Forecasting Financial Statements
Effectively forecasting financial statements is a critical component of a company’s predictive accounting system, which involves forecasting the future financial performance of said company through a statistical understanding of the business’ processes. The pro forma statement is a type of financial document used to forecast a company’s future financial performance, which highlights anticipated expenses and revenues for your company and overall projected operating results. A basic method used to forecast financial statements involves the percent of sales method. With this method, the assumption is that certain assets, liabilities and expenses sustain a continuous relationship with sales volume.
Estimate sales for the upcoming year by analyzing the growth in sales for your company over the previous three years. Forecasting sales is essential as sales generally influence your account balances for current assets and liabilities. Fluctuations in sales for a particular company may depend on the season, the current state of the economy or the specific industry, which means your pro forma statements need to reflect changing trends (industry), cyclical industries (economy) or monthly fluctuations (seasonal).
Predict accounts that vary in relation to sales — accounts payable, accounts receivable and inventory — using the percent of sales method. Find the percent of sales figures for your inventory account, accounts payable and accounts receivable for the previous three years. Using an example amount of $500,000 for forecasted sales and inventory figures representing 20, 23.5 and 22.7 percent of sales respectively over three years, the average of those numbers (22.1) multiplied by your sales forecast ($500,000) results in a forecasted inventory amount of $110,500.
Repeat the preceding steps for accounts payable and accounts receivable.
Forecast retained earnings that represent a cumulative account that increases annually by way of net income and decreases by way of dividends paid. Your retained earnings reflect your company’s profitability and dividend policy (how dividends will be distributed) in relation to net income. Forecast retained earnings by adding current retained earnings to your net income and subtract the amount paid out as dividends (if any) to shareholders. Using this formula assumes that dividends are paid out as either a constant dollar amount or proportion of earnings.
Approximate your fixed asset accounts that typically do not vary directly with sales and may remain at a constant dollar amount but can change during some years unrelated to sales volume. Use information from past financial statements, present-day policies and future development projects to make an educated guess to forecast these types of accounts. As an example, look at your total current long-term debt (financial obligations more than one year old) and subtract all debt payments then add any monies from newly acquired debts to arrive at your forecasted long-term debt for the upcoming year.
Determine the amount of external financing required, if any, as indicated by any imbalance between forecasted sales and expenses. The amount of external financing, also known as the “plug figure,” is an indication of extra resources that are needed to balance your company’s current projected income with projected fund uses or expenses and liabilities.