Financial forecasting consists of various techniques that can be used to determine the amount of additional financing a firm will require in the future. If internal sources of funds (cash) are not sufficient to achieve its goals, then the firm must seek to obtain external funding from the capital markets.
This section presents an overview of the financial forecasting process, with emphasis on the important role of pro forma financial statements. Pro forma financial statements, showing the results of some assumed event, rather than an actual event, are usually an integral part of a financial forecast. For example, an operating budget that shows the level of net income that can be expected if sales and expenses are at a given assumed level next year is a pro forma income statement.
Short -term forecasts, those that deal with one year or less, tend to be rather detailed, whereas long-term forecasts are more general. This section discusses the percentage of sales forecasting method, cash budgets, the pro forma statement of cash flows, computerized financial forecasting and planning models, and using financial ratios to forecast future financial performance.
Percentage of Sales Forecasting Method
The percentage of sales forecasting method permits a company to forecast the amount of financing it will need for a given increase in sales. This method is simple and can provide information useful in preparing pro forma financial statements and in estimating future funds needs.
Consolidated Statement of Cash Flows for PepsiCo, Inc., and Subsidiaries (in $ Millions)
The method assumes that (1) present asset levels are optimal with respect to present sales; and (2) most items on the balance sheet increase in proportion to sales increases. The use of this method is illustrated with the following example of the Industrial Supply Company (ISC). The present (2006) ISC balance sheet and income statement are shown in Table 4.4. Management forecasts that sales will increase by 25 percent, or $3,750,000, next year to $18,750,000 and that expenses, including interest and taxes, will increase to $17,750,000. One of management’s primary concerns is the amount of funds (cash) needed to finance this sales growth.
Until now, the company has financed its growth by using both internally and externally generated funds. The company has reinvested most of its past earnings, primarily into additional inventory. The company has also used external financing in the form of short -term borrowings from its bank.
To determine the amount of additional financing necessary to reach the expected $18,750,000 annual sales level, the ISC management has made the following observations about the company’s various assets and liabilities:
Industrial Supply Financial Statements
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Financial Management Tutorial
The Role And Objective Of Financial Management
The Domestic And International Financial Marketplace
Evaluation Of Financial Performance
Financial Planning And Forecasting
The Time Value Of Money
Risk And Return On At&t Common Stock
Fixed-income Securities: Characteristics And Valuation
Common Stock: Characteristics,valuation, And Issuance
Capital Budgeting And Cash Flow Analysis
Capital Budgeting: Decision Criteria And Real Option Considerations
Capital Budgeting And Risk
The Cost Of Capital
Capital Structure Concepts
Capital Structure Management In Practice
Working Capital Management
The Management Of Cash And Marketable Securities
Management Of Accounts Receivable And Inventories
Lease And Intermediate-term Financing
Financing With Derivatives
Internationan Financial Management
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