Projecting Income Statement Line Items

When building a three statement model, it becomes necessary to get into the habit of
projecting income statement line items. Being able to project the main line items of the
income statement should become second nature. Each speci c line item will have drivers
that impact their future values. In fact, if a speci c nancial model you are using is similar to
another company that you need to model, you may even be able to copy the model directly,
and simply replace the historical values.

Main Line Items to Forecast

The following are the main accounts that need to be covered when projecting income
statement line items:

Sales Revenue
Cost of Goods Sold (or Gross Revenue)
Total or Speci c General Expenses (SG&A)
Depreciation Expense
Interest Expense
Tax Expense

By including all of the above (and more if necessary), you can arrive at net income, or
bottom line of the income statement.

Below is a screenshot from one of CFI’s nancial modeling courses of the main drivers of an
income statement forecast.

 
 

Source: CFI’s nancial modeling courses.

Sales Revenue
Projecting income statement line items naturally begins with the top of the income
statement. This is the sales revenue. All subsequent line items will usually be based on the
sales revenue value.

Sales revenue can be forecasted in several di erent ways. Firstly, you can model sales
revenue as a simple growth rate from previous years. This means that any subsequent year
is the past year’s sales revenue multiplied by one plus the growth rate.

Secondly, you can model sales revenue as a factor of GDP or some other macroeconomic
peg/metric. This means that revenue for each year will depend on a regression formula
based on historic sales revenue and the input of that years GDP.

Finally, you can model sales revenue as a simple dollar value. This method of forecasting is
the least dynamic, and usually the least accurate. However, it is available when quick and
dirty sales revenue forecasts are needed.

 
Cost of Goods Sold (or Gross Pro t)
The next step is to forecast Cost of Goods Sold. By doing so, we can subtract COGS from
revenue to nd Gross Pro t. Alternatively, Gross Pro t can be forecast, and then we can
mathematically nd Cost of Goods Sold.

Regardless of which line item we choose to forecast, the method is simple. Most of the time,
the simple percentage of sales revenue method will su ce. We take past gures of cost of
goods sold (or gross pro t) over sales revenue and use these percentages to predict future
percentages.

Alternatively, a more robust model may model out speci c cost of goods items. These may
be split into raw material, work in progress, nished goods, labor costs, direct material costs,
or some other line items depending on business operations. These can be forecast as
percentages of sales revenue, as well, or using whole dollar values.

Selling, General, and Administrative Expenses

A simple and clean model will elect to forecast the total Selling, General and Administrative
(SG&A) expense as one line item. This is easily done with the percentage of sales method.
However, a more robust model may want to break out SG&A into individual components,
which is a more involved method. This is because each individual line item will have
di erent drivers.

For example, rent expense will generally be xed every month, and so a xed dollar value
will be more appropriate than a percentage of sales revenue. However, advertising expense
may be correlated with sales revenue, so in this case percentage of sales may be more
accurate. There may also be “one-o ” line expenses that do not appear every month, and so
will require speci c judgment. We discuss this more in our article on nancial statement
normalization.

There are also two line expenses that sometimes appear under SG&A that need speci c
forecasting work. These are depreciation expense and interest expense.

Depreciation Expense
Depreciation expense ties the gradual usage of machinery and PP&E to their bene t of
generating revenue. Because the economic bene t (revenue) of using PP&E lasts more than
one accounting period, the matching principle dictates that their expense must also be
accrued over more than one accounting period.
We forecast depreciation expense through the use of a depreciation schedule. This shows
us the opening balances of PP&E, any new capital expenditures and the closing balance of
PP&E. Through historic balances and capex, we can nd historic depreciation expense.
These values can then be used to predict future depreciation expense and capital
expenditures.

Depreciation expense can be forecasted in the schedule using a percentage of the opening
balance, or any of the depreciation accounting methods. If we know the company’s
depreciation policy, then we can directly apply straight-line, units-of-production or
accelerated depreciation to nd the proper expense values.

Learn more about the various types of depreciation.

Interest Expense
Interest expense is found through using the debt schedule. This schedule outlines each
individual piece of debt on their own schedule, and sometimes makes a summary schedule
that totals all balances and interest expense.

Interest expense is found by multiplying the opening balance in each period with the
interest rate. This interest expense is then added back to the opening balance and is then
reduced by any principal repayments to nd the closing balance.

Tax Expense
Finally, we arrive at the last line item to nd tax expense. Tax expense is a found as a
percentage of earnings before tax (EBT). This percentage is known as the e ective tax rate
or cash tax rate. EBT must be found by subtracting all the previous expense line items from
sales revenue. After multiplying EBT with the historical e ective tax rate, we are able to
forecast future tax expense.

Putting it all together

After projecting income statement line items, the income statement is found as follows:

Sales revenue
Less cost of goods sold
Gross pro t
Less SG&A
 EBITDA
Less Depreciation Expense
EBIT or Operating Income
Less Interest Expense
EBT
Less Tax Expense
Net Income

Source: CFI’s nancial modeling courses.

Forecasting an Income Statement

Additional Resources
CFI is the o cial provider of the global Financial Modeling & Valuation Analyst (FMVA)™
certi cation program, designed to help anyone become a world-class nancial analyst.
Through nancial modeling courses, training, and exercises, anyone in the world can
become a great analyst.

To keep advancing your career, the additional resources below will be useful:

3 Statement Model
Financial Statement Normalization
The Ultimate Cash Flow Guide
Projecting Balance Sheet Line Items

Financial Modeling Certi cation

Financial Modeling Certi cation online

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