Projecting the 3 Statements & 3-Statement Modeling Quiz Questions

Projecting the 3 Statements & 3-Statement Modeling Quiz Questions 1. Let s say that we re creating 3-statement projections for a company, and in its historical filings Depreciation & Amortization and Stock-Based Compensation are NOT listed as separate items on its income statement. Which income statement line items might INCLUDE these figures, and how should we project these items in future years? a. They always show up exclusively in operating expenses; you only need them for the cash flow statement so you don t need to break them out separately in income statement projections. b. They may show up in either operating expenses or COGS, or in both; it s better to break them out as separate line items by modifying the historical statements and then project them separately going forward. c. They almost always show up exclusively in COGS; you should break them out as separate line items and project them separately going forward. d. If they re not listed on the income statement, the company does not have significant expenses in either category so we don t need to do anything. 2. Which of the following items should NOT be projected as a percentage of revenue? a. Depreciation & Amortization b. Accounts Receivable c. Accounts Payable d. Capital Expenditures

3. In the past 3 historical years, SG&A as a percentage of revenue was 15%, 17%, and 20%. Revenue grew by 10% each year. Why might SG&A as a percentage of revenue have INCREASED over time? Shouldn t the company achieve greater economies of scale as it grows? a. The company's market has become more competitive over time, and greater competition is driving up employee salaries and sales & marketing spending. b. The company has a high amount of long-term subscription revenue, with high deferred revenue balances as a result, its cash collected is growing quickly but its revenue growth is lagging behind and its income statement expenses appear to be growing as a percentage of revenue. c. The company has been developing a major new product over the past few years, and has hired additional staff to support that development. d. All of the above. 4. We re looking at the past 3 years of historical financial statements for a company. The cash at the bottom of the Cash Flow Statement matches up with what s on the Balance Sheet, but when you try to link all the items on the Balance Sheet to the corresponding items on the Cash Flow Statement, the historical statements do NOT balance why does that happen? a. This should never happen on the historical statements, so it indicates that you ve made a mistake somewhere and that you ve forgotten to count an item, you ve doublecounted an item, or you ve used the wrong sign. b. While not common, this does happen sometimes and indicates that the company has changed its accounting policies, possibly made an acquisition, or made off-book adjustments. c. It indicates that the company itself has made a mistake in its filings for example, they might be unaudited and may require further adjustments. d. Historical statements will never tie together.

5. A company records Depreciation of $10 on its income statement, and $20 for Depreciation on its cash flow statement. Which number represents its total Depreciation? a. $30 b. $10 c. You need more information to determine the answer. d. $20 6. In a simplified 3-statement model, you re projecting Capital Expenditures as a percentage of revenue, and Depreciation also as a percentage of revenue. To ensure that the PP&E figure never changes, you set CapEx as a % of revenue equal to Depreciation as a % of revenue. For example, CapEx is 3% of revenue and Depreciation is also 3% of revenue. What s the MAIN flaw with projecting CapEx and Depreciation this way? a. To grow, the company will likely need to do more than simply maintain its existing PP&E it will most likely need to spend to acquire or build new assets such as land, factories, and equipment. b. You should never project Depreciation as a percentage of revenue it should always be tied to the PP&E balance. c. A company will depreciate its PP&E over many years, so it s not accurate to assume that Depreciation in a single year will always equal CapEx in that year. d. CapEx and Depreciation rarely move in-line with revenue because a company s need to re-invest into its own business is independent of its sales growth. 7. You re linking Inventory to Cost of Goods Sold (COGS) in order to project it over a 5-year period. Over the past 3 historical years, Inventory as a percentage of COGS was 10% on average. What does that mean? a. 10% is far too low, so you should project Inventory in a different way and not link it to COGS. b. It means that, on average, the company goes through its Inventory balance and sells off all its Inventory 10 times per year. c. It means that your calculations are off, because Inventory on the Balance Sheet should always exceed COGS. d. You can t say anything definitive without more detailed information.

8. A company does NOT disclose average interest rates on its cash & cash-equivalents and debt in its filings. If you consider ONLY the answer choices below, which of the following methods is the BEST way to determine the historical interest rates to use in a 3-statement projection model? a. Take the interest income in each year and divide by the ending cash balance in that year, and take the interest expense in each year and divide that by the ending debt balance. b. Look at the interest rates that similarly sized companies with similar business models in the industry have earned on their cash balances or paid on their debt balances. c. Take the interest income in each year and divide by the average cash balance in that year, and take the interest expense in each year and divide that by the average debt balance in each year. d. Use Bloomberg or another industry news source and look up the average interest rates across all industries in the past 3 years. 9. A company has the following revenue growth and expense margin profile for the past 3 historical years: Which of the following sets of 5-year revenue growth assumptions is LEAST appropriate? a. 25%, 17%, 11%, 9%, 7%. b. 50%, 40%, 30%, 20%, 10%. c. 15%, 14%, 13%, 11%, 10%. d. 30%, 25%, 20%, 15%, 10%.

10. You re projecting the interest income and interest expense in a 5-year projection model for a company. Since the company does not list its actual interest rates, you use the 3-year historical average rates to determine the interest rates on cash and debt going forward. What s the MAIN flaw with making the projections this way? a. The macroeconomic environment may change in the future and interest rates might shift dramatically, so historical averages may not be appropriate. b. There is no flaw you should use historical averages for projecting interest rates, just as you would with everything else in a model. c. It s fine to use this method for cash since interest rates are lower anyway, but for debt you sometimes see fixed, rather than floating, interest rates and so historical averages aren t as appropriate. d. This method works if the company does not disclose its actual historical interest rates, but if it does then you can t use it. 11. In a 3-statement model you re creating, you calculate Accounts Receivable / Revenue and take the historical average over the past 3 years. You also calculate Days Sales Outstanding (DSO) (also known as Accounts Receivable Days) by multiplying this percentage by the number of days in each year, and then you calculate the average DSO over the past 3 years. What s the advantage to using the average DSO method, rather than the percentage of revenue method, to project Accounts Receivable in future years? a. Using the DSO average will give you more accurate numbers because it better represents what happens in the real world (it takes the company a certain number of days to collect receivables from customers). b. There is no advantage they give you exactly the same result. c. It s actually better to use AR / Revenue instead because it requires less work. d. They give you the same numerical result, but calculating DSO is slightly better because it gives you additional insight into the company s business model and how quickly it collects cash from customers.

12. Consider the following scenario with Deferred Taxes resulting from different Depreciation methods used for book vs. tax purposes: Rather than making the Deferred Taxes increase the Deferred Tax Liability, we will model this scenario by using a Deferred Tax Asset instead. What would the Deferred Tax Asset be at the end of Year 1, assuming that it s initially $0? a. ($20): Negative $20 b. $20: Positive $20 c. $0 d. $30: Positive $30 13. A company has purchased $1,000 worth of securities in Year 2 of its historical statements, but has NOT purchased securities in any other year. What s the BEST assumption to make under Cash Flow from Investing on the Cash Flow Statement? a. Take the historical average of security purchases, even though it was $0 in all the other years, and use that number going forward. b. Assume that it continues to purchase $1,000 of securities each year going forward, and reflect this with a negative number under Cash Flow from Investing, representing a use of cash. c. Assume that the company purchases nothing going forward, and therefore record $0 for this entry under Cash Flow from Investing in future years. d. Assume that it purchases nothing in future years, but that it sells off these securities at some point in the next 5 years, representing an inflow of cash and a positive entry under Cash Flow from Investing.

14. What s the best way to project Amortization of Intangibles in a 3-statement model? a. Average the Amortization expense in the last 3-5 historical years and use that number going forward in each year. b. Make it a percentage of revenue, take the average of those percentages over the last 3-5 years, and use that average to determine the Amortization number in each future year. c. Hold it constant since Amortization doesn t change much from year to year. d. Look in the company s filings and use its own projected numbers for the Amortization of Intangibles in future years. 15. A company has been repurchasing $1,000 $2,000 worth of common stock over the past 3 years. Why might we ignore that and assume $0 in for stock repurchases a projection model anyway? a. The company has indicated in its filings that it plans to stop repurchasing stock in future years due to market conditions. b. Based on our projections, the company will not have sufficient cash flow to repurchase that amount of stock in the future. c. We re simplifying the model by assuming that the company only spends its cash on items that are absolutely required, such as capital expenditures and working capital. d. All of the above.

16. You ve created a 3-statement model, but the Balance Sheet does not balance. It s off by the following amounts in each year: What is the MOST likely source of this error? a. You ve forgotten to reflect a single item, such as Accounts Receivable or Deferred Revenue, on the Cash Flow Statement. b. You are likely double-counting a smaller line item, such as Amortization of Intangibles, and adding or subtracting it in too many places. c. You used the wrong sign for an item on either the Balance Sheet or Cash Flow Statement. d. You ve forgotten a single item in year 1, but have included it in all the subsequent years. 17. A company issues new stock to investors and records an increase to both its Common Stock and Additional Paid-In Capital (APIC) line items under Shareholders Equity as a result. At the time, its share price is $20, and after issuing the shares, it records $1,000 in Common Stock and $100,000 in APIC on its Balance Sheet. A week later, its share price doubles to $40. What is its APIC now? a. $150,000 b. $199,000 c. $200,000 d. $100,000

18. Which of the following describes the most common METHOD and RATIONALE for why a company might record different Depreciation numbers for book vs. tax purposes on its financial statements? a. It records a higher number for tax Depreciation in earlier years to reduce its cash tax burden immediately after investing in an asset. b. It records a higher number for book Depreciation in earlier years to reduce the income taxes as shown on its income statement. c. Most companies actually prefer to use the same number for Depreciation on both sets of financial statements to simplify record-keeping. d. It depreciates an asset over a longer time period for tax purposes so that it can save on taxes over many years. 19. The Change in Working Capital on the Cash Flow Statement should include Current Assets and Current Liabilities, excluding cash and debt, according to the definition of Working Capital. Why would you include changes in BOTH Current AND Long-Term Deferred Revenue in this section? After all, Long-Term Deferred Revenue is not a Current Asset. a. This is not correct Long-Term Deferred Revenue should be counted in Cash Flow from Financing instead, because it s a long-term liability. b. You might do this in order to simplify the statements and save time, but it should really be counted elsewhere. c. You do this because Long-Term Deferred Revenue is related to a company s core business operations, just like everything else in Cash Flow from Operations, so it belongs there. d. If you wanted to do this, you should consolidate both the Deferred Revenue line items into a single item on the balance sheet instead.

20. Which of the following methods is the LEAST valid way of projecting revenue growth in a 3- statement model? a. Create a unit-by-unit buildup, and assume that a certain volume of units is sold for certain prices in future years. b. Calculate the total market size and the percentage that the company captures, and make assumptions for both of those going forward. c. Use simple percentages for revenue growth, ensuring that growth rates decline from historical levels as the company grows bigger. d. Use simple percentages for revenue growth, taking the historical average over the past several years and using that in future years.

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