margin can be used to forecast operating profits for the next period.