Financial Forecasting

Dr. Eduardo Añonuevo

Financial Forecasting
• enables managers to predict the future financial
position and performance of a company.
• Combines information from the past financial
statement with external economic and industry
data

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Scope of the Topic

1.Usefulness of financial statement forecasting

2.Financial Forecasting Techniques

3.Forecast Financial Statement

4.Toward improving the quality of forecast

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Usefulness of financial statement forecast

They support short and They provide a They improve the

long term managerial and comprehensive view of planning process
financial plans the intended results of throughout the
the investment and organization
financial decision of
management

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Forecast yield information that are of value to managers. Forecast results are valuable
to a manager , whose actions depend on the scenario that is likely to prevail in the

FORECAST
future.

MANAGERS COULD THEN PLAN FOR THE FF:

1. Inventory levels

2. Customer credit terms

3. Materials purchasing schedule and

4. Equipment acquisition depending on forecast scenarios

Pitch deck title

 Difficulties in forecasting

1. Inherent uncertainty of future events 2. Judgmental nature of the forecast

The degree of uncertainty in the forecast is determine by the following

a) Industry conditions
b) Nature of the product
c) Market

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Difficulties in Since forecast could not cover all possible
contingencies, they focus only on likely
forecasting scenarios about the environment such as,
Sales Forecast which is based on,

1. Assume Industry growth rates

2. How competition responds
3.Various economic activity level indicators

When things turn out differently from what

managers think would be “likely scenarios”,
forecast lose their ACCURACY.

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Since forecasting takes time and is costly, a manager
should decide how much information to gather.
Management can decide either to expand resources in
forecasting or not plan at all and deal with
unanticipated situations later.
An analyst could gather HISTORICAL DATA and PRIMARY
DATA to improve his forecast. Good forecast enable a company to
make better business decisions.

Forecasting efforts and cost pay off with:

1.Future cost savings
2.Opportunities gained

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 FINANCIAL 1. SUBJECTIVE OR
FORECASTING JUDGEMENTAL APPROACH
TECHNIQUES
2. TREND OR TIME SERIES
ANALYSIS

3. CORRELATION OR CAUSAL
RELATIONSHIP ANALYSIS

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Subjective or Judgemental Approach

Advantages

a. A manager assimilates his awareness of operating conditions into the forecast.

b. A manager is more committed to achieving the objectives of plans that are based
on his own forecasts.

c. Subjective forecast only require an expert.

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Subjective or Judgemental Approach

Disadvantages

•Forecast manipulation
•When managers realize that Top Management uses forecast as standards of
performance, they might play games with the top management. A manager knows the
operating conditions and may not reveal them to the top management on his forecast.
•Example;
•A sales manager may set a sales target which is too low and easily achievable with
minimal effort
•A factory manager might set a high overhead cost budget that is easily achievable
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• .
Quantitative Analysis
• Supplements managerial judgment or the
accuracy of judgment forecast

• Objectively reveals patterns not

evident to a manager.

• Personal style and risk attitudes may affect the

accuracy of judgmental forecast

• Managers tend to be excessively

pessimistic or optimistic about
their own business prospects.

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Financial Forecast
Dr. Jane Tiong
TREND FORECAST

• Quantitative trend forecast

predict financial variables using
past date
• Example: Sales Forecasting on
past sales and cost data

• Trends are patterns in past data

• Example: Growth Trends and cycles

• Trend forecast use historical

information about the
financial variable .
• A common approach is to
extrapolate from past
experiences
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3 Methods

1.) Prior year as indicator.

2.) Simple or Compound

Growth rates.

3.) Time series regression

Prior Period’s Result
as a BEST indicator of
the next period:
• one-period forecast methods = disregard
past data
• except the most recent
• useful when the variable is highly random.
• best forecast of the prices of stocks for the
following day , eg. Philippine Stock Exchange
• could be based on the previous day’s prices.
• useful for very short forecast periods.
• a default method, works only because of the
absence of better forecasting methods.

PAGE 18
Forecast based on average
growth rates
• Second trend forecasting.
- approach is the use of historical
average growth rates. Growth rates are
either simple or compound rates.
- Simple Growth Rate-
• Simple growth rate formula - relates the
change in the variable over the number
of periods that have elapsed as in the
equation 13- 1

g =
( Sales t+ n – S a l e s t)
S a l es t X n
8/05/20XX 19
 The forecast model based on the
simple growth rate is in equation
13-2:
Equation(13 - 2)
S a l es t+ n = S a l es t + ( g X S a l es t )
g = s i m pl e growth r ate

Table 13.1
     
ABC Company Inventory and Sales
Over Time
   

(in million pesos)

   
Year Sales Inventory  
1 53 14  
2 35 15  
3 63 22  
4 83 19  
5 127 39  
6 132 36  
7 140 29  
8 179 25  
9 190 29  
10 228 44  
11 303 57  
12 476 80  
8/05/20XX 13
Conference Presentation 525 71 20  
14 532 87  
ILLUSTRATIVE EXAMPLE 13.2
CALCULATING THE SIMPLE GROWTH RATE

• ABC Company wants to determine the simple growth rate of sales for the last 14 years
• For n=, the average simple growth rate of sales shown in Table 13.1
• For the 14-year period is

g =
( Sales t+ n – Sales
t ) S a l es t X n

( P 532 m i l l ion – P 53 m i l l io
=

n ) P 53 m i l l ion X 14

P479 million = 64 . 6 %
P 742 m i l l i on
ILLUSTRATIVE EXAMPLE 13.3 FORECAST BASED ON SIMPLE GROWTH RATE

-ABC Company would like to forecast its sales for Year 15 using
the past average annual growth rate.

-Using the simple growth rate method, the forecast sales for
Year 15 are:

S a l es t+ n = S a l es t + (g X S a l es t. )

S a l es ( Y e a r 15 ) = S a l es ( Y e a r 14 ) + ( Growth rate x S a l es (Year

14 ))

= P 532 m i l l i on + ( 0 . 646 X P 5 3 2 m i l l i o n )
= P 532 m i l l i on + P 343 . 672 m i l l i on

=P 875 . 7 m i l l ion
Average Compound Growth
Rate
• Average compound growth rates -use the compounding formula in
the future value analysis.

• The base is the starting point of calculation of the compound

growth rate.

• also called “true rate” in the future analysis.

• The formula of average compound growth rate = comes from

compounding formula.

8/05/20XX Conference Presentation 23

 Equation 13-3.

Fu tur e v a l u e = P r e s e n t value X ( 1 + g) n

Solving f or g : g =( Future value / Present value ) 1 /n – 1

•Th e f or e c a s t model b a s e d on the simple growth r ate is

• S a l es
)
t+ n = S a l es t + (g X S a l es t

8/05/20XX Conference Presentation 24

ILLUSTRATIVE EXAMPLE 13.4 COMPOUND GROWTH RATE
FORECAST
- ABC Company wants to determine the compound growth rate
of its sales and inventory for the past 13 years and to forecast for
Year 15 on this basis
g= ( Fu tu r e v a l u e /( P r e s e n t v a lue ) 1 /n - 1

=
P 532 mi ll i on / (P 53 million ) 1 / 13 -1

= 0 . 194
-For the inventory, the average growth rate is 15.1
-Using these growth rates, the forecast sales of Year 15 are:
Similarly for the forecast of inventory for year 15
Forecast based on FINANCIAL DATA in TIME SERIES
-statistical time series analysis method= responds to
limitations of two growth rate techniques.
- example of the time series method -is a regression model with
sales or inventory as dependent variables and time period an
independent variable.

time series model = a sound framework in cases when (a) time

is a surrogate variable or substitute for an unknown underlying
explanatory variable, and (b) data on the underlying explanatory
variable are difficult to obtain
 Types and Uses of Forecast Financial Statements:
- Each financial variable is forecast in order to
prepare forecast financial statement.
- are comprehensive predictions of a company’s
over-all financial status and performance .
​

3 forecast financial statements :

1. Cash Flow Forecast
2. Forecast Income Statement
Forecast 3. Forecast Balance Sheet
Financial
Statement

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Cash Flow Forecast • Shows the sources of cash and uses for operation , investment and
repayment of loans.
• prepared on a monthly basis for the year.
• Many companies prepare daily cash flow forecast in order to
closely control the company’s liquidity position.
• A company that fails to control its cash position loses income
opportunities due to idle cash balances or experiences cash
shortages result in lost income and higher cost
​

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Forecast Income Statement

• sales forecast = the starting point of a forecast

income statement
• Management prepares the sales forecast using either
subjective trend or statistical correlation methods.
• Keyline officers review the results of the forecasting
exercises
• Management then initiates the preparation of an
income statement forecast.
• The commitment of management converts a sales
forecast into a sales target which is the planning
tool.
• Management estimates cost of goods by evaluating
the required physical
• quantities of materials , labor, and other
requirements and past cost of these items.
• Management forecast the future prices of these
inputs. When input requirements are stable , the
past ratio of cost of goods sold to sales serves as
a basis for a forecast of the cost of goods.

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•analyst derives a relationship between operating expenses and sales.
•Expenses are either fixed or variable relative to the sales level.
•fixed expenses the analyst forecasts prices.
•Example:insurance for factory building.
•The analyst determines the cost of the building based on planning additions
and on the current value of the building. Insurance companies provide
estimates of insurance rates.
-expenses that vary with sales , the analyst derives the ratio each expense
item relative to sales. Methods like correlation analysis and subjective or
engineering estimates is useful in estimates.
-variable cost expenses. Example: sales commission. The analyst forecast total
commissions expense by multiplying the
• sales level by applicable commission rates.
-Other income and expenses include interest income and
expenses and taxes.
Forecast interest
income
is equal to the average yield
on
investment multiplied by the
forecast balances of
temporary and interest-bearing
long-term investments.
PAGE 33
Interest expense is analyst forecast net income
forecast based on the using the standard income
expected future rate of statement format. The forecast
interest on a company’s net income carries over to the
average outstanding debt. stockholder’s equity section of
the forecast balance sheet.
Tax expense is forecast
based on the corporate tax
rate of 35 percent.
FINANCIAL FORECASTING
JANICE A. URETA-AÑONUEVO, MD
 FORECAST BALANCE SHEET

Individual balance sheet accounts

are forecast in relation to

Activity factors like sales and cost of

goods

Forecast changes in policies

Planned fixed assets expansion

Forecast Balance Sheet
Balance sheet forecasting involves the following activities:
a) Forecasting balances of all assets except cash
b) Forecasting balances of all liabilities and equities
except bank loan
c) Determining the “PLUG” figure in a forecast balance
sheet. The PLUG is a balancing figure wncih can
either be
• A forecast cash surplus if the company’s total
liabilities and capital exceed total assets, or
• A forecast short-term bank loan if the
company’s total assets , including an assumed
minimum cash balance exceed total liabilities
and capital
• A more detailed description of techniques for
forecasting major balance sheet accounts
follows
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 ASSETS
• Cash balance is a balancing figure that depends on the
relationship between total assets and total equities as
previously described . This amount is equal to the
ending balance of a cash flow forecast.

• Accounts receivables forecast considers the forecast

sales level, credit policy and expected bad debts. The
forecast of accounts receivable uses the relationship of
sales with accounts receivable and considers
management’s desired collection period.

• For example, if accounts receivable were 8.33 percent

of sales corresponding to a 30- day collection period ,
the forecast formula for accounts receivable would be
as in equation 13.6
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THE TEAM

13 - 6
For e c a s t
= 8 . 33 % of f or e c a s t s a l e s
A c c ou n ts R e c e i va bl e
= 30 d a ys X For e c a s t s a l es / 3 60

Similarly, a forecast of inventory uses the past relationship between cost of goods
and inventory level , and considers the desired stock level in the future. A forecast
formula for inventory is equation 13.7

13 - 7
For e c a s t D a ys ’ I nv e ntor y X For e c a s t P u r c h a s e
I nv e ntor y =
360

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• A forecast of investment uses past balances and management’s planned
acquisition and disposal of assets. Forecast of fixed assets rely on capital
expenditure plans and on expected depreciation expenses. Estimates of net
fixed assets are made by adding the amount of planned capital expenditures
and deducting the planned disposition of fixed assets and depreciation to the
previous balance of this account
• The forecast of other current and fixed assets uses judgement. Forecasts of
items like research and development and prepayments follow capital
expenditures plans. Other minor items remain at the previous year’s level
• Forecast total assets are the sum of all forecast assets , initially developed by
assuming cash at the minimum desired balance.
LIABILITIES

• Forecast of accounts payable relate past

balances of this account and purchases and
company payment policies.
• If the company expects a change in supplier’s
credit terms, the forecast incorporates such
change. For example if s company strictly
follws the terms of the supplier, the
forecasting formula for the accounts payable
is equation 13.8
 C r e d i t P e r i od
For e c as t A c c ou n ts P a ya = X P u r c h a se s f or th e ye a r
360
ble

• Income tax payable corresponds to the taxes due for he following year. The
forecast of long-term debt relies on the forecast of future financing. It may be
part of the capital expenditure programs of a company. The forecast of
accruals and other liabilities rely on prior years pattern.
 • Short-term bank loan is the PLUG or balancing
figure of the forecast balance sheet.
• If assets exceed liabilities without the loan , a positive
PLUG figure represents the total amount of bank loan
that the company should obtain at the end of thr
forecast period. Equation 13-9 shows the bank loan as
PLUG

To tal A s s e ts – L i ab i l i t i es
13 - 9 B a n k L oa =
( e xc ep t B a n k L oa n ) + S toc k h ol de r ’ s
n
E q u i ty
CAPITAL

• The forecast capital takes into account the beginning balance

of capital plus planned new stock issues for the next period.
The forecast carries over any other capital accounts like
revaluation capital. Retained earning increase due to forecast
net income and decreases due to future dividends

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 Table 13.4- XYZ Company Forecast Balance Sheet (1994) (in
thousand pesos)

Actual Forecast Forecast Method Used

19x0 19x1
Assets
Cash and temporary investments 5000 5000 Same as 19x0
Accounts receivable 8000 10000 Turnover of 12 times sales
Merchandise Inventory 11161 14286 Turnover of 60 days cost of sales
Prepayments 3000 3000 No change over 19x0
Investments 7500 7500 No change over 19x0
Banking, leaseholds and equipment 46000 56000 Plant expansion for 19x1, net of depreciation
Total Assets 80661 95786
Liabilities and Stockholder’s Equity
Accounts payable 11000 10714 Supplier credit reduced to 45 days
Notes payable 36000 PLUG Balancing amount
Income Tax payable 2161 3530 19x1 income tax payable
Total Liabilities 49161 60730
Capital Stock 12000 12000 No new capital stock issue in 19x1
Other Capital accounts 7000 7000
Retained Earnings 12500 16056 19x0 balance plus net income, net dividends
Total Stockholder’s Equity 31500 35056
Total Liabilities and Stockholder’s Equity 80661 95786
 An alternative forecasting method

Percent-of-sales
method It is useful for external analyst who do not have access to
management’s plans. For example , bankers would like to
predict a company’s future solvency position in deciding
whether to grant credit or not. The technique requires a sound
sales forecast and past trends showing relationships between
balance sheet accounts and sales. Assets are proportionate to
sales under the principles of turnover or capital intensity.
Turnover is the ratio of sales to asset. It reflects the capacity of
assets to generate sales.

Capital intensity, which is the reciprocal of turnover,

is the ratio of assets to sales . It shows the required
investment for every unit of sales

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 • Under this principle , every asset that
support sales should likewise
increase by a reasonably stable, if not
constant, proportion. Exceptions are
assets that are not directly related to
the business of a company, for
“Percent-of- example investments, other assets
and intangibles.

sales method”. • The principle covers liabilities that

support sales like accounts payable
and accrued liabilities. These are
sources of financing that are so called
spontaneous because their balances
change with sales. Capital accounts
change with income and other
dividends.
 Table 13.5 XYZ Company Percent of Sales Forecast Balance
Sheet
ILLUSTRATIVE EXAMPLE 13.10 FORECAST Actual Percent of Sales Forecast 19x1
BALANCE SHEET USING THE Assets
Cash and Temporary 5000 0.05 9600
PERCENT-OF-SALES METHOD Investments
Accounts receivable 8000 0.08 9600
Merchandize Inventory 11161 0.11 13200
Prepayments 3000 0.03 3600
Imodium Stockbrokers, Inc, wants to Investments 7500 7500
forecast the balance sheet of XYZ Company Building, leaseholds& 46000 0.46 55200
using the percent-of-sales relationship, except equipment
for all capital accounts and investments Total Assets 80661 98700
Liabilities and
A percent-of-sales method for forecasting the Stockholder’s Equity
balance sheet of XYZ Company is shown in Accounts Payable 11000 0.11 13200
Table 13.5 Notes Payable 36000 PLUG 48044
Income Tax Payable 2161 0.02 2400
Total Liabilities 49161 63644
Capital Stock 12000 12000
Other capital accounts 7000 7000
Retained earnings 12500 16056
Total Stockholder’s 31500 35056
Equity
Total Equities 80661 98700
Sales 10000 120000
2 nd
1997
Cesar Saldana, Principles of Managerial Finance: A
Financial Analysis Approach,
Edition, AFA Publications,

48
Thank You

Group 7
Dr. Sirikit Batara

Dr. Eduardo Añonuevo

Dr. Jane Tiong

Dr. Janice Añonuevo