Financial Forecasting, Planning, and Budgeting
FINANCIAL FORECASTING: THE PERCENT-OF-SALES METHOD
What is financial forecasting and why is it done?
Financial forecasting, an essential element of planning, is the basis for budgeting activities. It is also needed when estimating future financing requirements. The company may look for financing either internally or externally. Internal financing refers to cash flow generated from the company’s normal operating activities. External financing refers to funds provided by parties external to the company. You need to analyze how to estimate external financing requirements. Basically, forecasts of future sales and related expenses provide the firm with the information to project future external financing needs.
The four basic steps in projecting financing needs are:
1. Project the firm’s sales. The sales forecast is the initial step. Most other forecasts (budgets) follow the sales forecast.
2. Project additional variables, such as expenses.
3. Estimate the level of investment in current and fixed assets to support the projected sales.
4. Calculate the firm’s financing needs.
How does the percent-of-sales method work?
The most widely used method for projecting the company’s financing needs is the percent-of-sales method. This method involves estimating the various expenses, assets, and liabilities for a future period as a percentage of the sales forecast and then using these percentages, together with the projected sales, ...