Chapter 2. Forecasting Financial Statements

Forecasting is the prediction of future events, in this part of the paper various areas of financial statements used in forecasting will be discussed as follows.

Production forecast; Forecasting production is important in the organization since it enable the business organization to estimate the product required to meet the forecasted sales.

Marketing department forecast; this entails the expenditure which is estimated by the marketing department for advertising and promotion, sales force salaries, bonuses and expenses, marketing research.

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Sales forecasting; while forecasting sales, the following questions have to be considered. First we have to ask ourselves whether sales are seasonal, the impact of the economy on sales and the past sales. It is important to note that the higher the growth rates the easier it may be to forecast. The next step in sales forecasting is to look at the Pro-forma income statement, here sales is the first item to forecast. In the pro-forma statements, you have to identify the items which move with sales. After they have been identified, it is important that their historical ratios be considered. These ratios have to be expressed as percent of sales then forecast them for instance, cost of goods sold, accounts receivable, account payable e.t.c.

Forecasting non sales items

Identify and forecast the non sales items, here identification of the tax rates, depreciation is crucial. Some items may have no relation to history at all. Under this circumstance, the use of wisdom may be applied.

It is important to note that some items are related to other financial statement forecast. These should be forecasted after the rest have been completed for instance, interest expense and interest income.

Some accounts require complex formulae for them to be computed and completed. Plug accounts such as cash or debt depending on the company. Finally you have to balance your cash flow statements and then come up with the best form of forecasting.

2.1 Steps in Financial Forecasting

According to (Brigham and Ehrhardt 2010). There are six basic steps which are crucial in financial forecasting. The organization has to go through the following steps in order to come up with a good financial forecasting. First and foremost, the organization or the manager has to determine what and why to carry out the financial forecasting. Apart from this, identification of what might be needed (resources) in order to carry out a good financial forecasting should also be put into consideration.

The second step in financial forecasting is to determine whether forecasting should be done for long term or short term. After deciding on the time horizon, the next thing to do is to decide on the techniques which you would like to use in forecasting. After one have decided on the technique, it will be important that the person collects relevant data which are important in forecasting.

The next step is to identify the assumptions which you have used to develop the forecast then finally it is important that you keep on monitoring the forecast in order to find out whether the forecast is performing in the desired manner. If it is not performing, then it would be prudent that you come back to the first step of your financial forecasting.

The term financial forecasting simply means the process of estimating future business performance for instance in terms of sales, costs, earnings Most corporations use financial forecasting to do financial planning which is crucial in accessing the future financial needs of the corporation

2.1.2 Reasons for Forecasting

The need to plan; most managers engage in financial forecasting in order to plan for the future, this is because planning put the organization in the right track which is vital in achieving what has been predicted. Planning ensures careful evaluation of resources and alternatives, the selection of goals for the future and a strategy for achieving the set goals. It therefore goes without say that planning is an integral part of forecasting. This is because; planning is the only factor which can lead to profitability and growth in the business. It is crucial to note that planning helps managers to control their firms and to compare the actual results with planned results. Therefore, before a manger forecast, he/she has to plan first. (Brigham and Ehrhardt 2010).

Dealing with uncertainty; The notion that the future is uncertain is true. It is important to note that single financial variable can have a variety of consequences. This is actually what defines risk and risk is a strong reason why the firms should engage in forecasting.  However, forecasting is not an easy task, the manager have to come up with better procedures if the quality of prediction about financial variables is to improve.

Forecasting by the use of targets   and budgets can serve as a motivational tool to the employee. This may lead to the achievement of much greater result. In other words financial forecasting can enable the organization to achieve the set objectives because it uplifts the spirits of the employees.

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2.2 What to Forecast

2.2.1 Techniques Used In Forecasting Financial Statements

According to (Wahlen, Stickney, Brown, Baginski and Bradshaw 2010). There are various techniques that have been used by business organizations in financial forecasting. This part of the term paper will describe the techniques briefly after which the advance techniques will be selected and described in details. The methods include:

  • The use of cash budgets: cash budget is one of the financial statements which indicate the sources of revenue, expected expenditure and any expenditure which is anticipated as cash deficit or surplus.
  • Regression analysis: this is an advance technique of financial forecasting that has been used by some of the business organization to carryout forecasting. The method entails the identification of the dependent and the independent variable meant form a regression equation y=a+bx on which forecasting is based.
  • percentage of sales method: it entails the use of forecasted sales in the balance sheet
  • simulation method
  • Delphi method
  • Additive method

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