Finance 4333

Financial Forecasting

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 Financial Forecasting Methods
• Percent-of-sales method
– Some (but not all) Income Statement and Balance
Sheet items maintain a constant relation with the
level of Sales

• Forecasting using trend line or regression

analysis
– Use (linear) trends in financial statement items to
forecast where expect the items to go in future
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 Percent of Sales Method
• We will use the Excel upload file on D2L
• Forecasting the Income Statement
– Forecast 2018 numbers – Add a “2018*” column
• First: Forecast 2018 sales
– Sell 3 products: hats, boots, saddles
– Determine average sale growth rate for each
product (based on past sales)
– Use average growth rates to forecast 2018 sales

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 Percent of Sales Method
• Income Statement (continued)
– Find COGS and SG&A as a percentage of sales for
2018
• Use the average of 2016 and 2017 as the percentage of
Sales for the 2018 forecast
– Come back to depreciation and interest expense
– Tax rate is 38%

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 Percent of Sales Method
• Forecast the Balance Sheet numbers
• Assume Cash is the same as 2017
• Use the percent of sales method for A/R and
Inventory
• Project investment of $80,000 in P&E in 2018
– Assume 10 years straight-line depreciation
– Update 2018 depreciation on the Income Statement
• Add additional depreciation from the 2018 P&E
investment to depreciation expense in 2017

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 Percent of Sales Method
• Use the percent of sales method for A/P and
Other current liabilities
• Assume ST Notes, Long-Term Debt, and Common
Stock do not change
• Assume that the forecast for Dividends paid is
400,000
• 2018 Retained Earnings are 2017 Retained
Earnings plus 2018 Net Income minus 2018
Dividends
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 Percent of Sales Method
• Let’s come back to Interest Expense (on the
pro-forma Income Statement)
• For 2017, Cowboy Corp’s interest rate was
8.88% (Interest expense divided by ST Notes
plus LTD). Assume the same rate for 2018
– Use this rate to compute 2018 interest expense
• Coming back to the pro-forma Balance Sheet,
is there a problem?

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 Percent of Sales Method
• Cowboy Corp will need to raise money to satisfy the Balance
Sheet
• Let’s issue bonds - increase Long-Term Debt – to raise money
• This is not simple: raising Long-Term Debt will, in turn,
increase interest expense, lowering Net Income, which
changes Retained Earnings, and thus the Balance Sheet
won’t balance
• The textbook solves this problem using circular references
and iteration
• We will use Solver instead
– Alternatively, can use Goal-Seek

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 Linear Trend Forecasting
• Now we’ll use linear trend forecasting
• Let’s forecast Sales and COGS
• Below is the data for Cowboy Corp.:
Year 2013 2014 2015 2016 2017
Sales 1,505,000 1,647,000 1,745,000 1,986,000 2,237,000
COGS 834,000 1,326,000 1,589,000 1,437,000 1,186,000

• Put this into Excel (arrange the data vertically

instead of horizontally)
– Plot Sales as a function of Year using a scatter chart
– And plot COGS as a function of Sales (add trendline)
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 Regression Analysis
• Let’s
  use time (year) to forecast Sales
• We can estimate the following regression model
to forecast sales as a function of years:

• Use the regression tool under the Data tab (Hint:

make sure the data is in columns instead of rows)

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 Regression Analysis
•  Now take a closer look at the from the
regression equation we estimated:

• What do we learn from beta’s t-statistic?

• What do we learn from the regression’s R-
squared value

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 Regression Analysis
• Now run a 2nd regression, using COGS as the
dependent variable and Sales as the
independent variable
• Compare the R-squared values of the two
regressions
– Is this what you would expect from simply looking
at the two charts?
• Compare the t-stats for the coefficients from
the two regressions
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 Linear Trend Forecasting
• Should we use the regression (or trend) line to forecast Sales
and/or COGS?

• Multiple methods in Excel to forecast based on trend

• Can use the TREND function to generate the 2018 Sales forecast
– Is the result from the TREND function consistent with the trend line on
the chart?

• Can also use the regression (or trend) line equation to forecast
2018 Sales

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 Financial Planning: Maximizing Sales
• Now let’s use Solver to maximize the revenue for a
small business: a pizza shop
• Here is the menu:
– Cheese pizza - $7
– Supreme pizza - $12
– Calzone - $6
• Because of the oven size, the shop can only make 300
total items a day. In addition, it can make a maximum
of 175 pizzas (max of 100 supreme pizzas)
• What combination maximizes revenue?
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