To Plug or Not to Plug, That is the Question: No Plugs, No Circularity: A Better Way to Forecast Financial Statements (Proyección de Estados Financieros sin Cuentas de Cuadre (Plugs))

Abstract

Typical textbooks on corporate finance and forecasting and budgeting recommend closing and matching the financial statements what is known as a plug. A plug is a formula to match the Balance Sheet using the differences in some items listed in it in such a way that the accounting equation holds. This is a very easy way to do it but it encompasses some risks. The risks are that certain numbers in the financial statements could be in error and still the plug would indicate that everything is correct because the Balance Sheet matches..

In this work the reader finds a simplified financial model. In reality, financial models are huge and cumbersome. This is a very simplified model compared with what is found in practice.

We present some basic principles for constructing consistent financial statements. The reader is encouraged to construct the financial statements for herself on a spreadsheet. The relevant financial statements are: the Balance Sheet (BS), the Income statement (IS) and the Cash Budget (CB). The construction of the financial statements starts from policies and/or targets (i.e. accounts receivable policy or target). With these targets or policies we can construct the financial statements.

The contribution of this work is to show that we can construct financial statements without the use of plugs and circularity.

Note: Downloadable document is in Spanish.

Keywords: Accounting, Forecasting Financial Statements, Decision Making, plugs, Planning and control, double entry principle, unbalancing problem

JEL Classification: E47, G31, M40, M41, M46