Hi everyone. As we discussed, the sequence in which you execute your financial statement forecast is important as the financial statements are linked together. In many items such as revenue, serve as the forecast driver for individual line items within the income statement, balance sheet, and statement of cash flows. Within this video, we'll discuss our approach to forecasting the income statement. As previously mentioned, we start with the gap income statement, adjust for one time non-recurring items, and then perform ratio analysis, and in effort to identify trends that could serve as a starting point for developing the forecast. We start at the top of the income statement and work our way down. First is net sales. I believe it's important to forecast revenue by each reportable segment. This is how the chief operating decision maker analyzes the business. Oftentimes there are different trends in growth rates by segment. I first look at historical trends and then adjust up or down depending upon company guidance, the overall industry outlook, the company's strategies, and their competitive position. You can see from this excerpt that this company has four reportable segments: household products, personal care products, consumer international, and especially products division or SPD. The growth rates vary by segment. Within the forecast model I insert an area to document my assumptions so that I can use for post-auditing purposes after actual results are reported. I then input future growth rates based upon historical trends, company guidance, industry outlook, and my assessment of the company strategies and competitive position in order to calculate my 2021-2023 net sales forecast. Calculating the net sales forecast is extremely important as this serves as a driver for many other line items within the income statement, balance sheet, and statement of cash flows. Next is gross profit. It's important to analyze gross margin percent of sales results for the past 2-3 years. Oftentimes trends emerge. They can be used as a starting point for your forecast. Also many companies discuss gross margin percentage of sales within the MD&A section of the 10-K and include as part of their company guidance. Specific initiatives focused on gross margin improvement can have an impact on forecast and should be considered when developing the future outlook. You can see from this excerpt that gross margin as a percent of sales has range from 44.4 percent to 45.5 percent in the latest three fiscal years. In addition, the company has a track record of focusing and improving gross margin. In fact, per review of their proxy filing, gross margin percent of sales is a bonus metric for the management team. As a result, we have forecasted a 20 basis points improvement for each of the next three years. Forecasted gross margin percent of sales rates multiplied by the net sales forecast for 2021, 2022, and 2023 allows us to calculate gross profit dollars, and then back into cost of goods sold. The approach to forecasting operating expenses is similar to forecasting gross profit. The focus is on a percent of sales. It's important to analyze operating expenses as a percent of sales results for the past 2-3 years. Oftentimes, trends emerge they can be used as starting point for your forecast. Also many companies discuss operating expenses as a percentage sales within their MD&A section of the 10-K and include as part of their company earnings guidance. Specific initiatives focused on expense improvement can have an impact on forecast and should be considered when developing the future outlook. Finally, it's important that your forecast is internally consistent, meaning, accelerated growth and revenue will likely need to be supported by investments in key drivers such as advertising and a research and development. Using a percent of sales approach will help in driving this internal consistency. You can see from this excerpt that SG&A as a percent of sales has ranged from 13.6 percent to 14.1 percent in the latest three fiscal years. In addition, advertising as a percent of sales has increased steadily from 11.7 percent in 2018 to 12.1 percent in 2020. Per review, the earnings call transcripts, the MD&A, and investor presentations, the company has indicated a focused effort to reducing SG&A cost, and a commitment to increasing support of their brands through investments in advertising to drive continued sales growth. As such, we have forecasted 10 basis points improvement within SG&A as a percent of sales and forecasted to reinvest these savings by increasing advertising as a percent of sales, by 10 basis points each year. Forecasted SG&A and advertising as a percent of sales rates multiplied by net sales for 2021, 2022 and 2023 allows us to calculate SG&A and advertising expenses for 2021 through 2023. The approach to forecasting financing and other items is mainly trend-based. Unless there's a stated plan to increase leverage or de-lever, it's reasonable to assume that current maturities will be refinanced at similar rates and thereby debt and interest expense levels will remain consistent with trend. In addition, other income expense items are usually immaterial. As such, forecasting consistent with trend or prior year is a reasonable approach. As you can see, financing and other items have decreased from 72.2 in 2018 to 55.9 in 2020. Per review of the company guidance, the MD&A and investor call transcripts, there has been no mention of plans to increase or decrease leverage. As such, financing and other items has been forecasted to be flat to 2020 levels. Due to the complexity and unique aspects of a company's tax situation, many companies provide guidance for investors as to their expected future tax rate. If company guidance is not provided, it's reasonable to forecast using a prior year trend-based approach. Alternatively, primarily US-based companies can be forecasted at the 21 percent federal tax rate plus an average of the state tax rate. As you can see, the effective tax rate calculated as income tax expense divided by pre-tax income has remained relatively consistent over the past three years. Based on company guidance and consistent with prior year trend, the 2021 through 2023 effective tax rate is forecasted to equal 18.5 percent, consistent with 2020 levels. The forecasted effective tax rate of 18.5 percent multiplied by pre-tax income allows us to calculate tax expense in each of the forecasted years. Finally, the approach to forecasting common shares outstanding is often based upon trend. However if there's significant volatility in prior year levels due to share issuances or repurchase activity, it is reasonable to forecast shares equal to the prior year. This approach allows you to compare earnings per share based upon base business results absent capital allocation decisions such as share repurchases. When reviewing the past three years of activities for shares outstanding, there is a consistent trend of modest increases from year to year. This activity is likely driven by equity compensation awarded to members of management. Given the consistent trend, it is reasonable to forecast a continuation of an increase in share count of 20 basis points in each of the forecasted years.
