Lesson 2 of 7 · All lessons in this module
- What to forecast: forecast objects and principles
- Forecast approaches and the forecast horizon
- Forecasting revenue: top-down, bottom-up and non-recurring items
- Forecasting operating costs: COGS, SG&A and segment margins
- Working capital, capital investments and capital structure
- Integrated case: fixed assets class by class and a marketplace cost base
- Scenario analysis: risk factors, cost structure and sensitivityVideo lesson
Lesson 2 of 7 · 14 min
Forecast approaches and the forecast horizon
Any forecast object can be projected from historical results, from a base rate it converges to, from management guidance or from the analyst's own discretion, and the right choice depends on industry structure, cyclicality, the business model and the quality of information.
In short
- Historical results (past is precedent): simplest, the default; fits stable industries with low cyclicality, and immaterial items. Poor for cyclical or restructuring companies.
- Historical base rates and convergence: the object converges to an industry, peer or macro average over a chosen time frame. Fits mature industries with many peers and smaller firms 'maturing into' a peer profile; poor for new industries, highly cyclical ones and dominant leaders.
- Management guidance: forward-looking and informed, but check management's track record; the upper end of a range often reflects true expectations better than the midpoint. Avoid for macro-sensitive items.
- Analyst's discretionary forecast: surveys, models, analogies; most common for cyclical companies, few comparables, no guidance, or fundamental change.
- The forecast horizon depends on the investment strategy, the industry's cyclicality (reach mid-cycle), company-specific factors (acquisitions, restructuring) and the employer's preferences.
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