LECTURE 10

PROSPECTIVE ANALYSIS
FORECASTING

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What is prospective analysis

Techniques of forecasting
Projected financial statements

Prospective analysis summarises the

analysts forward looking views
Two basic tasks

Forecasting: pro forma financial statements are

the analytical tool used to summarize analysts
projections
Valuation: projected data are used as input to
valuation

Forecasting implies a summary of what

we have learned:
Business analysis
Accounting analysis
Financial analysis

Overall structure

Be comprehensive
Rely on key drivers: sales growths, asset
turnover, profit margin

Cash flows forecasts are normally

derived from accounting numbers

The objective of forecasting is to produce

reliable and realistic expectations of future
earnings, cash flows and dividends.
Forecasts should be comprehensive
Forecasts must have consistent
assumptions and relations
Forecasts must rely on assumptions that
have internal and external validity.

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Projecting operating revenues

Projecting operating expenses
Projecting assets
Projecting the operating liabilities and financial
leverage and capital structure
Projecting interest expense, interest income,
non-recurring items, income tax, Net income,
Dividends and changes in Retained Earnings.
Deriving cash flows from operating, investing
and financing activities

Sales projection (sales volumes and prices)

Historical trends
Expected level of macroeconomic activity
The competitive landscape
Strategic initiatives of management

If no change in relation between expenses

and sales is anticipated, operating
expenses are forecasted using common-size
In case operating expenses include variable
and fixed components, separate schedule
can be used for forecasting.
Historical growth rate for operating
expenses can also be used.

Projecting cash:
Use forecasted sales and number of days of sales
in cash to compute average balance in cash
Or cash is a plug in (not very common)

Projecting account receivable

Using average receivable turnover rate to project
average receivable and compute the implied
year-end balance.

Projecting inventories
Using average inventory turnover rate to project
average inventory and compute the implied yearend balance.

Projecting other current assets

These items can vary in relation to the level of
operating activity (sales or total assets).

Projecting PPE
Forecast capital expenditure in relation to the
level of sales and compute the balance of PPE
Compute depreciation on balance of PPE and
determine net book value.

Projecting other non-current assets

Forecast other non-current assets in relation to
the level of sales.

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Projecting accounts payable

Using average payable turnover rate to project
average payable and compute the implied yearend balance.

Projecting accrued liabilities

Forecasting accrued liabilities in relation to sales
growth

Projecting short term borrowings

Can be forecasted as % of total assets

Projecting long term debt

Can be forecasted as % of total assets

Projecting other non-current liabilities

Forecasting in relation to sales growth
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Projecting common stock

Assume initial estimate of common stock is equal
to the prior years balance unless they have
significant change

Projecting retained earnings

Assume retained earnings are equal to the prior
years balance plus (minus) net profit (loss) and
less expected dividends.

Projecting other equity accounts

Assume other equity accounts are equal to the
prior years balance unless they have exhibited
noticeable trends.

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Projecting interest expense based on average

interest-bearing debt using average interest rate on
debt

Project tax expense as an average of historical

tax expense to pre-tax income

Balancing items can be

Marketable securities
Short term or long term debt
Dividends or treasury stock

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The projected statement of cash flows is

prepared using the projected income
statement and the projected balance sheet

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Problem 10.9
Problem 10.10
Problem 10.11
Problem 10.12
Excel problem 10.16

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