Financial Forecasting

Chapter 4

Chapter 4 - Outline

What is Financial Forecasting?2 Methods of Financial Forecasting3 Financial Statements for Forecasting

Steps in a Pro Forma Income Statement (I/S)

Determining Production RequirementsPercent-of-Sales Method

What is Financial Forecasting?

Financial forecasting is looking ahead to develop a financial plan for the future

Very important for the strategic growth of a firm

2 Methods of Financial Forecasting:

– Using Pro Forma, or Projected, Financial Statements (more exact, time consuming)

– Percent-of-Sales Method (less precise, easier to calculate)

Often times these statements are required

by lenders

3 Financial Statements forForecasting

Pro Forma Income Statement (I/S)Cash BudgetPro Forma Balance Sheet (B/S)

The first step is to develop a sales projection

Steps in a Pro FormaIncome Statement (I/S)

Establish a sales projectionDetermine a production schedule (or production requirements)

Compute other expensesDetermine profit by completing an actual pro forma income statement (I/S)

Determining ProductionRequirements

Projected Units Sales PLUS

Desired Ending Inventory (EI) MINUS

Beginning Inventory (BI)EQUALS

Production Requirements (or Units to be Produced)

FIGURE 4-1Developmentof pro formastatements

FIGURE 4-2Development of a pro formabalance sheet

Percent-of-Sales Method

A short-cut, less exact, easier method of determining financing needs (The “quick and dirty” approach)

Assumes that B/S accounts will maintain a constant percentage relationship to sales

Assets / Current Sales = % of Sales

Percent-of-Sales Method

RNF = A/S (change S) – L/S (change S) – PS2(1-D)

Where:A/S = % relationship of assets to saleschange S = Change in Sales (forecast – prior

sales)P = Profit marginS2 = Forecasted SalesD = Dividend Payout Ratio. (1-D) is retention

rate.