Forecasting Financial Statements with No Plugs and No Circularity

Abstract

Textbooks on corporate finance and budgeting and forecasting recommend 'closing' the financial statements using what is known as a plug. A plug is a formula to match the Balance Sheet (BS) using differences in some items listed in it in such a way that the accounting equation holds. This is risky because certain numbers in the financial statements could be in error and still the plug would indicate that everything is correct. This paper shows how to construct financial statement without plugs and circularity. It explains how the plug works and what are its drawbacks. It presents a detailed example that can be used by any student, teacher or practitioner to properly construct consistent financial statements. The example shows how to relate different cells in the spreadsheet. Some criticisms against the no plug, no circularity approach are also presented and discussed. Finally, the paper suggests that the use of plugs should be discontinued while teaching forecasting financial statements and budgeting.