Sales driven vs Policy decision

Policy vs Sales

Almost all financial statement models are sales driven. This means the most important financial statement variables are assumed to be a function of sales.

For example, accounts receivables are often taken as a direct percentage of the sales of the firm.

As a slightly more complicated example, you might postulate fixed assets (or some other account) to be a step function of sales, like so:

Fixed Assets:

a if sales < A
b if sales > B

For financial planning models, one must usually try to distinguish between financial statement items that have a functional relationship with sales, and those other items that are determined by some kind of policy decision instead.

The asset side of the balance sheet is usually assumed to be dependent only on functional relationships.

Current liabilities may also be taken to involve functional relationships, leaving the mix between long-term debt, and equity as a policy decision.

For example, you might assume:

• Current liabilities: Assumed to be 8% of end-of-year sales
• Debt: The firm neither repays any existing debt nor borrows any more money over a 5-year horizon of its pro-formas
• Stock: Shareholders are assumed to provide no additional direct financing. So there are no new stock issues or repurchases

All of these kinds of decisions will affect the eventual form and shape of the final Pro-Forma model built.