Forecasting

Most likely profit may not be the most relevant profit

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Analyst forecasts may not take into account the distribution, particularly the skewness, of potential outcomes. A forecast of the most likely profit can significantly differ from the more relevant probability weighted expected value.

Whether a forecast is a mean or a mode is also important in financial reporting. Most IFRS standards, including IFRS 9 regarding loan impairments, require a probability weighted expected value; however, this is not universal. In some cases, such as IAS 37 regarding provisions, the requirements are unclear.

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Disaggregation is key to understanding performance

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Limited disaggregation of income and expense items with different characteristics impairs investors’ ability to assess and forecast performance. Recent proposals by the IASB for a new disaggregation principle and related disclosures of ‘unusual’ items will help. However, in our view, they do not go far enough.

The IASB also proposes to include management alternative performance measures (non-GAAP or non-IFRS) within audited financial statements. We welcome this. Additional subtotals can be helpful if they are clearly described and what is omitted is clearly identified. What would also help is to ban the use of labels such as ‘underlying’, ‘core’ and ‘recurring’.

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Forecasting ‘sticky’ stock-based compensation

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Stock-based compensation grants to employees in 2020 are likely to be affected by the changes to share prices and reduction in profitability currently being experienced by many companies. However, the impact on the related expense and on reported profit may not be what you might expect.

For most companies, stock-based compensation is a ‘sticky’ expense that is only indirectly or partially affected by current period changes. Limited disclosure in financial statements makes forecasting this expense a challenge. You should focus on the value of new grants, the vesting period and the effect of potential changes to assumptions. Our interactive model will help.

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IFRS 15 revenue recognition may impact forecast growth

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For some companies the change in revenue recognition due to the adoption of IFRS 15 in 2018 has resulted in a material change in reported revenue and profit. However, your analysis needs to go beyond the transition effect and also consider the impact on future growth.

We illustrate how your forecast of profit growth can be impacted by IFRS 15 using a simple interactive model.

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