Forecasting Financial

Statements and
Financial Planning
Forecasting Financial
Statements
• Future performance is more
important than past performance.
• Hence, in addition to financial
analysis of past results,
forecasting future financial
performance is critical.
Forecasting Financial
Statements
Projected or pro Forma Financial Statements are
used in 4 ways:
1. Managers can assess whether future
performance is in line with targets and
investors’ expectations
2. Proposed operating changes can be
inputted into the financial projections
3. Future financing needs may be determined
4. Future free cash flows may be estimated,
determining the value of the firm.
Forecasting Financial
Statements

• Securities analysts may also project a

company’s financial statements to
determine the intrinsic value of the
company’s stock.
• Companies provide guidance to
analysts so that they can make realistic
forecasts.
 Forecasting Financial
Statements
• Projecting Financial Statements
• Begin with a sales forecast based on a
combination of historical performance and
anticipated prospects
• This is the most important component of a
forecast:
– If sales are underestimated, opportunity loss
and loss of market share will result
– If the sales forecast is too optimistic,
overcapacity & unnecessary investment
 Forecasting Financial
Statements
• Most other items in the income statement as well as
certain items in the balance sheet may be forecasted
using the percentage-of-sales method.
• Most items are projected to rise proportionately with
sales – Cost of Sales and Variable Operating expenses.
• General & Administrative Expenses may be forecasted
based on historical growth rate or ass a % of operating
revenues.
• Depreciation is forecasted as a % of fixed assets.
• Interest Expense is forecasted as a % of interest-
bearing debt.
• Income tax is a proportion of Earnings before Income
Tax (EBIT).
• EBIT less income tax is Net Income.
• Dividends may be projected after Net Income.
 Forecasting Financial
Statements
• Balance sheet items like receivables, inventories
and payables also rise proportionately with sales.
They may be projected by assuming a certain level
of turnover rate or days.
• Additions to property, plant & equipment may be
forecasted using the company’s capital
expenditure plans. Longer-term, Net PPE may be
forecasted a a percentage of sales, usually based
on the historical ratio.
• Depreciation is usually forecasted as a proportion
of net property, plant & equipment.
• Accrued liabilities may also be forecasted as a
constant ratio to sales.
 Forecasting Financial
Statements
• Forecasts of balance sheet items may be tweaked to
reflect conscious management decisions and plans.
• Retained earnings will be the projected net income
for the year less projected cash dividends added to
last year’s retained earnings.
• In order for Assets to be equal to Liabilities +
Stockholders’ Equity, either cash or liabilities must
be adjusted. This adjusting figure is known as the
Plug.
Forecasting Financial
Statements
• The Cash Flow Statement may be
derived based on the projected Income
Statements and Balance Sheets.
• The financial modeler must ensure that
the end-of-period cash equals the
projected Cash in the Balance Sheet.
Forecasting Financial
Statements

• The projections may then be used

to prepare a financial ratio
analysis.
The Financial Plan
• Six steps:
– Project the financial statements and
prepare a financial analysis. Subject the
projections to sensitivity analysis.
– Determine the funds needed to support the
plan.
– Forecast funds availability. Estimate funds
that can be internally-generated and funds
needed to be sourced externally.
The Financial Plan

– Establish and maintain a control system to

govern the allocation and use of funds
within the firm.
– Develop procedures for adjusting the plan
in the event actual results deviate from the
plan.
– Establish a performance-based
management compensation system.