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Alternative Assumptions and Sensitivity and Scenario Analyses

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In this chapter, you must have learned by now that one cannot trust a single pro forma and the estimation related to the same. And if it’s a calibrated Pro Forma, be careful with the same. But if you are trying to create a pro forma for your own company, you need to understand the robustness included in the same. You can prepare analyses for the same, which are easy to perform on the spreadsheet format as different assumptions and alternatives are allowed in the same.

20.7 A Fiddling with Individual Items

Please keep one aim in the mind and that is estimating the best market value of your business. And hence, use your knowledge, imagination and a little bit of a common sense for the same keeping an attentive eyes on the information including your intuition. And yes, your consumers will definitely not agree with the pro formas you develop, and therefore, you should be ready with your reasoning and answering each WHY and WHAT to be asked! But remember, your defense should be credible and not illogical.

Also, keep in mind that using the formula of perpuity is not mandatory to calculate the terminal value of the market. Instead of those assumptions you can possible create your own formula based on real time information and internal data of facts and figures. Preparing a pro forma on the spreadsheet is always beneficial and appreciated as it allows you consider future assumptions and cases as well. Also, please note that sky is the limit and can you cannot really include every financial segment in your spreadsheet. So when you can realize that your point cannot be explained further in a specific manner, one must stop your generalization there itself!

Alternative Assumptions and Sensitivity and Scenario Analyses 3320.7 B Do Not Forget Failure

Please note that pro forma just discuss a particular scenario under consideration which can lead to better market value only if the project is accepted. So if you consider an example of a magazine. If you are pitching the idea of a magazine to your clients, your pro forms might reflect excellent market value but it cannot change the fact that there are various magazines which folds within a span of one year.

And hence, you might receive failure in Pro forma as well. So be articular on the scenario you base for your pro forma research and the type of business you are leading to.

Alternative Assumptions and Sensitivity and Scenario Analyses 34

20.7 C Assessing the Quality of a Pro Forma

By now, you might have realized that some questions are just not good, for example: which pro forma of PepsiCo is correct? But the question here should be which one is better? Sometimes the lousy pro forma is considered better than a forecast of good pro forma. So I suppose the question that one must ask here is, “how to judge if the pro forma is good or not?”

In any case, one must take care of three tools in order to determine if there pro forma is good or not:

  • The value of the terminal
  • The eternal growth rate of cash flow
  • Cash flow estimation

If possible, try to understand the mind set and business expectations of the client. For example, Pepsi Co will expect the presentation of pro forma with at least $80 billion market value and nothing less than that. So keep the expectations in mind in order to present a better pro forma. And if you are creating a calibrated pro forma, be aware of the fact and figures you alter in your model because you might be asked questions on the same.

And hence, creating the model of pro forma on a spreadsheet is a better platform as one can alter the assumptions and specification if required in future.

Alternative Assumptions and Sensitivity and Scenario Analyses 35

 

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