Straight lining - PE Modeling test
In a modeling test, let's say for example you had to project out COGS, and you decided to straight line COGS using historical data.
do you use historical COGS from from just latest year, or do you take an average of latest 3-5 years?
It wouldn't make sense to straight-line the costs themselves (unless truly all fixed). I would keep the margins consistent (if that's your assumption) and apply a constant margin % to the flexing revenue profile.
Yeah moreso meant for the margin %, would you straightline it from latest year or take an avg of say, last 3 years?
If the business is growing/scaling, I'd just use the latest year (i.e., if margins have improved, would straightline at the latest/highest). They've probably optimized the cost structure and improved margins as they've grown.
really appreciate it. and what if there is no clear trend in the margins? say the margins for the past 5 years are 45%, 46%, 43%, 46%, 47% ?
would probably hold flat at the most recent year, unless you can substantiate doing something different from the CIM / case overview. Much easier IMO to justify operating leverage than gross margin uplift if you do want to play around with the margins
could you clarify why justifying operating leverage is easier? aren't those two things directly related? from what I understand a business with high operating leverage will have margins improve as you sell more volume?
Pretty sure he just means that it is easier to justify EBITDA margin expansion due to fixed or slower growing OPEX compared to revenue growth rather than improving gross margins as you would typically expect most of COGS to be variable (so COGS should grow in line with revenue at a steady % of revenue and the only way gross margin would get better is through operational improvements which are harder to justify than just holding OPEX flat in an extreme example or growing at some inflationary rate which would typically lead to EBITDA margin expansion if revenue grows at a faster rate which is usually the case unless a very mature industry).
^ This. If you're calling for gross margin expansion, a good justification would be you've done a cohort analysis and discover new cohorts are coming on at higher unit margins due to greater pricing flow through while showing strong retention metrics. For a simple modeling test, proving something like that is obviously harder than waving your hand in the air and saying we're cutting G&A and pulling back on development costs as the business grows
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