Transcript Module 11 – Forecasting Financial Statements

FINANCIAL STATEMENT
ANALYSIS & VALUATION
Third Edition
Peter D.
Easton
©Cambridge Business Publishers, 2013
Mary Lea
McAnally
Gregory A.
Sommers
Xiao-Jun
Zhang
Module 11:
Forecasting
Financial Statements
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Overview of the Forecasting Process
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Reformulated financial statements - we adjust the
financial statements to reflect the company’s net operating
assets and the operating income that we expect to persist
into the future.
Garbage-In, Garbage-Out - the quality of our decision is
only as good as the quality of the information on which it is
based.
Optimism vs Conservatism - our objective is not to be
overly optimistic or overly conservative. The objective for
forecasting is accuracy.
Level of Precision - borderline decisions that depend on a
high level of forecasting precision are probably ill-advised.
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Overview of the Forecasting Process
continued
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Smell Test - our forecasts must appear reasonable and
consistent with basic business economics.
Internal Consistency - forecasted financial statements
must articulate and our forecast assumptions must be
internally consistent.
Crucial Forecasting Assumptions - assumptions that
are identified as crucial to a decision must be investigated
thoroughly to ensure that forecast assumptions are as
accurate as possible.
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Revenues Forecast Impacts Both the
Income Statement and the Balance Sheet
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Dynamics of Growth (I/S and B/S)
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Cost of goods sold are impacted via increased inventory purchases
in anticipation of increased demand, added manufacturing
personnel, and greater depreciation from new manufacturing PPE.
Operating expenses increase concurrently with, or in anticipation
of, increased revenues; these expenses include increased costs for
buyers, higher advertising costs, payments to sales personnel, costs
of after-sale customer support, logistics costs, and administrative
costs.
Cash increases and decreases directly with increases in revenues as
receivables are collected and as payables and accruals are paid.
Accounts receivable increase directly with increases in revenues as
more products and services are sold on credit.
Inventories normally increase in anticipation of higher sales volume
to ensure a sufficient stock of inventory available for sale.
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Dynamics of Growth (I/S and B/S)
continued
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Prepaid expenses increase with increases in advertising and other
expenditures made in anticipation of higher sales.
PPE assets are usually acquired once the revenues increase is
deemed sustainable and the capacity constraint is reached; thus, PPE
assets increase with increased revenue, but with a lag.
Accounts payable increase as inventories are purchased on credit.
Accrued liabilities increase concurrent with increases in revenuedriven operating expenses.
Other operating assets and liabilities such as deferred revenues,
deferred taxes, and pensions, increase and decrease concurrent with
revenues.
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Dynamics of Balance Sheet Growth
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Forecasting Steps
1. Forecast revenues.
2. Forecast operating and nonoperating expenses. We
3.
4.
assume a relation between revenue and each specific
expense account.
Forecast operating and nonoperating assets, liabilities
and equity. We assume a relation between revenue and
each specific balance sheet account.
Adjust short-term investments or short-term debt to
balance the balance sheet. We use marketable securities
and short-term debt to balance the balance sheet. We then
recompute net nonoperating expense (interest/dividend
income or interest expense) to reflect any adjustments we
make to nonoperating asset and liability account balances.
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Forecasting Revenues
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Impact of Acquisitions - revenues from acquisitions are only
included from the date of the acquisition. Historical revenues used
for comparison do not include the acquired company.
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Impact of Divestitures - revenues and expenses of divested
business are excluded form current and historical totals.
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Existing vs. New store growth - new store growth can be more
costly than organic growth.
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Impact of unit sales and price disclosures - forecasts that are
built from anticipated unit sales and current prices are generally
more informative, and accurate, than those derived from historical
dollar sales.
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Sources of Information
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Public disclosures via meetings and calls
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Recordings and supporting documents are
frequently available on the “Investor Relations”
section of the company’s web site
Public reports: segment disclosures and MD&A
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Companies are required to disclose summary
financial results for each of their operating
segments along with a discussion and analysis of
each
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P&G Data from MD&A
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Determining the
Revenue Growth Forecast
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Morgan Stanley Forecast
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Each product forecast is built from the bottom up; that is, analysts use
information about a product’s market share and the forecasted growth rate
for the market of each product within each country the product is sold.
Morgan Stanley analysts also have internally-developed databases of
commodity-price indices, inflation indices, and other macroeconomic
indices against which to evaluate the reasonableness of company-provided
forecasts.
Sales forecasts are determined by quantity and price along with growth
forecasts of the product markets, the company-provided future pricing
strategy, and forecasts of price elasticity of demand.
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Forecasting Expenses
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Morgan Stanley Forecasts
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Forecasted Income Statement
for P&G
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Forecasting the Balance Sheet
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Forecasting Balance Sheet Items
1. Forecast amounts with no change - common
for nonoperating assets (investments in securities,
discontinued operations, and other nonoperating
investments).
2. Forecast contractual or specified amounts we assume that the required payments are made
as projected.
3. Forecast amounts in relation to revenues - the
underlying assumption is that, as revenues change,
so does that item in some predictable manner.
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Computational Options
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Forecasts using percent of revenues :
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Forecasts using turnover rates :
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Forecasts using days outstanding :
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Equivalence of Forecasting Methods
We use the percent of sales in our forecasts of balance
sheet accounts because
1. it appears to be the most commonly used method,
2. it is the method that P&G management uses in its
meetings with analysts, and
3. it is the method used by Morgan Stanley in the real-world
analysis illustration we provide in the Module and in
Appendix 11A.
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Morgan Stanley Assumptions
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Forecasted
Balance
Sheet for
P&G
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Adjusted Forecasted Income Statement
for P&G
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Forecasted SCF for P&G
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Reassessing the
Financial Statement Forecasts
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Many analysts and managers prepare “what-if” forecasted
financial statements.
They change key assumptions, such as the forecasted sales
growth or key cost ratios and then recompute the
forecasted financial statements.
These alternative forecasting scenarios indicate the
sensitivity of a set of predicted outcomes to different
assumptions about future economic conditions.
Such sensitivity estimates can be useful for setting
contingency plans and in identifying areas of vulnerability
for company performance and condition.
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Two-Year Ahead Forecasts of the
P&G Income Statement
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Two-Year
Ahead
Forecasts
of the P&G
Balance
Sheet
continued
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Two-Year Ahead Forecasts of the SCF
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Parsimonious Method of
Multiyear Forecasting
Inputs:
■ Sales growth
■ Net operating profit margin (NOPM = NOPAT / Sales)
■ Net operating asset turnover (NOAT = Sales / NOA)
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End Module 11
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