How to understand a company’s projections?

Projections are the forward-looking map for a business that answers the “What would happen if?” questions. Analyzing the historical income statements, balance sheets and cash flow statements along with the projections helps made at that time explain a company’s approaches to projections. 

Review historical Company projections and compare with actual performance

Review how well a Company was able to use its income statement and balance sheet projections to project its actual cash flows. Its historical projections should also be reviewed against its actual performance for every year available. Review if the Company could successfully mitigate historically projected profitability downturns by making timely operational (cost and pricing) changes. If yes, take this into consideration to assess the company’s accuracy in making projections.

Review historical growth trends by segment and product and compare with projections

Review segment-wise (demographic, psychographic, geographic, and behavioral) and product-wise historical growth trends (actual sales, revenue, and profit) and compare those with the company’s projections. Ascertain if the company projected and executed successfully the growth trends for reaping high revenue growth. 

Review with management the drivers of growth within projections by product and segment

Review what drives the projections along with the management of the company. Undertake this exercise separately for each product and segment. Identify the direct and interdependent projection performance drivers. Check revenue and expense projections along with internal and external accounting, market and customer behavior data to draw a fair view of the success drivers of the business.

Check and compare industry outlook as described by analysts, consultants, and competitors

Projections should be developed and reviewed in consonance with the market trend analysis and industry outlook as depicted by analysts, consultants, and competitors. The company’s projections should provide for long-term business planning to thwart competitors. Compare industry data over a set of time from the each of the analysts, consultants, and competitors to identify consistency in trends. Check if the company has considered the conclusions from these sources with its own projections to develop a fair outlook for its own business. Compare the company projections with industry influencers’ (thought leadership) perspectives and publications to assess its influence on business performance as a whole. Also assess industry behavior via digital analytics tools to analyze the marketplace alongside the company projections. Review competitors’ market positioning and their reactions to emerging market trends. 

Thorough understanding of fixed and variable components in gross margins

Develop a robust understanding of the various financial measures of the company. These include cost of goods sold (COGS), sales revenue, total net sales, percentage of total sales revenue, gross profit, and costs pertaining to producing sold goods or services. Determine what margin is left post subtracting the goods’ cost from its earned revenue. Ascertain if or not the company is generating the required revenue to provide for the costs. Check if the company is financially well-off against its rivals. Also compare the current financials with historical data of gross margins. Special attention must be given to the cost of sales.

Historical gross margin trends by product and division

Gross margin trends analysis would explain the percentage of total sales revenue kept by the company as gross profit. In this case, the analysis would show product and division-wise gross margin trends of the company. Access the company’s profitability ratio’s history to evaluate gross margin trends by product and division. Check how profitably the company sells its inventory (i.e., what’s its percentage markup). Give particular attention to ascertaining pure profit from inventory sales used then to pay for operating expenses (utilities, rent, salary, etc.). Check at what price the company has been buying its inventory (with or without a purchase discount). Alternatively, review if the company marks their goods up higher. If so, has it been done competitively to attract customers to buy the product.

Apart from evaluating historical and internal projections’ data, attempt should be made to understand a company’s method for projections. Short-term, mid-term, and long-term projections should each be equally considered to draw strategic conclusions. Weigh past and future revenues and expenses at each stage of evaluating a company’s projections. Understand current or estimated projections data to draw a blueprint of a company’s income and expenses. Further evaluate these conclusions across various scenarios. This will help in comprehending how alterations in one element of a company’s finances (e.g., increased sales or lesser operating expenses) impacted profitability going forward.