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CHAPTER 4

Forecasting and Pro Forma


Financial Statements
Learning Objectives
… Understand the basic steps used in selecting a
forecasting model.
… Know how to evaluate a forecasting model.
… Given a business situation, choose the proper
forecasting model.
… Calculate a forecast using time series data.

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Learning Objectives (continued)
… Explain the role that the Mean Absolute Deviation
(MAD) plays in selecting a forecasting model.
… Understand the relationship among a business’s
revenue base, sales forecast, assets, and need for
financing.

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Learning Objectives (continued)
… Construct pro forma financial statements from
available data on a proposed or existing business.
… Apply the percentage of sales method in
determining any required new financing needed for
a business.

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Forecasting
… A forecast is a quantifiable estimate of future
demand.
… Forecasting in business is the process of estimating
the future demand for our products and services.
… Forecasting for the financial manager also requires
estimates of future interest rates.

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Forecasting Process

… Determine the type of model to be used.


… Determine the forecast horizon.
… Select one or more forecasting models.
… Evaluate the models.
… Apply the chosen model.
… Monitor and control the model.

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Determine the Type of Model
to be Used
1) Who will be using the forecast and what
information do they require?
2) How relevant is historical data, and what is its
availability?
3) How accurate does the forecast have to be?
4) What is the time period of the forecast?
5) How much time do we have to develop the
forecast?
6) What is the cost or benefit (value) of this
forecast to our company?
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Determine the Forecast Horizon
… Inverse relationship between forecast accuracy
and time horizon.
† The longer the time horizon the more inaccurate the
forecast will be.
… Time horizon should be at least as long as time
period of strategic plan.
… Product life cycles influence length of forecasts.
† Technological product sales would have a short
forecast.
† Milk sales would have a long forecast.

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Select One or More Forecasting
Models
… Must consider the basic six questions.
1) Who will be using the forecast and what information
do they require?
2) How relevant is historical data, and what is its
availability?
3) How accurate does the forecast have to be?
4) What is the time period of the forecast?
5) How much time do we have to develop the forecast?
6) What is the cost or benefit (value) of this forecast to
our company?
… Some instances will require a combination of
forecasting models.

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Evaluate the Models
… Compare the accuracy of forecasting models by
use of Mean Absolute Deviation (MAD)
… Remember the model assists the forecaster, it
does not make the decision.
… Changing market and economic conditions
require us to constantly evaluate our forecasting
models.

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Apply the Chosen Model
… Application in business is used to determine future
requirement.
… Application of the model and specific units of
measurement used depends on the area of the
business that uses the model:
† Marketing wants demand of product.
† Production requires units.

† Finance requires dollars.

† Personnel requires human resources.

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Monitor and Control the Model
… Model should allow us to develop controls in a
three-step process:
† Determine standard for measuring progress toward
forecast.
† Measure actual performance against this standard.

† Take corrective action.

… When the forecasting model no longer allows the


manager to do this, then a new forecasting model
must be developed.

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Types of Forecasting Models
… Judgmental models, which use qualitative methods
… Time series models, which use quantitative methods
… Causal models, which use cause-and-effect
methods

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Judgmental Models
… Judgmental models are qualitative and essentially
use estimates based on expert opinion.
† Survey of Sales Forces: most appropriate for
manufacturing and wholesale firms.
† Surveys of Customers: applicable to all firms.
Customers express preference for new or modified
products.

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Judgmental Models (continued)
† HistoricalAnalogy most appropriate for firms that
have several outlets. Introduction of new product which
has characteristics similar to previous products.
† Market Research can include surveys, tests, and
observations. Results are statistically extrapolated to
develop forecasts of demand for products.

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Judgmental Models (continued)
… Delphi Method uses a panel of experts to obtain a
consensus of opinion. Used primarily for unique new
products or processes for which no previous data
exist.

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Time Series Models
… Time series forecasting models normally use
historical records that are readily available
within the firm or industry to predict future sales.
† For this reason they are often referred to as internal
or intrinsic models.
† Assumption in time series forecasting is that past
sales are a fairly accurate predictor of future sales.

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Time Series Models (continued)
… Moving average model
… Weighted moving average model
… Exponential smoothing model
… Linear regression model

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Time Series Models (continued)
… References for mathematics in forecasting:
†A = Actual observation of the variable to be forecast.
† F = Forecast of the variable.

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Time Series Models (continued)
… References for mathematics in forecasting (continued):
† t = current time period. Time periods can be a measure of any time
period (e.g., hour, day, month, year, decade, etc.). If time periods
are measured in months and the current month is April, then t = April.
† t-1 = one time period in the past. If time is being measured in
months and t is April then one time period in the past is March.
† t-2 = two time periods in the past, etc. If time is being measured in
months and t is April then two time periods in the past is February.
† t+1 = one time period in the future. If time is being measured in
months and t is April then one time period in the future is May.
† t+2 = two time periods in the future. If time is being measured in
months and t is April then two time periods in the future is June.

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Time Series Models (continued)
… References for mathematics in forecasting
(continued):
†Δ = the difference between two numbers. For
example ΔAF would be actual observation of
variable minus forecast.
† Σ= Sum of several numbers, normally in a column.

† n = the number of observations used in a calculation.


The n for months in a year equal 12 and n for years
in a decade is 10.

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Moving Average Model
… Moving average model assumes that actual sales
for some recent previous time periods are the best
predictor of future sales.
… It assumes that each time period taken in succession
has an equal influence on the prediction of future
sales.

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Moving Average Model

… The procedure is to obtain the arithmetic average of


actual sales for several past time periods.
A( t −[ n−1]) + ... + At −1 + At
Ft +1 =
n

ƒ For a three-month forecast of year 1 data:


At −2 + At −1 + At
Ft +1 =
3
(245 + 244 + 250)
FApril = 246.33
3

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Table 6-1 Moving Average Model

A( t −[ n−1]) + ... + At −1 + At
Formula for Moving Average: Ft +1 =
n
Moving Average = Forecast
Actual
Numerical
3 Month Deviation Absolute 4 Month Absolute
Time Actual Moving = Actual - Deviatio Moving Deviatio
Year Month Period Sales Average Forecast n Δ |A-F| Average n Δ |A-F|
0
Year 1 Jan 1 245
Feb 2 244
Mar 3 250
Apr 4 260 246.33 13.67 13.67
May 5 265 251.33 13.67 13.67 249.75 15.25
Jun 6 260 258.33 1.67 1.67 254.75 5.25
Jul 7 255 261.67 (6.67) 6.67 258.75 3.75
Aug 8 245 260.00 (15.00) 15.00 260.00 15.00
Sep 9 240 253.33 (13.33) 13.33 256.25 16.25
Oct 10 255 246.67 8.33 8.33 250.00 5.00
Nov 11 265 246.67 18.33 18.33 248.75 16.25
Dec 12 270 253.33 16.67 16.67 251.25 18.75
Year 2 Jan 13 250 263.33 (13.33) 13.33 257.50 7.50
Feb 14 250 261.67 (11.67) 11.67 260.00 10.00
Mar 15 258 256.67 1.33 1.33 258.75 0.75
Apr 16 267 252.67 14.33 14.33 257.00 10.00
May 17 273 258.33 14.67 14.67 256.25 16.75
Jun 18 278 266.00 12.00 12.00 262.00 16.00
Jul 19 260 272.67 (12.67) 12.67 269.00 9.00
Aug 20 256 270.33 (14.33) 14.33 269.50 13.50
Sep 21 255 264.67 (9.67) 9.67 266.75 11.75
Oct 22 270 257.00 13.00 13.00 262.25 7.75
Nov 23 275 260.33 14.67 14.67 260.25 14.75
Dec 24 283 266.67 16.33 16.33 264.00 19.00
Year 3 Jan 25 276.00 270.75
ΣΔ| A-F|= 62.00 255.33 232.25
n= 21 21 20
MAD= 2.95 12.16 11.61

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Mean Absolute Deviation
… Mean absolute deviation (MAD) is a tool used to
measure the forecasting error of a model.
† MAD is simple to calculate and provides us with a
method of determining which weights, or alpha, to
choose for our model and which model is most
appropriate for predicting sales.

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Mean Absolute Deviation (continued)

† Absolute deviation is the absolute difference between


forecasted sales and actual sales.
† The absolute value of any number is positive and is
represented mathematically by vertical lines drawn on
either side of the number or formula.

Absolute deviation = A - F

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Average Arithmetic Deviation vs.
Average Absolute Deviation

… The average arithmetic deviation is the actual


difference between two numbers:
13.67 + ( − 13.33) 0.34
Average arithmetic deviation = = = 0.17
2 2

ƒ The average absolute deviation using the same numbers:

13.67 + 13.33 27
Average absolute deviation = = = 13 .5
2 2

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Mean Absolute Deviation (continued)

… Mean absolute deviation (MAD) is the measure of


the overall forecast error.
† MAD represents the average difference between our
forecast and actual sales data.

Σ Actual sales − Forecast sales


MAD =
n
ΣA−F
MAD =
n

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290

280

270

Actual
Sales in Units

260

250

240

230
Forecast Sales

220

210
Year Feb M ar Apr M ay Jun Jul Aug Sep Oct Nov Dec Year Feb M ar Apr M ay Jun Jul Aug Sep Oct Nov Dec Year
1 Jan 2 3
Jan Jan

Figure 6-1 Year and Month


Plot of Actual Sales and Forecast Sales

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Weighted Moving Average Model
… Weighted moving average model assumes that the
closest time period is a more accurate predictor of
future sales than previous time periods.
† Previous time periods do have some influence on future
sales.
† Forecaster will assign weights to the time periods based
on his or her judgment.

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Weighted Moving Average Model
(continued)

… The sum of the weights normally equal one.


† Ifthe forecaster does not want to use a sum of one,
then we sum the weights and use this sum as the
denominator in our equation.
† The value of each weight is based on how much of
an influence the forecaster believes the
corresponding time period has on overall sales.

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Weighted Moving Average Model
(continued)

… The formula for this method, using three months, is


as follows:
Ft +1 =
(W1 )( At −2 ) + (W2 )( At −1 ) + (W3 )( At )
∑W
Using weights of 0.1, 0.3 & 0.6 with actual sales
of 245,244, & 250 we solve as follows:
Year 1
Ft+1 = (W1)(At22) + (W2)(At21) + (W3)(At)
F Apr = (0.1)(245) + (0.3)(244) + (0.6)(250)
F Apr = 247.70

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Table 6-2 Weighted Moving Average Model

(Wt )( At − 2 ) + (W2 )( At −1 ) + (W3 )( At )


Formula for weighted moving average: Ft =
ΣW

W1=0.1, W1=0.25, W1=4


Time Actual W2=0.3, W2=0.35, W2=5
Year Month Period Sales W3=0.6 Δ |A-F| W3=0.40 Δ |A-F| W3=8 Δ |A-F|
0
Year 1 Jan 1 245
Feb 2 244
Mar 3 250
Apr 4 260 247.70 12.30 246.65 13.35 247.06 12.94
May 5 265 255.40 9.60 252.50 12.50 253.29 11.71
Jun 6 260 262.00 2.00 259.50 0.50 260.00 0.00
Jul 7 255 261.50 6.50 261.75 6.75 261.47 6.47
Aug 8 245 257.50 12.50 259.25 14.25 258.82 13.82
Sep 9 240 249.50 9.50 252.25 12.25 251.47 11.47
Oct 10 255 243.00 12.00 245.50 9.50 245.00 10.00
Nov 11 265 249.50 15.50 247.25 17.75 248.24 16.76
Dec 12 270 259.50 10.50 255.25 14.75 256.18 13.82
Year 2 Jan 13 250 267.00 17.00 264.50 14.50 265.00 15.00
Feb 14 250 257.50 7.50 260.75 10.75 259.41 9.41
Mar 15 258 252.00 6.00 255.00 3.00 254.71 3.29
Apr 16 267 254.80 12.20 253.20 13.80 253.76 13.24
May 17 273 262.60 10.40 259.60 13.40 260.35 12.65
Jun 18 278 269.70 8.30 267.15 10.85 267.71 10.29
Jul 19 260 275.40 15.40 273.50 13.50 273.94 13.94
Aug 20 256 266.70 10.70 269.55 13.55 268.35 12.35
Sep 21 255 259.40 4.40 262.90 7.90 262.35 7.35
Oct 22 270 255.80 14.20 256.60 13.40 256.47 13.53
Nov 23 275 264.10 10.90 261.25 13.75 262.29 12.71
Dec 24 283 271.50 11.50 268.25 14.75 268.82 14.18
Year 3 Jan 25 279.30 276.95 277.59
ΣΔ| A-F| = 218.90 244.75 234.94
n= 21.00 21.00 21.00
MAD = 10.42 11.65 11.19

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Exponential Smoothing Model
… Exponential smoothing model uses a smoothing
constant, alpha (α), as an adjustment in
determining the forecast.
†A smoothing constant is a value assigned by the
forecaster to adjust the forecast based on the
forecaster’s assumption of the relationship between
sales in one time period and sales in the next time
period.
† Alpha can have any value between 0 and 1;
however, alpha is normally 0.1, 0.2, or 0.3.
† The higher the value of alpha, the greater the
emphasis given to sales for the current time period.

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Exponential Smoothing Model
(continued)
… With exponential smoothing we must begin with
an assumed rather than an actual forecast.
ƒ The formula is Ft +1 = α ( At ) + (1 − α )( Ft )

or Ft +1 = ( Ft ) + α ( At − Ft )

Year 1
Ft +1 = α ( At ) + (1 − α )( Ft )
FMarch = (0.1)(244) + (1 − 0.1)(245) = 24.4 + (0.9)(245) = 24.4 + 220.5
FMarch = 244.90

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Table 6-3 Exponential Smoothing Model

Formulas for Exponential Smoothing Model: F t +1 = α (A t ) + (1 − α )(F t )


F t +1 = F t + α (A t − F t )

Time Actual Forecast Forecast Forecast


Year Month Period Sales (A) for α =0.1 Δ| Α−F| for α =0.2 Δ| Α−F| for α =0.25 Δ| Α−F|
0
Year 1 Jan 1 245
Feb 2 244 245.00 245.00 245.00
Mar 3 250 244.90 5.10 244.80 5.20 244.75 5.25
Apr 4 260 245.41 14.59 245.84 14.16 246.06 13.94
May 5 265 246.87 18.13 248.67 16.33 249.55 15.45
Jun 6 260 248.68 11.32 251.94 8.06 253.41 6.59
Jul 7 255 249.81 5.19 253.55 1.45 255.06 0.06
Aug 8 245 250.33 5.33 253.84 8.84 255.04 10.04
Sep 9 240 249.80 9.80 252.07 12.07 252.53 12.53
Oct 10 255 248.82 6.18 249.66 5.34 249.40 5.60
Nov 11 265 249.44 15.56 250.73 14.27 250.80 14.20
Dec 12 270 250.99 19.01 253.58 16.42 254.35 15.65
Year 2 Jan 13 250 252.89 2.89 256.86 6.86 258.26 8.26
Feb 14 250 252.60 2.60 255.49 5.49 256.20 6.20
Mar 15 258 252.34 5.66 254.39 3.61 254.65 3.35
Apr 16 267 252.91 14.09 255.11 11.89 255.49 11.51
May 17 273 254.32 18.68 257.49 15.51 258.36 14.64
Jun 18 278 256.19 21.81 260.59 17.41 262.02 15.98
Jul 19 260 258.37 1.63 264.07 4.07 266.02 6.02
Aug 20 256 258.53 2.53 263.26 7.26 264.51 8.51
Sep 21 255 258.28 3.28 261.81 6.81 262.38 7.38
Oct 22 270 257.95 12.05 260.45 9.55 260.54 9.46
Nov 23 275 259.16 15.84 262.36 12.64 262.90 12.10
Dec 24 283 260.74 22.26 264.89 18.11 265.93 17.07
Year 3 Jan 25 262.97 268.51 270.20
ΣΔ| A-F| = 233.54 221.36 219.80
n= 22.00 22.00 22.00
MAD = 10.62 10.06 9.99

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Linear Regression Model
… Linear regression uses a statistical method known
as least squared regression.
† Four areas of variation:
„ Seasonal variation is caused by the predictable shopping
habits of our customers.
„ Trend variation is variation caused by growth or decline
in demand for our product or service over time.
„ Cyclical variation is caused by general economic factors
that affect our industry.
„ Noise is random variation in our data that is not
explained by the preceding factors.

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Linear Regression Model (continued)

… Linear regression is used to determine two factors:


† The slope of the regression line
† The intercept of the regression line

ƒ Basic formula for the regression line is:


y = a + bx.

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Regression line defined
y = a + bx.
Where:
y is the dependent variable. A dependent variable is one that
relies on other variables for its value.
x is the independent variable. An independent variable is
one that does not depend on other variables for its value. In
forecasting models, x is often a time period.
a is the y intercept. The y intercept is the value of y when x
equals 0.
b is the slope of the regression line.
y2 − y1
b=
x2 − x1

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SCATTER DIAGRAM

290

280

270
SALES IN $(000)

260

250

240

230

220

210

200
0 5 10 15 20 25 30
Figure 6-2 TIME PERIOD IN MONTHS

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FIGURE 6-3
Sales Chart with Regression Line

290

280

270

260
SALES IN $(000)

250

240

230

220

210
0

10

12

14

16

18

20

22

24

26

28

30

32

34

36
TIME IN MONTHS

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Table 6-4 Calculation of the Regression Line

Time Actual
Period Sales
2
Year Month (x) (y) x xy
Year 1 JAN 1 245 1 245
FEB 2 244 4 488
MAR 3 250 9 750
APR 4 260 16 1,040
MAY 5 265 25 1,325
JUN 6 260 36 1,560
JUL 7 255 49 1,785
AUG 8 245 64 1,960
SEP 9 240 81 2,160
OCT 10 255 100 2,550
NOV 11 265 121 2,915
DEC 12 270 144 3,240
Year 2 JAN 13 250 169 3,250
FEB 14 250 196 3,500
MAR 15 258 225 3,870
APR 16 267 256 4,272
MAY 17 273 289 4,641
JUN 18 278 324 5,004
JUL 19 260 361 4,940
AUG 20 256 400 5,120
SEP 21 255 441 5,355
OCT 22 270 484 5,940
NOV 23 275 529 6,325
DEC 24 283 576 6,792
SUMS (Σ) 300 6,229 4,900 79,027

Using the formulas below , w e substitute from Table 6-3 above and obtain an intercept (a) of
246.8841 and a slope (b) of 1.0126
y=a+bx

Σx2Σy − ΣxΣxy (4,900)(6,229) − (300)(79,027) (30,522,100) − (23,708,100) 6,814,000


a= = = = = 246.8841
nΣx2 − (Σx)2 (24)(4,900) − (300)2 (117,600) − (90,000) 27,600
nΣxy - ΣxΣy (24)(79,027) − (300)(6,229) 1,896,648− 1,868,700 27,948
b= 2 = = = = 1.0126
nΣx − (Σx)2 (24)(4,900) − (300)2 117,600− 90,000 27,600

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Table 6-5, Forecast of sales, including seasonal adjustment.
y= a + bx
a= 246.8841
b= 1.0126
Regression Seasonal Seasonal
Time Actual Sales (A) Forecast (F) Ratio Forecast of
Year Month x Jan-01 - Dec-02 y = a + bx (A)/(F) Sales
0 246.88
Year 1 Jan 1 245 247.90 0.99 245
Feb 2 244 248.91 0.98 244
Mar 3 250 249.92 1.00 250
Apr 4 260 250.93 1.04 260
May 5 265 251.95 1.05 265
Jun 6 260 252.96 1.03 260
Jul 7 255 253.97 1.00 255
Aug 8 245 254.98 0.96 245
Sep 9 240 256.00 0.94 240
Oct 10 255 257.01 0.99 255
Nov 11 265 258.02 1.03 265
Dec 12 270 259.04 1.04 270
Year 2 Jan 13 250 260.05 0.96 250
Feb 14 250 261.06 0.96 250
Mar 15 258 262.07 0.98 258
Apr 16 267 263.09 1.01 267
May 17 273 264.10 1.03 273
Jun 18 278 265.11 1.05 278
Jul 19 260 266.12 0.98 260
Aug 20 256 267.14 0.96 256
Sep 21 255 268.15 0.95 255
Oct 22 270 269.16 1.00 270
Nov 23 275 270.17 1.02 275
Dec 24 283 271.19 1.04 283
Year 3 Jan 25 272.20 0.97 265
Feb 26 273.21 0.97 265
Mar 27 274.22 0.99 272
Apr 28 275.24 1.03 282
May 29 276.25 1.04 288
Jun 30 277.26 1.04 288
Jul 31 278.27 0.99 276
Aug 32 279.29 0.96 268
Sep 33 280.30 0.94 265
Oct 34 281.31 1.00 281
Nov 35 282.33 1.02 289
Dec 36 283.34 1.04 296

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Regression Forecast with Seasonal Factors Included

320
Actual sales first 24 Months,
forecast sales months 25-36

300

280
Sales in ($000)

260
Regression Line

240

220
0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32 34 36 38
Time in Months

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Causal Models

… Causal models are also known as external or


exogenous models.
† Causal models take into account variables in the
general economy that affect the revenue obtained
by a company.
† Causal models can be simple or very complex.

† Most of them require multiple regression analysis,


which is normally beyond the scope of a small
business manager.

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Practical Sales Forecasting for
Startup Businesses
… Steps to take for a sales forecast:
† Listing what you know:
„ Expertise, experience, knowledge of charges and fees.
„ Previous revenue and cost information based on experience.
† Research similar companies via EDGAR competing company
annual reports, or industry-specific publications.
† List three types of expenses:
„ Startup
„ Fixed
„ Variable
† Develop a revenue forecast

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Forecast of Revenue for a Startup
Table 6-6 Forecast of Revenue for a Startup Service or Trade Busines

Billed Number Weeks


Hours per Days per Hourly Hourly Overtime of Worked
day Week Rate Wage Wage Workers per Year
Best Case 10 6 65 30 45 1 50
Worst Case 4 4

Weekly Annually
Worst Worst
Best Case Case Best Case Case
Gross Revenue $ 3,900 $ 1,040 $ 195,000 $ 52,000
Labor Cost 2,100 480 105,000 24,000
Material Cost - -
Gross Profit $ 1,800 $ 560 $ 90,000 $ 28,000

Note: All wages over 40 hours per week are paid at an hourly wage of 1.5 times the hourly
wage.

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Pro Forma Financial Statements
… A pro forma financial statement is a projected
statement based on the forecast.
… The three basic pro forma statements are:
† Pro forma income statement
† Pro forma cash budget

† Pro forma balance sheet

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Table 6-7, Pro Forma Income Statement
Income Statements for Time Periods Indicated
Actual Pro Forma
Sales for Sales for
2007 2008
Sales $ 200,000 $ 250,000
COG 100,000 $ 125,000
Gross Profit $ 100,000 $ 125,000
Operating Expenses
Rent 24,000 24,000
Utilities 3,000 3,600
Salaries 60,000 63,000
Insurance 2,400 3,000
Depreciation 5,000 7,000
Equipment 4,500 7,800
Total Operating Expenses $ 98,900 $ 108,400
Operating Profit $ 1,100 $ 16,600
Interest Expense 5,000 6,800
Net Profit $ (3,900) $ 9,800

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Table 6-8 Pro Forma Cash Budget

Monthly Cash Receipts


Actual Sales 2007 Pro Form a Sales and
October November December January February March April May June
Sales $ 17,625 $ 20,250 $ 22,500 $ 13,000 $ 14,500 $ 14,000 $ 19,000 $ 23,000 $ 24,500
Current Month Collection at 30% of Sales 5,288 6,075 6,750 3,900 4,350 4,200 5,700 6,900 7,350
Outstanding Current Month Accounts Receivable (AR) 12,338 14,175 15,750 9,100 10,150 9,800 13,300 16,100 17,150
60% of AR Collected Month Follow ing Sale 7,403 8,505 9,450 5,460 6,090 5,880 7,980 9,660
40% of AR Collected in 2nd Month Follow ing Sale 4,935 5,670 6,300 3,640 4,060 3,920 5,320
Total Receipts $ 20,190 $ 19,020 $ 16,110 $ 13,930 $ 15,640 $ 18,800 $ 22,330
Monthly Cash Paym ents
Accounts Payable (AP) Previous Month $ 10,125 $ 11,250 $ 6,500 $ 7,250 $ 7,000 $ 9,500 $ 11,500
Operating Expenses 8,450 8,450 8,450 8,450 8,450 8,450
Interest Payments 567 567 567 567 567 567
Total Payments $ 20,267 $ 15,517 $ 16,267 $ 16,017 $ 18,517 $ 20,517
Monthly Cash Budget
Total Receipts $ 19,020 $ 16,110 $ 13,930 $ 15,640 $ 18,800 $ 22,330
Total Payments 20,267 15,517 16,267 16,017 18,517 20,517
Net Cash Flow $ (1,247) $ 593 $ (2,337) $ (377) $ 283 $ 1,813
Cash Budget W ith Borrowing and Repayment
Net Cash Flow $ (1,247) $ 593 $ (2,337) $ (377) $ 283 $ 1,813
Beginning Cash Balance 4000 $ 4,000 $ 4,000 4,000 4,000 4,000
Total Cash Balance $ 2,753 $ 4,593 $ 1,663 3,623 4,283 5,813
Monthly Loan or (Repayment) 1,247 (593) 2,337 377 (283) (1,813)
Cumulative Loan Balance 9000 10,247 9,654 11,991 12,368 12,085 10,272
Ending Cash Balance $ 4,000 $ 4,000 $ 4,000 $ 4,000 $ 4,000 $ 4,000 $ 4,000

Note: Shaded row s, Sales and Outstanding Current Month Accounts Receivable and cumulative loan balance do not represent cash flow .
Note: Shaded rows, Sales and Outstanding Current Month Accounts Receivable do not represent cas

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Table 6-9 Pro Forma Balance Sheet
Balance Sheets for Year Ending December 31
Pro
Actual Forma for
for 2007 2008
Current Assets
Cash $ 4,000 $ 8,406
Accounts Receivabe 21,420 28,500
Inventory 15,000 18,750
Total Current Assets $ 40,420 $ 55,656
Fixed Assets
Net Machinery & Equipment 30,000 43,000
Total Assets $ 70,420 $ 98,656

Liabilities and Owner's Equity


Current Liabilities
Accounts Payable $ 11,250 $ 15,000
Salaries Payable $ 2,500 $ 2,625
Notes Payable 9,000
Total Current Liabilities $ 22,750 $ 17,625
Long-Term Liabilities
Long-Term Loan $ 30,000 $ 50,000
Total Liabilities $ 52,750 $ 67,625
Owner's Equity 17,670 31,031
Total Liabilities & Owner's Equity $ 70,420 $ 98,656

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Pro Forma Balance Sheet Using
Percentage of Sales
… Percentage of sales method is based on the fact
that assets and liabilities historically vary with
sales.
† Thus any increase in sales will cause a subsequent
buildup in both assets and liabilities.
† Both profit margins and dividend (owner) payout
ratios determine the amount of internal financing
that can be applied to support increased asset
buildup.

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Pro Forma Balance Sheet Using
Percentage of Sales (continued)

The basic formula for percentage of sales is:

Balance Sheet Entry in $


Percentage of Sales =
Actual Net Sales in $
$4, 000
Percentage of Sales = = 0.02 or 2%
$200, 000

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Table 6-10 Pro Forma Balance Sheet using percentage of sales method
Balance Sheets for Year Ending December 31
Sales taken from Table 6-7 $ 200,000 $ 250,000
Actual Percentage Pro Forma
sales for of 2005 sales for
2005 sales 2006
Current Assets
Cash $ 4,000 2.00% $ 5,000
Accounts Receivabe 21,420 10.71% 26,775
Inventory 15,000 7.50% 18,750
Total Current Assets $ 40,420 20.21% $ 50,525
Fixed Assets
Net Machinery & Equipment 30,000 15.00% 37,500
Total Assets $ 70,420 35.21% $ 88,025
$ -
Liabilities and Owner's Equity $ -
Current Liabilities $ -
Accounts Payable $ 11,250 5.63% $ 14,063
Salaries Payable 2,500 1.25% 3,125
Notes Payable 9,000 4.50% 11,250
Total Current Liabilities $ 22,750 11.38% $ 28,438
Long-Term Liabilities
Long-Term Loan $ 30,000 15.00% $ 37,500
Total Liabilities $ 52,750 26.38% $ 65,938
Owner's Equity 17,670 8.84% 22,088
Total Liabilities & Owner's Equity $ 70,420 35.21% $ 88,025

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Using Percentage of Sales to
Determine New Financing
… The following is used based on pro forma balance
sheet (Table 6-9):

⎛ Assets ⎞ ⎛ Liabilities ⎞
Required Financing = ΔSales ⎜ ⎟ − ΔSales ⎜ ⎟ − ( S 2 )( P )(1 − Owner Payout)
⎝ Sales ⎠ ⎝ Sales ⎠
⎛ $70,420 ⎞ ⎛ $52, 750 ⎞ ⎛ −3,900 ⎞
Required Financing = ($250,000-$200,000) ⎜ ⎟ − ($250, 000 − $200, 000) ⎜ ⎟ − ($250, 000) ⎜ ⎟ (1 − 0.66)
⎝ $200,000 ⎠ ⎝ $200, 000 ⎠ ⎝ $200, 000 ⎠
Required Financing = ($50,000)(0.3521)-($50,000)(0.2638)-($250,000)(0.0195)(0.34)
Required Financing = $17, 605 − $13,190 + $1, 657.50
Required Financing = $6, 072.50

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Monitoring and Controlling the
Business
… Monitoring in finance is normally accomplished by
use of budgets and pro forma financial financial
statements.
† Most small businesses require only two budgets for
monitoring and controlling purposes, the capital
budget and the cash budget.
… Controlling process requires three steps:
† Establishinga standard
† Comparing actual performance to the standard

† Taking corrective action if necessary

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Startup Business Costs
… Startup costs are those associated with getting the
enterprise up and running prior to generating any
sales.

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Gantt Chart
… A Gantt chart, Figure 6-5, shows all tasks that have
to be performed and the time that it takes to
accomplish these tasks.

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Figure 6-5 GANTT CHART, BASIC ENTRY FORM

Project: Manager: Phone: Page: ___

Plan Area: Manager: Phone: of ______ Pages


TIME PERIODS
Task TASK Task
NO... DESCRIPTION: Time RESOURCE PHONE

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