BA 7000-093 (Moore) Chapter 6
Chapter 6 – Prospective Analysis: Forecasting
Key Learning Outcomes
· The ability to relate forecasting to previous analysis performed
· Developing a logical and consistent framework to perform forecasts
· Familiarity with the methodological tools to perform defensible forecasts
· Understanding the different levels of confidence/precision associated with short-term, intermediate-term, long-term, and terminal value forecasts
A. Firm’s Future potential is governed by:
1. The Firm’s current and expected characteristics
2. Industry factors (growth, competition, substitutes)
3. Economic Factors
B. Time Horizon of Forecasts
1. Short-Term (1-3 years ahead), relatively precise
2. Intermediate-Term (4-7 years ahead), less precise, assumptions matter
3. Long-Term (8-10 years ahead), extremely imprecise, assumptions critical
4. Terminal Forecasts (Present value of an annuity)
· Need to make realistic assumptions on SGR
· Cost of Capital (discount rate)
· Required since firm is assumed to be a going concern
5. Think about severity of errors in terms of discounted future values
B. Forecasting Future Financial Statements
1. Start with Income Statement
a. Sales Forecast
b. Gross Profit Margin
c. Work your way down the income statement to net income forecast
d. Compare consistency of results with:
1) Firm’s Trends
2) Industry Trends
3) Economic Forecasts
4) EPS growth rates
5) Other published news and reports
6) Your original assessments
2. Work on Forecast Balance Sheet
a. Subject to dividend policy, net income flows to retained earnings
b. Use variety of asset turnover ratios to determine level of assets required to sustain forecast revenues.
c. Use trends of Liquidity Ratios (and forecasts) to establish projects current assets and liabilities.
d. Use trends of Efficiency Ratios (and forecasts) to establish components of current assets. Then plug in cash to make current assets balance.
e. Use trends of Leverage ratios (and forecasts) to establish long-term debt and common stock components.
3. Prepare Cash Flow Forecasts (based on Statement of Cash Flows)
a. Cash Flow from Operating Activities
b. Cash Provided (used) by Investing Activities
c. Cash Provided (used) by Financing Activities
d. Verify consistency with Balance Sheet and make necessary corrections.
C. Forecasts should be made on Annual and Quarterly Basis
1. Nearby quarters have lower discount rates (PV effects). Adjust Seasonality
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