Financial Forecasting

This note presents simple techniques for forecasting income statements and balance sheets. It focuses on a percentage-sale approach, but also introduces the use of financial ratios for the same purpose. Excerpt UVA-F-0899 Rev. May 1, 1991 Financial Forecasting One of the most important financial functions is to forecast financing needs in the future. The key relationship is between sales and assets. As sales change, so do assets. Increases in sales result in an increase in cash, accounts receivable, inventory, and possibly in fixed assets. These increases in assets must be funded. The liability and net worth side of the balance sheet must also increase to support the increases on the asset side. Some items such as accounts payable and accrued liabilities increase automatically with sales. Retained earnings also increase, but the increase depends on how much of earnings are retained by the firm. If the increases in spontaneously changing liabilities and retained earnings are not enough to offset the increase in assets, outside funds are required. Determining how much outside funding will be needed is important for planning. By forecasting funding needs, managers can either arrange the financing or revise their plans if funding is inadequate. This planning is done by producing pro-forma income statements and balance sheets for future periods. The easiest way to see how financial forecasting is done is to follow an example. Example . . .