Description
Financial forecasting is a planning process by which the company's management positions its firm's future activities related to the expected economic, technical, competitive and social environment. Business plans always have strategies and actions for achieving desired short - term, intermediate, and long - term results.
International J ournal of Management and International Business Studies.
ISSN 2277-3177 Volume 4, Number 3 (2014), pp. 371-374
©Research India Publicationshttp://www.ripublication.com
Financial Forecasting
C. Vijendra
Research Scholar, Kakatiya University, Warangal.
1. Need for Forecasting
Financial forecasting is a planning process by which the company’s management
positions its firm’s future activities related to the expected economic, technical,
competitive and social environment. Business plans always have strategies and actions
for achieving desired short-term, intermediate, and long –term results. These are
qualified in financial terms, in the form of projected Financial Statements (pro forma
statements) and a variety of operational budgets.
Basically there are three main techniques if financial projections. They are Pro
forma financial statements, cash budgets and operating budgets. Pro forma statements
are projected financial statements embodying asset of assumptions about a company’s
future performance and funding requirements. Cash budgets are detailed projections of
the specific incidence of cash moving in and out of the business. Operating budgets are
detailed projections of departmental revenue and/or expense patterns, and they are
subsidiary to both pro forma statements and cash flow statements.
By developing pro forma statements, a comprehensive look at the likely future
financial performance of a company can be obtained. These statements comprising of
P&L statement and a balance sheet are extended into the future. The pro forma
operating statement (P&L) represents an “Operational Plan” for the business as a
whole, while the pro forma balance sheet reflects the anticipated cumulative impact of
assumed future decisions on the financial condition of the business at a selected point
of time. Both statements are prepared by taking the most readily available estimates of
future activity and projecting, account by account, the assumed results and conditions
.A third statement, a pro forma funds flow statement, adds further insight by displaying
the various funds movements expected during the forecast period.
2. Performa Financial Statement
The preparation of pro forma statements is explained with an illustration of an
hypothetical manufacturing company called Wilsh Corporation. The company sells
two kinds of winter care products. These have a seasonal pattern with a low point of
sale during May. The most recent results are available for the first quarter of the year 1.
These statements give the initial set of data to project the future statements. the pro
forma projection is to be made for the second quarter of the year 1, and the objective is
C. Vijendra 372
to determine both the level of profit and the amount of additional funds required at the
end of the second quarter.
3. Pro Forma Income Statement
The operating system is usually prepared first because the amount of after-tax profit
must be reflected in the balance sheet as a change in retained earnings. The starting
point in the preparation of pro forma operating statement ,as shown on the first line of
the table 1 is a projection of the unit and rupee volume of sales .These can be estimated
in a variety of ways like trend-line projection to detailed departmental sales forecasts
by Individual Products.
In table 1, the actual operating statement for the first quarter ended March 31, is
shown as base for the analysis. Company statistics from past years shown that during
the second quarter a decrease of 29 to 31 percent from first quarter is normal. By
taking the mid- point of 30 percent as mid-point the sales figure is obtained by
decreasing the first quarter unit sales by 30 percent. After calculating a 30 percent
decrease in unit volume further assumption is that both prices and product mix will
remain unchanged. The assumption can be relaxed to have more insights or to test the
impact of “What if so and so is changed by some percentage “type of questions.
Next is the estimation of cost of goods sold. For this, Percent of sales method is
used .An assumption is made that the future relationship is between various elements
of costs to sales will be similar to their historical relationship. The actual first-quarter
operating statement provides details on the main components (labor, materials,
overheads and distribution) in cost of goods sold. As the second quarter is the
company’s seasonal low point, it is assumed that some inefficiencies are likely to raise
the overall cost of goods sold as operations slowdown. Cost of goods sold and gross
margin can be calculated directly without the detailed cost breakdown. Selling expense
is shown as Rs.8, 250. Given that the second quarter has lower sales activity, a small
decrease of Rs.750 can be assumed. A reduction fully proportional to the 20 percent
drop in volume would not be possible as some of the expenses are fixed in nature.
Similar is the case with the general and administrative expenses .This method of
estimating the value of various items on the basis of expected developments in the
future is called the budgeted expense method.
As a result of the assumptions, the second quarter operating profit falls by over
5,000 and the profit after-tax drops to less than one by five times is former level. This
is Mostly due to the 30 percent drop in sales volume and the associated profit
contribution loss. Interest is charged according to the provisions of the outstanding
debt, and this information can be obtained from the company’s annual reports. The
operating statement will be completed after we calculate the tax rates(assumed here at
the rate of 30%). It can be observed that there is a signified decrease in the amount of
net profit because of the slowdown in operations. One more assumption needs to be
made about the dividends to arrive at the retained earnings for the per the period, to be
reflected in the pro forma balance sheet. In Wilsh Corp’s case it is assumed that no
dividends will be declared because of low earnings.
Financial Forecasting 373
Actual
quarter ended
March
31,Year 1
Pro forma
Quarter
ended June
30,year 1
Assumptions
Units sold
15,000
10,500
Second quarter has
seasonally low sales, past
data show 30% decline
from first quarter.
Net sales
1,40,000
100.0%
98,000
100.0%
No change in Product mix
and price.
Cost of goods sold
labor
25,960
16,366
20% of cost of goods sold
as before.
Materials
Distribution
Over head
25,256
4,592
61,992
18,002.6
3,273.2
44,188.2
22%of cost of goods sold as
before.
4%of cost of goods sold as
before.
54% of cost of goods sold
as before.
Total
Gross profit
Gross Profit Margin
Expenses: Selling
expenses
Gen &Admn
Total.
Operating Profit
Interest
Depreciation
PBT
Tax@30%
Net income
Dividends
Retained Earnings
Cash Flow after
dividends
1,14,800
25,200
18.0%
8,250
4,450
12,700
12,500
2,500
2,000
7,000
2,100
4,900
900
4,000
6,000
81,830
16,170
16.5%
7,500
3,600
11,100
5,070
2,000
2,000
1,070
321
749
-0-
749
2,749
Increase by 1.5 percentage
point simulates operating
inefficiencies.
C. Vijendra 374
Assuming a drop of Rs.750
due to lower activity
Assuming a drop of Rs.850
Based on outstanding dept
No Payment of Dividends
Carried to balance sheet
Retained earnings
+Depreciation
Note: The above figures are assumed figures.
4. Cash Budget
Cash budgets are very specific planning tools that are prepared every month or even
every week. The financial manger who uses the cash budget after observing the
changing levels of cash flows, decides the minimum amount of cash that should be
kept to allow timely payments of obligation.
5. Operational Budget
The proforma statement and cash budget provide an overall view of the company’s
future performance. In big organizations normally specific operating budgets are
prepared for different divisions (sales, production, etc) in the organization hierarchy.
6. Sales Budget
Sales forecast provides the basis around which the firms planning process is centered.
Important area of decision making such as production and inventory scheduling,
investment in machinery and other fixed assets, manpower the sale forecast. A sales
forecast for the coming year would reflect:
1. Any past trend in sales that is expected to be continued in the coming year.
2. The influence of any events which might naturally effect that trend.
7. Conclusion
Financial planning plays a very important role in any business. The
owner/management need to have the financial planning. By doing financial planning
regularly say for every 3 months helps the management to know where the company is
going. It helps the management to plan standards and actual in order to asses adverse
and favorable conditions. Therefore, a sound financial planning is the need of the hour
for any business to prosper.
References
[1] The ICFAI University, April 2005, Financial Accounting, ICFAI Publication,
Hyderabad.
[2] S.P. J ain & K.L. Narang, 1994, Advance Accountancy, Kalyani Publication,
New Delhi
doc_500349572.pdf
Financial forecasting is a planning process by which the company's management positions its firm's future activities related to the expected economic, technical, competitive and social environment. Business plans always have strategies and actions for achieving desired short - term, intermediate, and long - term results.
International J ournal of Management and International Business Studies.
ISSN 2277-3177 Volume 4, Number 3 (2014), pp. 371-374
©Research India Publicationshttp://www.ripublication.com
Financial Forecasting
C. Vijendra
Research Scholar, Kakatiya University, Warangal.
1. Need for Forecasting
Financial forecasting is a planning process by which the company’s management
positions its firm’s future activities related to the expected economic, technical,
competitive and social environment. Business plans always have strategies and actions
for achieving desired short-term, intermediate, and long –term results. These are
qualified in financial terms, in the form of projected Financial Statements (pro forma
statements) and a variety of operational budgets.
Basically there are three main techniques if financial projections. They are Pro
forma financial statements, cash budgets and operating budgets. Pro forma statements
are projected financial statements embodying asset of assumptions about a company’s
future performance and funding requirements. Cash budgets are detailed projections of
the specific incidence of cash moving in and out of the business. Operating budgets are
detailed projections of departmental revenue and/or expense patterns, and they are
subsidiary to both pro forma statements and cash flow statements.
By developing pro forma statements, a comprehensive look at the likely future
financial performance of a company can be obtained. These statements comprising of
P&L statement and a balance sheet are extended into the future. The pro forma
operating statement (P&L) represents an “Operational Plan” for the business as a
whole, while the pro forma balance sheet reflects the anticipated cumulative impact of
assumed future decisions on the financial condition of the business at a selected point
of time. Both statements are prepared by taking the most readily available estimates of
future activity and projecting, account by account, the assumed results and conditions
.A third statement, a pro forma funds flow statement, adds further insight by displaying
the various funds movements expected during the forecast period.
2. Performa Financial Statement
The preparation of pro forma statements is explained with an illustration of an
hypothetical manufacturing company called Wilsh Corporation. The company sells
two kinds of winter care products. These have a seasonal pattern with a low point of
sale during May. The most recent results are available for the first quarter of the year 1.
These statements give the initial set of data to project the future statements. the pro
forma projection is to be made for the second quarter of the year 1, and the objective is
C. Vijendra 372
to determine both the level of profit and the amount of additional funds required at the
end of the second quarter.
3. Pro Forma Income Statement
The operating system is usually prepared first because the amount of after-tax profit
must be reflected in the balance sheet as a change in retained earnings. The starting
point in the preparation of pro forma operating statement ,as shown on the first line of
the table 1 is a projection of the unit and rupee volume of sales .These can be estimated
in a variety of ways like trend-line projection to detailed departmental sales forecasts
by Individual Products.
In table 1, the actual operating statement for the first quarter ended March 31, is
shown as base for the analysis. Company statistics from past years shown that during
the second quarter a decrease of 29 to 31 percent from first quarter is normal. By
taking the mid- point of 30 percent as mid-point the sales figure is obtained by
decreasing the first quarter unit sales by 30 percent. After calculating a 30 percent
decrease in unit volume further assumption is that both prices and product mix will
remain unchanged. The assumption can be relaxed to have more insights or to test the
impact of “What if so and so is changed by some percentage “type of questions.
Next is the estimation of cost of goods sold. For this, Percent of sales method is
used .An assumption is made that the future relationship is between various elements
of costs to sales will be similar to their historical relationship. The actual first-quarter
operating statement provides details on the main components (labor, materials,
overheads and distribution) in cost of goods sold. As the second quarter is the
company’s seasonal low point, it is assumed that some inefficiencies are likely to raise
the overall cost of goods sold as operations slowdown. Cost of goods sold and gross
margin can be calculated directly without the detailed cost breakdown. Selling expense
is shown as Rs.8, 250. Given that the second quarter has lower sales activity, a small
decrease of Rs.750 can be assumed. A reduction fully proportional to the 20 percent
drop in volume would not be possible as some of the expenses are fixed in nature.
Similar is the case with the general and administrative expenses .This method of
estimating the value of various items on the basis of expected developments in the
future is called the budgeted expense method.
As a result of the assumptions, the second quarter operating profit falls by over
5,000 and the profit after-tax drops to less than one by five times is former level. This
is Mostly due to the 30 percent drop in sales volume and the associated profit
contribution loss. Interest is charged according to the provisions of the outstanding
debt, and this information can be obtained from the company’s annual reports. The
operating statement will be completed after we calculate the tax rates(assumed here at
the rate of 30%). It can be observed that there is a signified decrease in the amount of
net profit because of the slowdown in operations. One more assumption needs to be
made about the dividends to arrive at the retained earnings for the per the period, to be
reflected in the pro forma balance sheet. In Wilsh Corp’s case it is assumed that no
dividends will be declared because of low earnings.
Financial Forecasting 373
Actual
quarter ended
March
31,Year 1
Pro forma
Quarter
ended June
30,year 1
Assumptions
Units sold
15,000
10,500
Second quarter has
seasonally low sales, past
data show 30% decline
from first quarter.
Net sales
1,40,000
100.0%
98,000
100.0%
No change in Product mix
and price.
Cost of goods sold
labor
25,960
16,366
20% of cost of goods sold
as before.
Materials
Distribution
Over head
25,256
4,592
61,992
18,002.6
3,273.2
44,188.2
22%of cost of goods sold as
before.
4%of cost of goods sold as
before.
54% of cost of goods sold
as before.
Total
Gross profit
Gross Profit Margin
Expenses: Selling
expenses
Gen &Admn
Total.
Operating Profit
Interest
Depreciation
PBT
Tax@30%
Net income
Dividends
Retained Earnings
Cash Flow after
dividends
1,14,800
25,200
18.0%
8,250
4,450
12,700
12,500
2,500
2,000
7,000
2,100
4,900
900
4,000
6,000
81,830
16,170
16.5%
7,500
3,600
11,100
5,070
2,000
2,000
1,070
321
749
-0-
749
2,749
Increase by 1.5 percentage
point simulates operating
inefficiencies.
C. Vijendra 374
Assuming a drop of Rs.750
due to lower activity
Assuming a drop of Rs.850
Based on outstanding dept
No Payment of Dividends
Carried to balance sheet
Retained earnings
+Depreciation
Note: The above figures are assumed figures.
4. Cash Budget
Cash budgets are very specific planning tools that are prepared every month or even
every week. The financial manger who uses the cash budget after observing the
changing levels of cash flows, decides the minimum amount of cash that should be
kept to allow timely payments of obligation.
5. Operational Budget
The proforma statement and cash budget provide an overall view of the company’s
future performance. In big organizations normally specific operating budgets are
prepared for different divisions (sales, production, etc) in the organization hierarchy.
6. Sales Budget
Sales forecast provides the basis around which the firms planning process is centered.
Important area of decision making such as production and inventory scheduling,
investment in machinery and other fixed assets, manpower the sale forecast. A sales
forecast for the coming year would reflect:
1. Any past trend in sales that is expected to be continued in the coming year.
2. The influence of any events which might naturally effect that trend.
7. Conclusion
Financial planning plays a very important role in any business. The
owner/management need to have the financial planning. By doing financial planning
regularly say for every 3 months helps the management to know where the company is
going. It helps the management to plan standards and actual in order to asses adverse
and favorable conditions. Therefore, a sound financial planning is the need of the hour
for any business to prosper.
References
[1] The ICFAI University, April 2005, Financial Accounting, ICFAI Publication,
Hyderabad.
[2] S.P. J ain & K.L. Narang, 1994, Advance Accountancy, Kalyani Publication,
New Delhi
doc_500349572.pdf