The document outlines the concepts of financial forecasting and planning, emphasizing the importance of utilizing past data to make informed predictions about future financial performance. It discusses various techniques for forecasting, including pro forma financial statements and budget methods, and highlights the need for sensitivity analysis to account for uncertainties. Additionally, it explores the relationship between a firm's growth, external financing requirements, and the sustainable growth rate without resorting to external equity.

1. L- 11
The Forecasting Function
Developed by Dr. IKRAM CPA,
Ph.D.

2. Financial Forecasting
& its Related Problems
Pronóstico financiero

3. Forecasting is the process of
making predictions of the
future based on past and
present data and most
commonly by analysis of
trends.
A commonplace example might
be estimation of some variable
of interest at some specified
future date.

4. Prediction is a similar, but more general
term. Both might refer to formal statistical
methods employing time series, cross-
sectional or longitudinal data, or
alternatively to less formal judgmental
methods.

5. "forecast" and "forecasting" are sometimes
reserved for estimates of values at certain
specific future times, while the term
"prediction" is used for more general estimates,
such as the number of times floods will occur
over a long period.

6. Risk and uncertainty are central to forecasting
and prediction; it is generally considered
good practice to indicate the degree of
uncertainty attaching to forecasts.
In any case, the data must be up to date in
order for the forecast to be as accurate as
possible. In some cases the data used to
predict the independent variable is itself
forecasted.

7. The use of historic data to determine the
direction of future trends. Forecasting is used
by companies to determine how to allocate
their budgets for an upcoming period of time.
This is typically based on demand for the
goods and services it offers, compared to the
cost of producing them.

8. Forecasting
A planning tool that helps management in its
attempts to cope with the uncertainty of the
future, relying mainly on data from the past
and present and analysis of trends.
Forecasting starts with certain assumptions
based on the management's experience,
knowledge, and judgment.

9. These estimates are projected into the coming
months or years using one or more techniques such
as Box-Jenkins models,
Delphi method, exponential smoothing, moving
averages, regression analysis, and trend projection.
Since any error in the assumptions will result in a
similar or magnified error in forecasting, the
technique of sensitivity analysis is used
which assigns a range of values to the uncertain
factors (variables).

10. Financial planning
 Financial planning indicates a firm’s
growth, performance, investments and
requirements of funds during a given
period of time, usually three to five years.
 It involves the preparation of projected or
pro forma profit and loss account,
balance sheet and other statements.
 Financial planning help a firm’s financial
manager to regulate flows of funds which
is his primary concern.

11. Financial Planning
Financing planning process involves the following facets:
 Evaluating the current financial condition of the firm.
 Analyzing the future growth prospects and options.
 Appraising the investment options to achieve the stated growth
objective.
 Projecting the future growth and profitability.
 Estimating funds requirement and considering alternative
financing options.
 Comparing and choosing from alternative growth plans and
financing options.
 Measuring actual performance with the planned performance.

12. Financial Forecasting and
Modeling
•Financial forecasting is a planning process with
respect to company’s management positions, the firm’s
future activities relative to the expected economic,
technical, competitive and social environment.
•A financial planning model establishes the relationship
between financial variables and targets, and facilitates
the financial forecasting and planning process.
•A financial planning model has the following three
components:
Inputs
Model
Output

13. Sales
Projection
Production
plan
Prior Balance
Sheet
Cash
Budget
Pro forma
Income
Statement
Pro forma
Balance
Sheet
Financial Forecasting

14. Three major Techniques of
Financial Projections:
1.Proforma Financial Statements
2.Cash Budgets and
3.Operating Budgets
Sales Budget
Production Budget

15. Proforma Financial Statements
 A comprehensive look at the likely
future financial performance.
 Pro forma Income Statement.
(Represents the operational plan for
the whole organization.)
 Pro forma Balance sheet. (Reflects
the cumulative impact of anticipated
future decisions).

16. Preparation of
Pro Forma Income Statements
Percent of Sales Method
 Assumes that future relationship between various
elements of cost to sales will be similar to their
historical relationships.
 These cost ratios are generally based on the
average of previous two or three years.
 For example, Cost of Goods sold may be
expressed as a percentage of Sales.

17. 2. Budgeted Expense
Method.
 Estimate the value of each item on the basis of
expected developments in the future period for
which the pro forma P&L a/c is being prepared.
 Calls for greater effort on the part of Management,
since they have to define the likely happenings.

18. 3. Combination method
 Neither the Percent of sales method nor the
Budgeted expense method should be used in
isolation.
 A combination of both methods work best.
 Items which have stable relationship to sales can
be forecasted using the Percent of sales method.
 For items where the future is likely to be very
different from the past, budgeted expense method
can be used.

19. Proforma Income Statement
Actual figures
for Quarter 31-
3-2006
Assumptions Proforma for
the qr ended
30-6-2006
1.No.of units sold
2.Net Sales
3.Cost of Goods
sold:
4.Labour
5. Materials
6.Distribution
cost
7. Overhead
8. Total
9. Ratio of CGS
to Sales.
10. Gross Profit
11. GP Margin
14000
140000
100%
22960
25256
4592
61992
114800
82.0%
25200
18%
Sales decline 30%
due to low demand.
No change in
Product mix.
20% of Cost of good
22% of COG
4% of COG
54% of COG
Increase by 1.5%
9800
98000
100%
16366
18002.6
3273.2
44188.2
81830
83.5%
16170
16.5%

20. Contd.
Actuals Assumption Proforma
12. Expenses:
13. Selling
Expenses
14. Admin. Expense
15. Others
16.Total
17. Operating Profit
18. Interest
19. Depreciation
20.PBT
21. Tax @ 30%
22.Net Income
23.Dividends
24.Retained
earnings.
25. Cash flow after
dividends.
8250
4450
Nil
12700
12500
2500
2000
7000
2100
4900
900
4000
6000
A drop of Rs.
750 .
A drop of Rs.
850
Rs.2000 only
No dividends
Carried to B/s.
Retained earning
+ Depreciation
7500
3600
Nil
11100
5070
2000
2000
1070
321
749
0
749
2749

21. Pro forma Balance sheet only to
explain not to be included.
 Projections for Balance sheet can be made as
under:
1. Employ Percent of Sales method to project items
on the asset side, except “Investments” and
“Misc Exp & Losses”.
2. Expected values for Investment and Misc exp
can be estimated using specific information.
3. Use Percent of sales method to project values of
current liabilities and Provisions. (Also referred to
as ‘spontaneous liabilities’)
4. Projected values of R & S can be obtained by
adding projected retained earnings from P&L
proforma statement.

22. B/S Contd..
5. Projected value for Equity and preferential capital
can be set tentatively equal to their previous
values.
6. Projected values for loan funds will be tentatively
equal to their previous level less repayments or
retirements.
7. Compare the total of asset side with that of
liabilities side and determine the balancing figure.
(If assets exceed liabilities, the balancing figure
represents external funding requirement. If
liabilities exceeds Assets, the balancing item
represents ‘surplus available funds’ )

23. PROFORMA BALANCE SHEET.
Actual Assumptions Proforma
for
June
Change
LIABILITIES:
A. CAPITAL
B. R& S.(C+D)
C. RESERVES
D. P&L
Balance
E. Total share
holders
funds.
F. Total Debt
G. Total
Liabilities
(E+F)
6500
4500
500
4000
11000
7500
18500
Issue of
shares Rs.500
P&L account.
7000
5250
500
4750
12250
7500
19750
+500
+750
0
+750
+1250
0
+1250

24. Proforma Balance sheet contd..
Actuals Assumptions Proforma Change
ASSETS;
H. GROSS BLOCK (I+j)
I. LAND
j. Plant & Machinery
K. LESS DEPRECN.
L. NET BLOCK (J-K)
M. CURRENT ASSETS
(N+O)
N. INVENTORIES
O. CASH.
Less:
P. CURRENT
LIAILITIES.
Q. Provisions
R. Net current assets
(M-P-Q)
s. Total assets (L+R)
t. Additional funds
required.
24000
3000
21000
10000
11000
14500
10500
4000
5000
2000
7500
18500
No change
Sale of 1000
Depreciation of
9500
Increase by 2000
Maintain CB of
3500
Decrease by 1000
23000
3000
20000
9500
10500
16000
12500
3500
4000
2000
10000
20500
-1000
0
-1000
-500
-500
+1500
+2000
-500
-1000
0
+2500
+2000

25. Other Proforma Statements
Cash Budget Operating Budget
Sales Budget Production Budget
Subjective
Method
Objective Method
Executive
Opinion
Sales Force
estimate
Trend Analysis
Regression
Analysis
2nd Factor economic
dev
3rd Factor Seasonal
Variation
4th Factor Erratic events
1st Factor Population

26. Cash Budget
 Prepared every month or every week.
 Helps in deciding the minimum
amount of cash that can be kept to
allow timely payments of obligations.
 Shows the cash needs or excess.

27. Techniques of Sales
Forecasting
1.Subjective Methods ( based on the
opinions or judgments of knowledgeable
individual within the organization- sales
force to executives)
 Jury of executive opinion
 Sales force estimates
2. Objective Methods
 Trend Analysis Via Extrapolation
 Regression analysis

28. While doing trend analysis, the analyst must keep in mind
that the time series of a product’s past sales is made up of
four major factors:
 Long-term trend- result of basic developments in population,
capital formation and technology
 Cycle-movements of sales as a result of swings in general
economic activity, which tends to be somewhat periodic.
 Seasonal variations- climatic factors, holidays, etc.
 Erratic events- strikes, riots, earthquakes and other natural
calamities.
Trend Analysis

29. Growth and External
Financing
Requirement
New Investment = growth rate X initial
assets
XYZ Co. started with Rs. 15,00,000 of
fixed
assets and working capital and forecasts a
growth of 10 percent.
What is the required addition to its assets?

30. External Financing
Requirement
EFR = A (ΔS) less L (ΔS) less mS1 (1-d)
S S
Where,
EFR = external financing requirement
A/S = current assets and fixed assets as a proportion of
sales
(ΔS) = expected increase in sales
M = net profit margin
S1 = projected sales for next year
D = dividend payout ratio
L/S = spontaneous liabilities as a proportion of sales

31. Or
EFR = A less L less m (1+g) (1-d)
(ΔS) S S g
Where, g is the growth rate in sales
Example
XYZ Company has the following ratios:
A/S 0 8 ΔS Rs lakh 0 3 = 0.8, =Rs. 5 lakh,
L/S =0.3, m= 0.05, S1= Rs. 50 lakh, and d
= 0.4
Solution:
EFR = (0.8) (5) –(0.3) (5) – (0.05) (50)
(0.6) = Rs.1 lakh

32. The equation highlights that :
External financing depends on the firm’s
projected growth in sales. Faster growth
more needs in investments more needs
to raise new capital. The firm should use
new securities for new investment.
Low growth less needs in investments
(can be through retained earnings)
external funds is negative (surplus is used to
pay off debt)
Growth rate is zero no needs of new
capital all retained earnings are surplus

33. Sustainable Growth Rate
Though having desire to grow, a firm may resist
to raise external equity due to various reason
like: High issuing cost and Unacceptable
dilution
of control etc. In this case the rate of growth
which it can achieve without resorting to issue
of
external equity is calculated as below:
m(1-d) A/E
g =
A/So – m(1- d) A/E

34. Assumptions:
The assets of the firm will increase
Proportionally to sales
Net profit margin is constant
Dividend-payout ratio and debt-equity ratio
will remain constant
External issue of equity will not be
resorted to

35. Example
M = 0.05, d = 0.4, A/E = 1.5, A/S0 = 0.8.
Find growth out the rate of sustainable
With internal equity.
Solution:
0.05(1-0.4) 1.5
g =
0.8 – 0.05(1- 0.4) 1.5
= 5.96%

36. Problems with Forecasting
Difficulty in comparison
 Differences in the basis of inventory
valuation
 Different depreciating method, estimated
working life of assets.
 Different treatment of extraordinary items
of income and expenditure.
Impact of Inflation
Conceptual Diversity