Forecasting

Michael Garcia, Ed Go, Chito Freyna

"Prediction is very difficult, especially if it's
about the future."
--Nils Bohr, Nobel laureate in physics
Learning Objectives

• Understand the relevance, practicality and

importance of financial forecasting to every business.
Outline
• Forecasting
• Users of Forecasting
• Forecasting Approaches
– Qualitative Forecast
– Quantitative Forecast
• Sample Analysis
• Group exercise
What is Financial Forecasting?

• It is a process of anticipating the future financial state

of the business. It requires a comprehensive analysis
of the firm’s past performance, market trends,
customer behaviors, assets and liabilities, firm’s
appetite for growth, and some of the other relevant
conditions that will affect the business performance
in the future.
FORECASTING DETERMINE ACTION PLAN
• Manufacturing
• Finances
• Human Resources
• Marketing
• Other Support Functions
Steps in Forecasting Process
1. Determine the purpose of the forecast
2. Establish a time horizon
3. Select a forecasting technique
4. Obtain, clean, and analyze appropriate data
5. Make the forecast
6. Monitor the forecast
7. Validate and implement results
Users of Forecasting
Internal External
• Management • Creditors
• Employees • Tax authorities
• Owners • Investors
• Customers
• Regulatory Authorities

http://accounting-simplified.com/financial/users-of-accounting-information.html
 Internal users (Primary Users) 
1. Management: for analyzing the organization's
performance and position and taking appropriate
measures to improve the company results.
2. Employees: for assessing company's profitability and its
consequence on their future remuneration and job
security.
3. Owners: for analyzing the viability and profitability of
their investment and determining any future course of
action.

*Accounting information is presented to internal users usually in

the form of management accounts, budgets, forecasts and financial
statements.
External User (Secondary Users)
1. Creditors: for determining the credit worthiness of the
organization. Terms of credit are set by creditors
according to the assessment of their customers'
financial health. Creditors include suppliers as well as
lenders of finance such as banks.
2. Tax Authourities: for determining the credibility of the
tax returns filed on behalf of the company.
3. Investors: for analyzing the feasibility of investing in the
company. Investors want to make sure they can earn a
reasonable return on their investment before they
commit any financial resources to the company.
External User (Secondary Users)
4. Customers: for assessing the financial position of its
suppliers which is necessary for them to maintain a
stable source of supply in the long term.
5. Regulatory Authorities: for ensuring that the company's
disclosure of accounting information is in accordance
with the rules and regulations set in order to protect the
interests of the stakeholders who rely on such
information in forming their decisions.

*External users are communicated accounting information

usually in the form of financial statements.
TO GET AN ACCURATE FORECAST, MANAGERS NEED TO CONSIDER

• Historical Sales Data

• Market Trend
• Economic statistics
• External Factors
• Post evaluation of market activities
Results of accurate forecasting
• Reduced COGS(Cost of Goods Sold)
– Reduce inventory
– Optimum operations
• Better Gross Margins
• Higher Net Income
• Best use of company’s wealth
When do we perform the forecasting?

• Monthly or annually, depends on the capability and

need of the business.
• Some companies like Nestle calls this Dynamic
Forecasting and is being done on a monthly basis to
ensure adjustments are made timely.
Basic Forecasting Approaches

Opinions from experts, Historical data from

decision makers, or time series or
customers correlation information
Basic Forecasting Approaches
Qualitative Methods
(subjective) = people expertise)
• Used when situation is
unclear & little data exist data exist.
• New products
• New technology
• Involves intuition, experience
e.g., forecasting sales on Internet
Quantitative Methods
(objective) = math models
• Used when situation is ‘stable’ &
historical data exist
• Existing products
• Current technology
• Involves mathematical
Techniques. e.g., forecasting
sales of colour televisions
 Uses subjective inputs

Executive Market Sales Force

Delphi Method
Opinion Research Estimates

Opinions of high Opinions from Customer: size, non-retail

level managers. experts, decision scope, demographics environments where
makers, or and buying habits, sales people or
customers account managers
have deep customer
relationship.
 assume that the variable being
forecasted is related
to other variables in the
environment.

look at past patterns of data and

Time Series attempt to predict the future Associative
Forecasting based upon the underlying
patterns contained
Models
within those data.

Regression
Naïve Moving Exponential
Approach Averages Smoothing
Uses last period’s average of a A weighted average
actual value as a specified number procedure with
forecast of the most weights declining
recent exponentially as data
observations. become older
Naïve Forecast Method

What is the forecast for April?

• assumes that demand in the

next time period will be the
same as demand in the last
time period.
Moving Average

A moving average is a technique to

get an overall idea of the trends in a
data set; it is an average of any
subset of numbers.

The moving average is extremely

useful for forecasting long-term
trends. You can calculate it for any
period of tim

Month Demand
Jan 32
Feb 26
Mar 12

  April
Exponential Smoothing
  Ft+1
  F3 26
  F4
  F5
  F6

The new forecast is the old one plus an

adjustment for the error that occurred
in the last forecast.
 Linear Regression Formula

Mean line Mean value

Square root

Bo is y intercept, b1 is slope, x is independent variable, y is dependent variable

This formula is using a least square method of linear regression. There are other methods for LR
Regression Analysis

Regression Analysis is a causal /

econometric forecasting method.

Some forecasting methods are

based on the assumption that it is
possible to identify underlying
factors that might influence a
variable that is being forecast.
Regression in Excel
 Choosing a Forecasting Technique
• Factors to consider
– Cost
– Accuracy
– Availability of historical data
– Availability of forecasting software
– Time needed to gather and analyze data and
prepare a forecast.
– Forecast horizon
Industry approach(common)
1. Moving average + Sales Force Estimate

– Provides a simple starting point by making an assumption that sales

will grow by a certain rate over time.
– It is based on a market analysis including consumer demand and
competitor behavior.

• This approach is generally used by large, established businesses but can

also be used by small start ups.
Industry approach(combination)

2. Forecast fixed and variable cost separately

3. ZBB for Capital expenses and working capital
4. Specify how funds are raised based on a financing plan
• AFN(Additional Fund Needed)

– There is better estimation of the expenses that will be incurred to support the
sales requirement. In this case only variable cost will assume same rate as
sales.
– Zero based budgeting allows a better analysis of what expenses will be
incurred regardless of whether the new budget is higher or lower vs prior
year.
– Financing plan will show better transparency of the management approach to
funding wisely
Jollibee FS
Jollibee
Income
Statement
Jollibee Balance Sheet
 Simple Income Statement and Balance Sheet
Fiscal year is January- Fiscal year is January-
December. All values December. All values
PHP Bio. 2016 2015 2014 2013 2012 PHP Bio. 2016 2015 2014 2013 2012
Sales/Revenue 113.91 100.78 90.67 80.28 71.06 72.88 65.65 54.14 46.04 41.79
Assets
Sales Growth 13.03% 11.15% 12.94% 12.98%
Asset growth
11.02% 21.26% 17.57% 10.19%
Expenses 108 96 85 76 67
Liabilities 38.58 33.87 26.04 22.67 20.04
Expenses growth 12.41% 12.36% 12.83% 12.30%
Liabilities growth 13.90% 30.08% 14.89% 13.12%
Net Earnings 6.17 4.93 5.36 4.67 3.73
Equity 34.30 31.77 28.10 23.38 21.75
Net Earnings
growth 25.10% -8.09% 14.77% 25.36% Equity growth 7.95% 13.09% 20.18% 7.49%
 Using Quantitative - Moving Average Method
• 3 year income statement forecast

2019 Forecast 2018 Forecast 2017 Forecast 2016 2015 2014 2013 2012

Sales/Revenue 161.77 144.08 128.17 113.91 100.78 90.67 80.28 71.06

Sales Growth 12.28% 12.41% 12.52% 13.03% 11.15% 12.94% 12.98%

Expenses 153.94 136.80 121.50 108 96 85 76 67

Expenses growth 12.53% 12.59% 12.77% 12.41% 12.36% 12.83% 12.30%

Net Earnings 7.82 7.28 6.67 6.17 4.93 5.36 4.67 3.73

Net Earnings
growth 7.50% 9.12% 8.20% 25.10% -8.09% 14.77% 25.36%

Forecast Approach
• Applied moving average since the
company trend has been stable for
the past 5 years
• 2017 - Insight from the company's
operating plans(350M expense due
to IBM contract)
• Reduced earnings in 2015 due to
Asset acquisition and
JV(Smashburger)
 Using Qualitative Method
• 3 year balance sheet forecast
• 2017 - 2018 assets will not grow as
2019 Forecast 2018 Forecast 2017 Forecast 2016 2015 2014 2013 2012 high as prior years due to existing
Assets 92.64 84.22 78.71 72.88 65.65 54.14 46.04 41.79 ventures and previous acquisition
• 2019 - company may recover after
Asset growth
10.00% 7.00% 8.00% 11.02% 21.26% 17.57% 10.19% stabilizing operations in China and
Liabilities 49.04 44.58 41.67 38.58 33.87 26.04 22.67 20.04 reduce A&P spending of Smash
Burger.
Liabilities growth 10.00% 7.00% 8.00% 13.90% 30.08% 14.89% 13.12%
• It is operating at higher debt to
Equity 43.60 39.64 37.04 34.30 31.77 28.10 23.38 21.75 equity ratio hence, need to be
Equity growth 10.00% 7.00% 8.00% 7.95% 13.09% 20.18% 7.49% careful about future investments.
Financial plan includes

• Investment plans:
– Capex and WC
• Financing Plan: Capital structure
– Choice of equity and debt
• Reinvestments/Dividend decisions
– How much allocation of the earning(internal fund)
are use to fuel for growth and what is to be
returned to shareholder as dividends
Group Exercise

• What are we forecasting? Name the 4 key areas.

• What are the approaches?
• What are the key elements of an income statement?
Balance sheet?
Key take away

• A firm must select the best approach based on the

nature and complexity of its business.
• A combination approach could be used for sales
forecasting to craft the best possible demand plan.
• Apart from the sales forecast, if a more accurate
Financial Forecast is being aspired, then the zero based
approach could be the ideal method but would require
a comprehensive analysis of the different element of
the forecast.
References

• http://mech.at.ua/Forecasting.pdf
• http://site.iugaza.edu.ps/aschokry/files/2010/09/OM
-TW-11.pdf
• http://www2.newpaltz.edu/~liush/OM/forecasting.p
df
• http://www.threadpunter.com/supply-chain-
management/quantitative-methods/