Financial Projection

Topics: Generally Accepted Accounting Principles, Balance sheet, Liability Pages: 11 (2678 words) Published: August 30, 2010
financial projection
essential element of planning that is the basis for budgeting activities and estimating future financing needs of a firm. Financial projections (forecasts) begin with forecasting sales and their related expenses. The basic steps in financial forecasting are: (1) project the firm's sales; (2) project variables such as expenses and assets; (3) estimate the level of investment in current and fixed assets that is required to support the projected sales; and (4) calculate the firm's financing needs. The basic tools for financial forecasting include the percent-of-sales-method, regression analysis , and financial modeling.

Financial Forecasting

Financial Forecasting describes the process by which firms think about and prepare for the future. The forecasting process provides the means for a firm to express its goals and priorities and to ensure that they are internally consistent. It also assists the firm in identifying the asset requirements and needs for external financing. For example, the principal driver of the forecasting process is generally the sales forecast. Since most Balance Sheet and Income Statement accounts are related to sales, the forecasting process can help the firm assess the increase in Current and Fixed Assets which will be needed to support the forecasted sales level. Similarly, the external financing which will be needed to pay for the forecasted increase in assets can be determined. Firms also have goals related to Capital Structure (the mix of debt and equity used to finance the firms assets), Dividend Policy, and Working Capital Management. Therefore, the forecasting process allows the firm to determine if its forecasted sales growth rate is consistent with its desired Capital Structure and Dividend Policy. The forecasting approach presented in this section is the Percentage of Sales method. It forecasts the Balance Sheet and Income Statement by assuming that most accounts maintain a fixed proportion of Sales. This approach, although fairly simple, illustrates many of the issues related to forecasting and can readily be extended to allow for a more flexible technique, such as forecasting items on an individual basis. Concepts

Percentage of Sales Method
The Percentage of Sales Method is a Financial Forecasting approach which is based on the premise that most Balance Sheet and Income Statement Accounts vary with sales. Therefore, the key driver of this method is the Sales Forecast and based upon this, Pro-Forma Financial Statements (i.e., forecasted) can be constructed and the firms needs for external financing can be identified. The calculations illustrated on this page will refer to the Balance Sheet and Income Statement which follow. The forecasted Sales growth rate in this example is 25% Balance Sheet ($ in Millions)|

Assets| 1999| Liabilities and Owners' Equity| 1999|
Current Assets|   | Current Liabilities|  |
Cash| 200| Accounts Payable| 400 |
Accounts Receivable| 400 | Notes Payable| 400 |
Inventory| 600 | Total Current Liabilities| 800 |
Total Current Assets| 1200 | Long-Term Liabilities|   |  |  | Long-Term Debt| 500|
Fixed Assets|   | Total Long-Term Liabilities| 500|
Net Fixed Assests| 800 | Owners' Equity|  |
 |  | Common Stock ($1 Par)| 300|
 |  | Retained Earnings| 400|
 |   | Total Owners' Equity| 700|
Total Assets| 2000 | Total Liab. and Owners' Equity| 2000|
| Income Statement ($ in Millions)|
 | 1999|  |
Sales| 1200|  |
Cost of Goods Sold| 900|  |
Taxable Income| 300|  |
Taxes| 90 |  |
Net Income| 210|  |
Dividends| 70|  |
Addition to Retained Earnings| 140|  |
Percentages of Sales
The first step is to express the Balance Sheet and Income Statement accounts which vary directly with Sales as percentages of Sales. This is done by dividing the balance for these accounts for the current year (1999) by sales revenue for the current...
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