Prospective Analysis: Guidelines for Forecasting Financial Statements

Abstract

We discuss some ideas useful when forecasting financial statements that are based on historical data.

The chapter is organized as follows: First we discuss the relevance of prospective analysis for non traded firms. In a second section we a basic reviews of subjects that will be needed for forecasting financial statements. We discuss the use of plugs for financial forecasting. We show an alternate approach to avoid such popular practice. The approach we propose follows the Double Entry Principle. This principle guarantees consistent and error free financial statements. We show with a simple example how the plug works and its limitations and problems that arise when using it.

Next, the reader will find what information is needed for the forecasting of financial statements and where and how to find it. We present the procedure to identify policies that govern the ongoing of a firm such as accounts receivable and payable, inventories, dividend payout, and identify price increases and other basic variables. We also deal with the real life problem of a firm with multiple products and/or services.

We start with historical financial statements. We include inflation rates, real increases in prices and volume and policies in order to construct intermediate tables that make very easy the construction of the pro forma financial statements. We use a detailed example to illustrate the method.

We derive the cash flows that will be used in the book to value a firm. This type of models might be used by non traded firm for a permanent assessment of the value creation. Finally we show some tools to perform sensitivity analysis for financial management and analysis.

Keywords: Financial statements forecasting, sensitivity analysis, cash flows, plug, financial statement balancing

JEL Classification: D61, G31, H43, M41, D92, E22, E31