Financial Forecasting and Decision Making

Appendix ATHE BASIC FORECASTING MODEL

This information is being provided as supplementary material and is not required reading as part of the course.

OBJECTIVE

The basic forecasting model will be presented in this appendix. This model is often called the percent of sales method. The percent of sales method is developed from the idea that a company's assets, liabilities, and expenses are related to the company's sales volume. Generally speaking, the larger a company's sales are, the larger its other accounts will be.

KEY WORDS

pro forma. A forecasted financial statement using assumptions about the future.

spontaneous accounts. Assets and liabilities that need to increase as sales increase.

quasi-spontaneous. Accounts such as retained earnings and fixed assets that may increase as sales increase.

reconciliation. The balance sheet and income statements are related. When we forecast them, we must make sure they agree by using the reconciliation equation.

reconciliation equation. A pro forma version of the equation:

assets = liabilities + owner's equity

retention ratio. The proportion of earnings retained in the company. It is one minus the payout ratio.

EFN. External financing needed as a company grows.

first-pass forecast. The first forecast that is computed with basic assumptions. These assumptions can be changed to better manage the company.

THE NEED FOR A SALES FORECAST

A good sales forecast is important as a starting point for the percent of sales method. In spite of ...