PROSPECTIVE ANALYSIS :

FORECASTING
 Prospective Analysis
2

Prospective
Analysis

Forecasting Valuation

Strategy analysis Accounting analysis Financial analysis

Why forecasting?
 Managers
 Analysts
 Banker and debt market participants
 Forecasting: comprehensive approach
4

Performance
Forecast

Earnings Balance Sheet Cash Flow

Forecast Forecast Forecast

Forecasting Increases in Decreases in cash

growth in sales Working Capital inflows
 Prospective Analysis
5

Forecasts Growth of sales

Key drivers Expenses follow

the sales’ growth

Sales Profit margin

forecast forecast Investment in
plant track sales
 Prospective Analysis
Points of departure
6

2007 2008 2009 2010 2011 2012 2015

Period of time in
The past which the Past, present
performances prospective analysis and future
of the business starts information
are well-known are integrated
together
Purpose:
Getting to a good and reasonable
valuation of the business
 Prospective Analysis
Main questions
7

 Firms strategy:
 What lines of business is it likely to be in?
 Are new products likely? (Customer acceptance for new?)
 What is the product quality strategy?
 At what point in the product life cycle is the firm?
 What is the firm’s acquisition and takeover strategy?

 Market for the products:

 How will consumer behaviour change?
 What is the elasticity of demand for products?
 Are substitute products emerging?
Behavior of sales growth: mean reverting
Behavior of earnings
 Random walk: next year’s earnings equals last
year’s earnings.
 Starting point
 Take in to account: long-term trend
 Adjust for earnings changes in most recent quarter
that deviates from the trend
Behavior of ROE: mean reverting
 Behavior of ROE components:

• Operating asset turnover and Net financial leverage : stable

• Spead and NOPAT margin: most varied
• Point of departure for rate of return and profit margins: most
recent figure, consider the industry norm and sustainability of
strategy
• Point of departure for Operating Asset turnover, financial
leverage and net interest rate: current period level, consider
technology & financial policy changes
“The art of financial statement analysis requires
not only knowing what the “normal” patterns
are but also expertise in identifying those firms
that will not follow the norm.”
Detailed forecast
Step 1: sales forecast
 Approaches:
 Last year’s sales + increases in expansion +
comparable growth (warning: mean reverting)
 Size of target market + degree of market penetration +
time (when)
 Sales forecast for whole company or break down
into major biz segments forecasts
Detailed forecast
Step 2: Expense and earnings forecast
 Most expenses are related to sales: COGS, SG&A
 How about R&D? Interest expense? Depreciation?
 Adjusted for recent changes in strategy
 Sales & expenses forecasts -> earnings forecast
Detailed forecast
Step 3: Balance Sheet forecast
 Forecast major items:
 OWC and operating long-term assets: fraction of sales
 Liability and Equity: depends on policies on capital
structure, dividends, and stock repurchases
 Three critical assumptions?
Detailed forecast
Step 4: Cash flow forecast
 Using forecasts of earnings and balance sheet
accounts
Sensitivity analysis
 “Best guess” vs broader range of possibilities
 Start with key assumptions underlying a set of
forecasts
 Examine sensitivity to the assumptions
 Consider: historical patterns of performance,
changes in industry conditions, company’s strategy