Financial Forecasting Chapter 4 Financial Forecasting

Chapter 4 - Outline What is Financial Forecasting? 2 Methods of Financial Forecasting 3 Financial Statements for Forecasting Steps in a Pro Forma Income Statement (I/S) Determining Production Requirements Percent-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 for Forecasting Pro Forma Income Statement (I/S) Cash Budget Pro Forma Balance Sheet (B/S) The first step is to develop a sales projection

Steps in a Pro Forma Income Statement (I/S) Establish a sales projection Determine a production schedule (or production requirements) Compute other expenses Determine profit by completing an actual pro forma income statement (I/S)

Determining Production Requirements Projected Units Sales PLUS Desired Ending Inventory (EI) MINUS Beginning Inventory (BI) EQUALS Production Requirements (or Units to be Produced)

FIGURE 4-1 Development of pro forma statements

FIGURE 4-2 Development of a pro forma balance 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 sales change S = Change in Sales (forecast – prior sales) P = Profit margin S2 = Forecasted Sales D = Dividend Payout Ratio. (1-D) is retention rate.