{"id":4026,"date":"2019-10-06T13:34:00","date_gmt":"2019-10-06T13:34:00","guid":{"rendered":"https:\/\/analystprep.com\/cfa-level-1-exam\/?p=4026"},"modified":"2025-03-16T15:55:06","modified_gmt":"2025-03-16T15:55:06","slug":"ratio-analysis-forecast-earnings","status":"publish","type":"post","link":"https:\/\/analystprep.com\/cfa-level-1-exam\/financial-reporting-and-analysis\/ratio-analysis-forecast-earnings\/","title":{"rendered":"Ratio Analysis to Forecast Earnings"},"content":{"rendered":"<p><iframe loading=\"lazy\" src=\"\/\/www.youtube.com\/embed\/n-tgI2uEev4\" width=\"611\" height=\"343\" allowfullscreen=\"allowfullscreen\"><\/iframe><\/p>\n<p>Data on the economy, industry and company are used in deriving forecasts for a company. The results of financial analysis, including common-size and ratio analysis, are integral to this forecasting process.<\/p>\n<p>The forecasts of a company\u2019s growth and expected relationships among financial statement data can be used to build an earnings model that can forecast the company\u2019s future performance.<\/p>\n<h2><strong>Modeling and Forecasting Earnings<\/strong><\/h2>\n<p>Pro forma financial statements and budgets are frequently used for financial forecasting within companies. The documents are particularly useful to a company&#8217;s board of directors and senior executives. These budgets and forecasts are also used in presentations to credit analysts and others when seeking external financing.<\/p>\n<p>Forecasting usually involves a range of possibilities, and several techniques may be utilized for this purpose. These include:<\/p>\n<ul>\n<li><b>sensitivity analysis or \u201cwhat if\u201d analysis<\/b>: this provides a range of possible outcomes as specific assumptions are changed;<\/li>\n<li><b>scenario analysis<\/b>: this shows the change in key financial quantities that may result from economic events, such as a loss of funding, loss of a supplier, or a natural disaster. If the list of economic events is mutually exclusive and exhaustive and the events can be assigned probabilities, then a range of outcomes can be evaluated as well as statistical measures such as the mean and median derived for various quantities of interest.<\/li>\n<li><b>Simulation<\/b>: this is a computer-generated sensitivity or scenario analysis that is based on probability models for the factors which drive outcomes. When doing simulations, each event or possible outcome is assigned a probability. After this multiple scenarios are run using probability factors assigned to the possible values of a variable.<\/li>\n<\/ul>\n<blockquote>\n<h3><strong>Question 1<\/strong><\/h3>\n<p>Which of the following statements is <em>least<\/em> accurate?<\/p>\n<ol style=\"list-style-type: upper-alpha;\">\n<li data-tadv-p=\"keep\">Forecasts should be limited to a single point estimate.<\/li>\n<li data-tadv-p=\"keep\">Scenario analysis shows the change in key financial quantities that may result from given (economic) events.<\/li>\n<li data-tadv-p=\"keep\">Financial analysis, analyst judgment, and analysis of other information are all integral to the development of forecasts.<\/li>\n<\/ol>\n<p><strong>Solution<\/strong><\/p>\n<p>The correct answer is <strong>A<\/strong>.<\/p>\n<p>Forecasts should not be limited to a single point estimate. Instead, they\u00a0 should focus on a range of possibilities.<\/p>\n<p>Both options B and C are accurate statements.<\/p>\n<h3><strong>Question 2<\/strong><\/h3>\n<p>Sensitivity analysis:<\/p>\n<ol style=\"list-style-type: upper-alpha;\">\n<li data-tadv-p=\"keep\">Shows the results of the change of key financial quantities.<\/li>\n<li data-tadv-p=\"keep\">Makes estimations of how future financial statements should look like.<\/li>\n<li data-tadv-p=\"keep\">Shows the range of possible outcomes as specific assumptions are changed.<\/li>\n<\/ol>\n<p><strong>Solution<\/strong><\/p>\n<p>The correct answer is <strong>C<\/strong>.<\/p>\n<p>Sensitivity analysis shows a range of possible outcomes as specific assumptions are changed.<\/p>\n<\/blockquote>\n","protected":false},"excerpt":{"rendered":"<p>Data on the economy, industry and company are used in deriving forecasts for a company. The results of financial analysis, including common-size and ratio analysis, are integral to this forecasting process. The forecasts of a company\u2019s growth and expected relationships&#8230;<\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[5],"tags":[],"class_list":["post-4026","post","type-post","status-publish","format-standard","hentry","category-financial-reporting-and-analysis","blog-post","no-post-thumbnail","animate"],"acf":[],"yoast_head":"<!-- This site is optimized with the Yoast SEO plugin v26.9 - https:\/\/yoast.com\/product\/yoast-seo-wordpress\/ -->\n<title>Forecasting Earnings with Ratio Analysis | CFA Level 1<\/title>\n<meta name=\"description\" content=\"Learn how ratio analysis helps predict earnings by evaluating economic, industry, and company data. 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