Corporate Valuation Modeling: A Step-by-Step Guide

CHAPTER 3

Revenue, Costs, and the Income Statement

The firm’s ability to generate revenue beyond costs is one of the most important components to a valuation. This excess revenue creates value to debt holders in the form of interest payments, or to equity holders in the form of dividends, or kept internally, which also yields return for equity holders in the form of capital appreciation. If a company has a decline of revenue or has none, then it must pay costs with other sources. Typically, some type of short-term facility, long-term loan, or equity infusion would be required to meet these costs. If there is a continued lack of revenue generation, then the liabilities of a firm can grow beyond the assets and the company could technically be classified as defaulted. Given the critical nature of generating revenue beyond costs, a significant amount of time should be spent analyzing the revenue and cost assumptions that go into a model and the methodologies employed for projections.

Once a growth analysis is complete, it’s equally important to have a practical implementation of the various revenue and cost assumptions in the model. This is done by creating a flexible scenario selector system and adhering to standard accounting methods through the creation of an income statement. Whereas the revenues, costs, and income statement will provide key insights to the earnings of the firm, we will find that they are inextricably linked, both conceptually and technically, to the capital ...