Financial Forecasting How can we use facts and assumptions to construct pro forma financial statements?

Steps in Financial Forecasting Choosing a model driver Making reasonable assumptions as needed Using the discipline of accounting definitions Making the forecast Interpreting the results Sensitivity analysis

Possible Model Drivers 1.Sales Assets are needed to support sales, so must keep pace with sales and be financed 2.Financing Policy Assets (and thus sales) can only grow as fast as the company’s ability to finance them

A Sales-Driven Model ABC Company: Which financial statement items can be forecast relative to sales? What other assumptions do we need to make? What will we use as a “plug” figure?

A Model Driven by Financing Growcorp: Financing policy: no new equity issues, debt ratio cannot exceed 0.4. Timing assumption: flow of activity determined by beginning-of-year assets What growth rate in sales can be “sustained”?

Sustainable Growth Sustainable growth rate = ROEb (return on equity times retention ratio) How can company grow faster than sustainable rate? –Issue equity, increase debt ratio What if company grows slower than sustainable rate? –Debt ratio decreases, stock retired, cash piles up