3. Revenue & Expenses.pptx

Financial Modeling Fundamentals:
3. Revenue & Expenses

OVERVIEW
With the financial statement shells now in place, it is now time to create the
revenue and expenses forecasts for Apple.
The revenue and expenses area of a financial model is used to determine
the operating profit of a business and can become very complex as the
model is customized to reflect revenue and expense drivers and the
relationships between them.
This exercise focuses on understanding the ways revenue and expenses
flow through the financial model and therefore ignores many of these
complexities.

REVENUE
Revenue is the total amount of income
generated by the sale of goods or
services related to the primary
operations of a business. It is also
commonly referred to as sales, or
the top line because it sits at the top of
the income statement.
Apple's total revenue for the past three
financial years can be found within the
top section of the income statement on
page 31 of its annual report. During
FY20, Apple derived revenue of
$274,515m, which represented a 5.5%
increase on its FY19 total revenue of
$260,174, as shown here:
Apple – Total Revenue

REVENUE
In a complex financial model, this revenue
would be forecast using prices and volumes
by product and service across different
business units across different regions. But for
the purposes of this learning exercise revenue
is going to be forecast by assuming a total
revenue amount for FY21 and revenue growth
rates in subsequent years.
In the Apple financial model, activate the
forecasts sheet in position 1.c. of the table of
contents. This sheet contains all the forecast
assumptions that will be used to build the
Apple financial model forecasts. The revenue
forecast assumptions are located in row 13,
as shown below:
Revenue –
Assumptions

REVENUE
Total revenue is currently assumed to be
$289,613 for FY21, which has been calculated
as a 5.5% increase on the FY20 total revenue
of $274,515m. A 5.5% annual growth rate has
then been assumed for all subsequent years.
When forecasting revenue in a financial
model, revenue is initially assumed to equal
cash, with the cash flow impacts of accounts
receivable being modeled separately. This
differs from traditional double-entry
accounting, which would initially debit
accounts receivable and only debit cash when
cash is received.
Revenue is the first reported line item on the
income statement, and is reported within the
cash receipts section of the operating cash
flows section of the cash flow statement, as
shown below for Apple for FY21:
Revenue – Financial
Statement Impacts
(FY21)

REVENUE
Activate the income statement then expand the collapsed period titles rows 5 – 8 to unhide the period counters in row
7. Then add revenue by entering the following heading into column B and data in columns J – N of the following row:
Row Heading Data
12 Revenue =IF(J$7=1,Forecasts!J13,I1
2*(1+Forecasts!J13))
Note that row headings will be entered as constants throughout this training course. This contravenes generally
accepted modeling best practices, which recommend avoiding duplicate headings using formulas, but has been done
to keep the exercise instructions as simple as possible.

REVENUE
The revenue formula within the income statement
uses an IF function to return the assumed amount in
the first year (i.e. when the value in the period
counter row 7 equals 1), and in subsequent years
returns the prior year revenue amount multiplied by
one plus the assumed growth rate.
Note that the reference to the period titles counter row 7 uses
an absolute row reference (i.e. the $ in the reference J$7).
This is not necessary in this instance but, as a general rule,
formula references to period titles rows should use absolute
row references so that they stay locked to these rows when
copying and pasting within sheets, often when using
categories. For this reason, all references to period titles
rows throughout this exercise will use absolute row
references.

REVENUE
After doing this, the
revenue forecasts
should start at
$289,613m in FY21 and
increase at 5.5% p.a. to
$358,780m in FY25, as
shown here
Income Statement - Revenue

REVENUE
Note that the balance sheet no longer
balances. This is because revenue has been
included within NPAT, which is flowing into
retained profits within the equity section of the
balance sheet, but not within the cash flow
statement, so it is not yet flowing into cash on
the balance sheet.
Hence, retained profits (and total equity) is
increasing by the accumulated revenue over
time, while cash (and net assets) is staying
unchanged at the opening balance sheet cash
balance of $38,016m, as shown here :
Revenue – Balance Sheet Error

REVENUE
To address this, activate the cash flow statement sheet in position 2.c. of the table of contents, then add revenue to
cash receipts by entering the following heading into column C and data in columns J – N of the following row:
Row Heading Data
12 Revenue =IS!J12
This formula simply equates the revenue in the cash flow statement with the revenue in the income statement,
thereby assuming revenue equals cash and that the revenue impact on NPAT (and total equity) is equal to the
revenue impact on the change in cash held (and net assets). As discussed previously, accounts receivable impacts
on cash flow will be handled via cash flow adjustments when building the working capital parts of the financial model.
Ensure that this revenue is included in cash receipts by overwriting the zero value in the cash receipts calculation cell
J14 with the following formula, then copy and paste across the range J14:N14:
=J12

REVENUE
change in cash held
should start at
$289,613m in FY21 and
increase at 5.5% p.a. to
$358,780m in FY25, and
the balance sheet
should balance, as
shown here:
Note that the balance
sheet now balances
because revenue is
equally impacting net
assets via cash from the
cash flow statement and
total equity via retained
profits via NPAT from the
income statement.
The revenue forecasts
within the Apple financial
model are now
complete.
Cash Flow Statement - Revenue

COST OF GOODS SOLD
Cost of goods sold (COGS) refers to the direct costs
of producing the goods sold by a business, including
the cost of the materials and labor directly used to
create the good. It excludes indirect expenses,
which are included in operating expenditure.
Cost of goods sold is also commonly referred to as
direct costs or cost of sales
In the income statement, cost of goods sold are
separated from fixed costs such as operating
expenditure in order to calculate gross margin,
which provides important information about the
direct profitability of providing products and services
– i.e. profitability prior to taking into account fixed
costs. In many businesses, fixed costs can be cut
back relatively easily compared with direct costs, so
gross margin provides a key business metric when
assessing the viability of the business.

COST OF GOODS SOLD
Apple's total cost of
goods sold for the past
three financial years can
be found below revenue
in the income statement
on page 31 of its annual
report, as shown here:
Apple – Total
Revenue

COST OF GOODS SOLD
The income statement in Apple's annual report does not
report depreciation and amortization (D&A) of assets as
separate line items. This implies that D&A expense has
been embedded within cost of goods sold and/or operating
expenditure.
In reality, Apple's D&A expense has probably been allocated
across both cost of goods sold and operating expenditure,
with D&A directly associated with products sold being
allocated to cost of goods sold, and the remainder being
allocated to operating expenditure.
In a financial model, the depreciation and amortization of
assets is forecast independently to cost of goods sold and
operating expenditure, as discussed later in this exercise.
So the important thing is to prevent double counting of D&A
by removing it from cost of goods sold and/or operating
expenditure.

COST OF GOODS SOLD
As discussed previously, the
cash flow statement in the
Apple annual report (on
page 35) uses the indirect
method, which includes
adding back the non-cash
D&A expense when
calculating cash flow from
operating activities, as shown
here:
Apple – Depreciation & Amortization

COST OF GOODS SOLD
The Apple annual report does not provide sufficient
information to determine where this depreciation and
amortization expense has been allocated within the income
statement, so for the purposes of this exercise it will be
assumed that it has all been allocated to cost of goods sold.
Hence, to prevent double counting of D&A, this D&A
expense must be removed from total cost of goods sold
when analyzing historical data to calculate margins, etc.
In a financial model, cost of goods sold is usually calculated
with reference to the revenue to which it relates, thereby
ensuring that changes to revenue forecasts are reflected in
corresponding changes in cost of goods sold.
The most common method used to do this is by basing cost
of goods sold forecasts on margin percentage assumptions
in each period. A margin of 10% on revenue of $100 implies
cost of goods sold of $90 – i.e. the margin assumption
refers to the profit margin as a percentage of sales.
During FY20 Apple's total cost of goods sold including D&A
was $169,559m, which reduces to $158,503m after
subtracting D&A expense of $11,056m.
This $158,503m of cost of goods sold represented a 42.3%
margin on Apple's FY20 total revenue of $274,515m.
Similarly, during FY19 Apple's total cost of goods sold
including D&A was $161,782m, which reduces to
$149,235m after subtracting D&A expense of $12,547m.
This $149,235m of cost of goods sold represented a 42.6%
margin on Apple's FY19 total revenue of $260,174m.
Applying this analysis to the FY18, FY19, and FY20 years
reveals an average cost of goods sold profit margin of
42.4%.

COST OF GOODS SOLD
In the Apple financial
model, activate the
forecasts sheet in
position 1.c. of the table
of contents. The cost of
goods sold forecast
assumptions are located
in row 14, as shown
here:
Cost of Goods Sold – Assumptions

COST OF GOODS SOLD
Apple's cost of goods sold margin has been
assumed to remain at 42.4% for all forecast
years.
When forecasting cost of goods sold in a
financial model, cost of goods sold is initially
assumed to equal cash, with the cash flow
impacts of inventory being modeled
separately. This differs from traditional
double-entry accounting, which would initially
debit inventory and credit cash when
purchasing inventory, before debiting cost of
goods sold and crediting inventory when the
inventory is sold.
Cost of goods sold is the second reported line
item on the income statement, appearing
between revenue and gross margin, and is
reported within the cash payments section of
the operating cash flows section of the cash
flow statement, as shown below for Apple for
FY21:
Cost of Goods Sold – Financial Statement Impacts (FY21)

Activate the income statement (sheet in position 2.a. of the table of contents), then add cost of goods sold by entering
the following heading into column B and data in columns J – N of the following row:
Row Heading Data
13 Cost of Goods Sold =-J12*(1-Forecasts!J14)
This formula multiplies the revenue in each period by one minus the margin assumption, thereby returning the cost of
goods sold amount corresponding to this assumed margin.
Note that the expenses are included in the income statement as negative numbers, which means data can be
summed down the page to calculate subtotals and totals. This is a personal choice. The key is choosing an approach
to signage within financial statements and applying it consistently throughout. In the Apple model, positive numbers
will be used for revenue and negative numbers will be used for expenses.
Ensure that cost of goods sold is included in gross margin by overwriting the existing formula in the gross margin
calculation cell J14 with the following formula (you can do this using the keyboard shortcut Alt+=), then copy and
paste across the range J14:N14:
=SUM(J12:J13)
COST OF GOODS SOLD

COST OF GOODS SOLD
After doing this, the cost
of goods sold forecasts
should start at
$166,817m in FY21 and
increase to $206,657m
in FY25, as shown here
sheet no longer
balances. This is
because cost of goods
sold has been included
within NPAT, which is
flowing into retained
profits within the equity
section of the balance
sheet, but not within the
cash flow statement, so
it is not yet flowing into
cash on the balance
sheet.
Income Statement – Cost of Goods Sold

To address this, activate the cash flow statement sheet in position 2.c. of the table of contents, then add cost of goods
sold to cash payments by entering the following heading into column C and data in columns J – N of the following
row:
Row Heading Data
15 Cost of Goods Sold =IS!J13
This formula simply equates the cost of goods sold in the cash flow statement with the cost of goods sold in the
income statement, thereby assuming cost of goods sold equals cash and that the cost of goods sold impact on NPAT
(and total equity) is equal to the cost of goods sold impact on the change in cash held (and net assets).
As discussed previously, inventory impacts on cash flow will be handled via cash flow adjustments when building the
working capital parts of the financial model.
Ensure that cost of goods sold is included in cash payments by overwriting the zero value in the cash payments
calculation cell J19 with the following formula, then copy and paste across the range J19:N19:
=J15
COST OF GOODS SOLD

COST OF GOODS SOLD
After doing this, the change in cash held
should start at $122,796m in FY21 and
increase to $152,123m in FY25, and the
balance sheet should balance, as shown
here:
Note that the balance sheet now balances
because cost of goods sold is equally
impacting net assets via cash from the cash
flow statement and total equity via retained
profits via NPAT from the income statement.
The cost of goods sold forecasts within the
Apple financial model are now complete.
Cash Flow Statement – Cost of Goods Sold

OPERATING EXPENDITURE
Operating expenditure is comprised of the
costs a business incurs when running its day-
to-day operations, not including direct costs
included in cost of goods sold. Common
examples include salaries and wages, office
rental, and selling, general, and administrative
expenses (SG&A).
Apple's total operating expenditure for the past
three financial years can be found below gross
margin in the income statement on page 31 of
its annual report. During FY20, Apple's total
operating expenditure was $38,668m, as
shown here:
During FY20, Apple's total operating
expenditure was $38,668m, which was 12.2%
higher than its FY19 total operating
expenditure of $34,462, as shown below:
Apple – Total Operating Expenditure

In the Apple financial
model, activate the
forecasts sheet in
position 1.c. of the table
of contents. The
operating expenditure
forecast assumptions
are located in row 15, as
shown here:
Operating Expenditure –
Assumptions

In a financial model, operating expenditure can be forecast
using a wide range of different drivers, such as growth rates,
employee numbers and salaries, office rental rates, etc. But
for the purposes of this exercise operating expenditure will be
forecast based on an assumed amount in each year to keep
things simple.
These assumptions have been created by assuming a 12.2%
annual growth in Apple's forecast total operating expenditure
of $38,668m in FY20 (i.e. $38,668m × 1.12 = $43,385m).
When forecasting operating expenditure in a financial model,
operating expenditure is initially assumed to equal cash, with
the cash flow impacts of creditors being modeled separately.
This differs from traditional double-entry accounting, which
would initially credit accounts payable and only credit cash
when bills are paid.

Operating expenditure is reported below
gross margin and above EBITDA on the
income statement, and is reported
within the cash payments section of the
operating cash flows section of the cash
flow statement, as shown below for
Apple for FY21:
Operating Expenditure – Financial Statement Impacts
(FY21)

Activate the income statement (sheet in position 2.a. of the table of contents), then add operating expenditure by
entering the following heading into column B and data in columns J – N of the following row:
Row Heading Data
15 Operating Expenditure =-Forecasts!J15
This formula simply links the income statement operating expenditure directly to the assumed operating expenditure
amounts assumptions, negating them so they appear in the income statement as negative numbers.
Ensure that this operating expenditure is included in EBITDA by overwriting the existing formula in the EBITDA
=SUM(J14:J15)

operating expenditure
forecasts should start at
$43,385m in FY21 and
increase to $68,756m in
FY25, as shown here:
sheet no longer
balances. This is
because operating
expenditure has been
included within NPAT,
which is flowing into
retained profits within
the equity section of the
balance sheet, but not
within the cash flow
statement, so it is not
yet flowing into cash on
the balance sheet.
Income Statement – Operating
Expenditure

To address this, activate the cash flow statement sheet in position 2.c. of the table of contents, then add operating
expenditure to cash payments by entering the following heading into column C and data in columns J – N of the
following row:
Row Heading Data
16 Operating Expenditure =IS!J15
This formula simply equates the operating expenditure in the cash flow statement with the operating expenditure in
the income statement, thereby assuming operating expenditure equals cash and that the operating expenditure
impact on NPAT (and total equity) is equal to the operating expenditure impact on the change in cash held (and net
assets).
As discussed previously, accounts payable impacts on cash flow will be handled via cash flow adjustments when
building the working capital parts of the financial model.
Ensure that this operating expenditure is included in cash payments by amending the formula in the cash payments
=SUM(J15:J16)

After doing this, the change in
cash held should start at
$79,411m in FY21 and increase
to $83,367m in FY25, and the
balance sheet should balance, as
shown here:
Cash Flow Statement – Operating
Expenditure

After doing this, the change in
cash held should start at
$79,411m in FY21 and increase
to $83,367m in FY25, and the
balance sheet should balance, as
shown here:
Note that the balance sheet now
balances because operating
expenditure is equally impacting
net assets via cash from the cash
flow statement and total equity via
retained profits via NPAT from the
income statement.
Cash Flow Statement – Operating
Expenditure

Note that capital expenditure has
not been included within the
financial model along with the
revenue and expenses reported
on the income statement. This is
because capital expenditure
results in the creation of fixed
assets, so it is usually included
within a financial model when
building the fixed assets
forecasts, which will be done later
in this exercise.
The Apple financial model now
includes revenue, cost of goods
sold, and operating expenditure,
all of which directly impact the
income statement and cash flow
statement, and balance via cash
and retained profits on the
balance sheet, as show below for
FY21:
Revenue & Expenses – Financial Statement Impacts
(FY21)
The Apple financial model now includes revenue, cost of goods sold, and operating expenditure
forecasts and is complete down to EBITDA on the income statement.

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