Financials Estimation

Another essential skill is estimation, which involves thinking critically about how to start estimating values and incorporating them into your analysis. When it comes to building market sizing or budget estimates, the first step is to state your assumptions. After that, select some metrics, and then proceed to estimate quickly using round numbers. This is crucial because the team needs to quickly evaluate whether the solution is financially feasible before diving deeper into the project.

If you skip this initial estimation, you risk reaching a point in the resolution where the finance team declares the approach unrealistic. At that stage, you’ll have to start all over again. Therefore, having rough estimates early on helps ensure that the project is viable enough to move forward.

As you go through this process, you want to continuously assess your approach and revise your answers while keeping the expectations and next steps in mind, particularly those of your audience. This applies to all aspects of your financial analysis, including budgets, return on investment, and eventually the valuation and profit of the companies you’re examining.

For example, let's consider daily long-distance railway ticket sales in China. We can start by making some assumptions with easy-to-use numbers to facilitate calculations. China has a population of approximately 1.4 billion people, and we estimate that about 40% of the population doesn’t work and therefore doesn’t travel. We also assume that rural residents are less likely to travel than urban residents. On average, each person makes two round trips per year, with a round trip equaling two tickets.

Using these figures, we arrive at an estimate of about 4.1 million tickets sold per day, which is quite close to the 4 million tickets that were actually sold in 2012. This example demonstrates the process of estimation and shows your thought process to judges during a case competition. If your logic is clear and the numbers are reasonable, judges are likely to accept your estimates without too many questions.

In the real world, precision is essential, but this method provides a way to generate rough estimates and determine if they make sense for your solution.

Additionally, consider the example of a hardware store with an annual revenue of $20 million. If we encounter a situation where the store becomes unprofitable after an event, we must investigate the reasons behind this drop in revenue. We can analyse the sales mix, which significantly impacts revenue.

Revenue is made up of price and quantity, while costs include fixed and variable expenses. By asking questions related to these factors, we can discover that changes in the sales mix have occurred. For instance, a reorganisation of the store may have shifted low-profit, loss-leading items to eye-level shelves, leading to a change in sales dynamics. Analysing these factors helps us track down potential answers as we work through the issue.