Financial Forecasting Flashcards
Why is financial forecasting important? Name three reasons.
- All our investment decision rules require CF forecasts
- If we want to value a co (e.g for M&A) we need to be able to forecast co. FCFs to get accurate valuation
- By forecasting our company’s future performance, we can better plan for future possible cash shortages or surpluses
What is a proforma?
- A prediction about co. future financial statements (I/S, B/S, etc.)
What is the purpose of proforma statements?
- To estimate a company’s future need for external financing
- For valuation purposes (clearly, info about a company’s future CFs affects our valuation for it)
What is the main approach we’ll use to forecast in this course?
Percent of sales forecasting
What are the four main steps in percent of sales forecasting?
(1) Look at historical data to find which items (e.g. COGS) tend to vary in proportion to sales
(2) Forecast sales
(3) Based on sales forecast and percentage estimates from step #1, compute forecasts for the other variables that are tied to sales
(4) Conduct a sensitivity analysis or scenario analysis with different assumptions about the variables
Days’ Sales in Cash = …
Cash / Sales per day
Collection period = …
Accounts receivable/ Credit sales per day
Inventory turnover = …
COGS / Ending inventory
Payables Period = …
Accounts payable / Credit purchases per day
The higher the days’ sales in cash number, the less urgent need for what?
Cash
A higher collection period number translates to what?
- The higher the number, the longer it takes (on average) for the company to receive payment for their sales on credit
A higher inventory turnover number translates to what?
- The higher the number, the less time inventory stays on the shelf
- E.g. inventory turnover = 12 means average shelf time is 1 month
What does the payables period ratio measure?
- Average amount of time it takes a company to pay off its account payables
If management isn’t comfortable with their days’ sales in cash and want to increase it, what can they do to increase their cash balance?
- Higher sales
- Increased profit margin
- Longer payables’ periods
- Shorter collection period
- Loan from a bank
What are two complications that arise in financial forecasting (in general)?
(1) What if our debt level changes at the beginning of the year rather than at the end?
(2) What happens if the co. has a minimum cash balance, rather than just letting the cash balance fluctuate with sales?