Basics of financial modeling
Price X Volume = Revenue
Price, in turn, is driven by both a company’s pricing strategy and inflationary considerations. Volume drivers include industry growth, product demand, and market share, among potentially others.
You can the calculate the company’s market share by dividing its sales by the total sales for the industry.
By contrast, modeling using a bottom-up approach is based on the unit economic approach of a single customer or selling unit, regardless of the segmentation. Bottom-up analyses generally rely heavily on historical data from actual sales in the past, and go from there.
There are 3 types of revenue patterns to look for
Seasonal: revenue patterns that increase and decrease with a regular pattern during specific periods of the year
Cyclical: similar to a seasonal business, in that business tends to be strong in certain periods but weaker in others. For cyclical businesses, however, the trend usually lasts for a time period longer than one year (sometimes as long as a decade), and is generally unrelated to the calendar
What causes this cycle? It depends, but usually the cycle is tied to the strength of some economic indicator, such as gold prices, GDP growth, or new housing starts.
Secular: typically lasts longer than a cyclical trend. It typically involves the advent of a new technology or consumer behavior that is here for good, or at least for a long time
Cost structure is divided between fixed and variable costs
Costs can also be divided into production-related expenses (often called Cost of Goods Sold, or COGS), and non-production-related expenses (often called Other Operating Expenses or just Operating Expenses).
Fixed costs typically stay constant year over year. Variable costs are usually directly related to the production and supply of goods or services available for sale.
Operating leverage measures the degree to which profit as a percentage of revenue grows as revenue grows. Companies with a high fixed cost structure tend to exhibit the most operating leverage.
Earnings before interest and taxes (EBIT) AKA Operating Profit: Revenue - COGS + Other Operating Expenses.
EBITDA takes this EBIT one step further by removing the non-cash expenses. EBITDA is a proxy for the cash flow of the operations of a business, assuming that no new Capital Expenditures are necessary
It is important to understand that EBITDA and EBIT are not drivers of a financial model. They are among the primary outputs of the model
Author: Streetwalls