1. Financial Forecasting
Chapter 4
Financial Forecasting

2. 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

3. 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

4. 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

5. 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

6. 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)

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

8. FIGURE 4-1
Development of pro forma statements

10. FIGURE 4-2
Development of a pro forma balance sheet

13. 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

14. 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.