Industry accepted assumptions are commonly used benchmarks, estimates, or expectations that are widely recognized and agreed upon within a specific industry or sector. These assumptions serve as a foundation for various financial analyses, forecasting, and decision-making processes. While specific industry accepted assumptions can vary depending on the sector and context, here are some examples of commonly used assumptions:
Growth Rate:
The projected growth rate of an industry or market segment is a key assumption used in financial models and forecasts. It helps estimate future revenue and market size. Industry experts, market research reports, historical data, and economic indicators are often considered when determining growth rate assumptions.
Cost of Goods Sold (COGS):
COGS assumptions involve estimating the cost associated with producing or acquiring goods or services. These assumptions consider factors such as raw material prices, production costs, labor expenses, and economies of scale. Benchmarking against competitors or industry standards can help inform COGS assumptions.
Gross Margin:
Gross margin assumptions determine the profitability of a company’s products or services before accounting for operating expenses. Gross margin is calculated by subtracting COGS from revenue and is expressed as a percentage. Historical financial data, industry benchmarks, and competitive analysis can guide gross margin assumptions.
Operating Expenses:
Operating expense assumptions encompass various costs incurred in running a business, including salaries, rent, marketing expenses, utilities, and administrative costs. These assumptions often consider past performance, industry benchmarks, and planned business initiatives. Expense ratios and industry-specific cost structures can also provide guidance.
Pricing Strategy:
Pricing assumptions involve determining the price points at which products or services will be sold. Factors such as market demand, competition, cost structures, and customer preferences influence pricing decisions. Industry-specific pricing models, customer surveys, and historical pricing trends can guide pricing assumptions.
Market Share:
Market share assumptions estimate the portion of the total market that a company or product is expected to capture. These assumptions consider factors like competitive landscape, product differentiation, marketing strategies, and customer preferences. Market research, industry reports, and historical market data are often used to inform market share assumptions.
Capital Expenditures (CapEx):
CapEx assumptions involve estimating the amount and timing of investments in fixed assets, such as property, plant, and equipment. These assumptions consider industry-specific requirements, technology advancements, maintenance needs, and growth plans. Industry benchmarks, equipment pricing, and financial projections guide CapEx assumptions.
Working Capital:
Working capital assumptions pertain to the amount of cash needed to fund day-to-day operations, including inventory, accounts receivable, and accounts payable. These assumptions consider industry-specific payment terms, inventory turnover rates, and sales cycles. Historical financial data, industry averages, and management expertise inform working capital assumptions.
Example:
- Growth Rate: The software industry is expected to grow at an average annual rate of 8% over the next five years based on market research reports and industry trends.
- Cost of Goods Sold (COGS): The COGS assumption for the software development company is estimated at 40% of revenue, which includes expenses related to software development tools, licenses, and third-party services.
- Gross Margin: The gross margin assumption is set at 60%, calculated by subtracting COGS from revenue. This assumption aligns with industry benchmarks and past performance of similar software development companies.
- Operating Expenses: Operating expense assumptions include salaries, rent, marketing expenses, utilities, and administrative costs. These expenses are projected to be 35% of revenue, based on industry benchmarks and the company’s historical cost structure.
- Pricing Strategy: The company adopts a value-based pricing strategy, setting its software development services at a premium price compared to competitors. Pricing assumptions consider market demand, customer perception of value, and competitor pricing analysis.
- Market Share: The company aims to capture 10% of the target market share within the next three years, taking into account the competitive landscape, product differentiation, and the company’s marketing and sales strategies.
- Capital Expenditures (CapEx): CapEx assumptions for the software development company include investments in software development tools, equipment, and infrastructure. These assumptions are based on projected growth plans, technology advancements, and industry-specific requirements.
- Working Capital: Working capital assumptions consider factors such as payment terms, inventory turnover, and sales cycles. The company estimates a working capital ratio of 1.5, ensuring sufficient cash flow to manage day-to-day operations and support growth initiatives.