Business

Forecasting

Anjana Vivek
anjana@bizkul.com

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Future analysis
Forecasting summarises future
expectations of:

Business strategy
 Accounting
 Financial analysis
Projects future expected scenario,
keeping past in view
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Financial Statements
Forecast should consist of the
following statements:
 Balance sheet
 Profit and loss account

Cash flow

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Future prediction
There should be a believable story
about the future performance of the
company. For eg.
 “Sales is expected to grow at more than
average industry expected rate of
growth in this BPO company. This is
because of the quality of the
management team, the investors and
the past track record of the company in
getting and retaining customers.”
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Strategic perspective
The strategic rationale should be
based on careful understanding of
 the company
 industry and

general economic scenario

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Strategic perspective
Value is driven by the excess of
return over cost of capital over a
long period of time. This comes
out of competitive advantage,
which could be due to:
 Superior product, service

Lower costs

Better utilisation of assets and
capital
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Strategic perspective

Porter model
 Customer segmentation
 Competitive business systems

SWOT analysis

Source: Valuation : Tom Copeland, Tim Koller, Jack Murrin

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Porter model

Substitute products / services
 Supplier bargaining power
 Customer bargaining power

Entry/exit barrier

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Substitute products Porter model


Speed post and courier service
competing in the service industry

 Replacement of glass containers

by metal cans

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Supplier bargaining power
Porter model


Shortage of technology experts
commanding premium for services
rendered
 Unique products or products with a
difference commanding better
price due to requirement of buyer

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Customer bargaining power
Porter model


Driving down of prices by
customers of software services
companies

 Customers moving from wholesale

stores to retailers as retail stores
are driven to pass on some of their
margins to their customers
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Entry / exit barriers Porter model


Limited availability of persons with
skill sets
 Minimum capital requirement for
setting up of BPO in a specific
area

Cost of exit, closure and
retrenchment may be prohibitive
due to statutes
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Customer Segmentation

Explicit identification of reason of
selection of one company’s product
over another
 Analyses the level of difficulty in
differentiation by competitors

Looks at profitability of customers,
based on their need and cost of
servicing them
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Customer Segmentation

Customer perspective
– Product attributes have different impact
on different kinds of customers (small
manufacturers may need after sales
service unlike bigger industries)
– Variation in product offerings may
impact sales as some customers may
prefer some bundled product offerings
as compared to others which are stand
alone
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Customer Segmentation

Customer perspective
– Segmentation of groups of customers
force analysts to understand why
customers prefer one product over
other (eg. in courier service some
customers want detailed tracking of
parcel, others do not)

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Customer Segmentation

Producers perspective
– Different customers have different
costs of servicing
 Advantage of segmentation is that
this helps identify existing and
potential competitive advantages

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Competitive Business
System
 Analysis from product design to after sales
service
– Product design, development, procurement,
manufacturing, marketing, sales & distribution
 Attempt to understand competitive advantage,
whether through lower costs, better capital use
or superior customer value
– (eg. A company may have advantage of
greater labour productivity, which needs to be
addressed by some alternate cost saving or
variation in product offering etc)
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Competitive Business
System
 Product design, development (product
attributes, quality, time to market, IP)

Procurement (Access to sources, costs,
outsourcing)
 Manufacturing (Costs, cycle time, quality)

Marketing (Pricing, advertisement,
packaging)

Sales and distribution (Sales
effectiveness, costs, channels, transportation)
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SWOT analysis

Strengths

Weaknesses
 Opportunities
 Threats

Check for links and patterns in these heads

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Capture strategy into
financial forecasts

Initially start with profit and loss
accounts and balance sheet
 Cash flow can be next derived
from these
 Prepare by keeping key ratios and
assumptions in mind

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Forecasting
methodology

Understand business strategy

Develop a complete picture
 Develop a complete financial
forecast of the BS, P&L and CF
statements

In short term calculate detailed
numbers, in long term summarise
trends expected
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Forecasting
methodology
 Compute sensitivity analysis, for
key drivers

Compute probability scenarios, in
the minimum, compute the
following scenarios:
– Normal
– Optimistic
– Pessimistic

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Forecasting
methodology
 Consistency checks
– key ratios and internal consistency
– industry parameters
 Cash flow and liquidity
– How will company raise funds
– How will funds be utilised
 Verify that the final numbers
reflect the overall strategy of
business
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Starting point

Make a start

What are the key drivers of the
business – now and in the future?
 What do you think are possible
starting points?

Translate your business story in words

into financial numbers

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Financial forecasts
 The general approach is to start
with demand, based on which
profit and loss statement is drawn
up
 Demand translates into sales
Revenue numbers are sensitive to volumes and prices

They also depend on product mix

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Starting point for start-
ups
In the case of early stage companies
which have not yet turned profitable the
following are the key drivers of the
business forecast for valuation purposes
 Cash burn
 Stake that the promoters are willing to
offer to the private equity
investor/venture capitalist

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Financial forecasts
 Expenses are based on sales
 Capex depends on capacity required
to generate revenues projected as
well as utilisation of capacity
 Revenue expenses are calculated
based on trends and requirements
One cannot just run an analysis
One has to understand trends
And then - Plan for the future
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Revenues forecast
 Dependent on industry and business
– Eg. retail industry, based on number of
stores
– ITES based on number of seats
– Manufacturing dependent on product mix
 Starting point Understanding
– Demand and supply normal industry
behavior is
– Market size and market share Necessary but not
– Break even point sufficient
– Growth trends www.bizkul.com 28
Earnings trends
 Generally observe 3 to 5 years

Check economic cycles – ie
seasonal/cyclic industries etc
 Check and remove unusual items
 Understand relevance of items to
normal earnings

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Adjustments/changes to
earnings
 Remove one time items

Remove abnormal/super earnings
which may not be sustainable
 Remove items not at market value
or not at arms length

Account for changes in accounting
policy (gross vs. net income etc.)
 Consider if future business can be
based on past earnings and
strategy www.bizkul.com 30
Forecasting earnings
 Past trends

Average of past few years

Industry trends
 Market share
 Forecast based on expected
strategy

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Some difficulties faced
 Incorrect adjustments

Adjustments only partially done, ie
in asset & not in impact of asset
on earnings/expenses (eg. land &
rent on land)

Error in calculation of growth

Error in base calculation of
earnings
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Expenses forecast
 Expenses to be listed, item by item
– Key drivers to be identified (eg salary – driven
by no. of people as well as expected salary
costs)
– Industry benchmarks may be used for cross
referencing (variations/deviations are to be
justified)
 Capex
– Based on requirement to reach target revenues
– Also impacts depreciation & cash flow
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Balance sheet and
Cash flow forecast
 Balance sheet accounts to be
individually forecast
– Based on expected sales and utilisation
of assets, company policies (debtors
collection period etc)
 Cash flow
– Based on forecast of balance sheet and
profit and loss account
– Consistency check is important after
getting the first set of numbers
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In Summary

Forecasting is the first step of
prospective analysis
 It is the start for any valuation
process
 The best way to forecast is to do it
comprehensively and in detail
including all key financial statements
 The forecast must stand up to
scrutiny; must be internally consistent
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