BA 7000-093 (Moore)
Chapter 6
Chapter 6 – Prospective Analysis: Forecasting
Key Learning Outcomes
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The ability to relate forecasting to previous analysis performed
Developing a logical and consistent framework to perform forecasts
Familiarity with the methodological tools to perform defensible forecasts
Understanding the different levels of confidence/precision associated with
short-term, intermediate-term, long-term, and terminal value forecasts
A. Firm’s Future potential is governed by:
1. The Firm’s current and expected characteristics
2. Industry factors (growth, competition, substitutes)
3. Economic Factors
B. Time Horizon of Forecasts
1. Short-Term (1-3 years ahead), relatively precise
2. Intermediate-Term (4-7 years ahead), less precise, assumptions matter
3. Long-Term (8-10 years ahead), extremely imprecise, assumptions critical
4. Terminal Forecasts (Present value of an annuity)
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Need to make realistic assumptions on SGR
Cost of Capital (discount rate)
Required since firm is assumed to be a going concern
5. Think about severity of errors in terms of discounted future values
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BA 7000-093 (Moore)
Chapter 6
B. Forecasting Future Financial Statements
1. Start with Income Statement
a. Sales Forecast
b. Gross Profit Margin
c. Work your way down the income statement to net income forecast
d. Compare consistency of results with:
1)
2)
3)
4)
5)
6)
Firm’s Trends
Industry Trends
Economic Forecasts
EPS growth rates
Other published news and reports
Your original assessments
2. Work on Forecast Balance Sheet
a. Subject to dividend policy, net income flows to retained earnings
b. Use variety of asset turnover ratios to determine level of assets required
to sustain forecast revenues.
c. Use trends of Liquidity Ratios (and forecasts) to establish projects
current assets and liabilities.
d. Use trends of Efficiency Ratios (and forecasts) to establish components
of current assets. Then plug in cash to make current assets balance.
e. Use trends of Leverage ratios (and forecasts) to establish long-term debt
and common stock components.
3. Prepare Cash Flow Forecasts (based on Statement of Cash Flows)
a.
b.
c.
d.
Cash Flow from Operating Activities
Cash Provided (used) by Investing Activities
Cash Provided (used) by Financing Activities
Verify consistency with Balance Sheet and make necessary corrections.
C. Forecasts should be made on Annual and Quarterly Basis
1. Nearby quarters have lower discount rates (PV effects). Adjust Seasonality
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