Financial Forecasting and Decision Making

Chapter 2USING THE BASIC FORECASTING MODEL

LEARNING OBJECTIVES

The purpose of this chapter is to introduce you to the basic forecasting model. After completing this chapter, you should be able to do the following:

•     Recognize the importance of assumptions.

•     Recall the EFN requirements for a company using the percent of sales method to prepare a sources and uses of cash equation.

•     Identify when an asset or liability is spontaneous.

Making Assumptions

Assumptions are a necessary part of the forecasting process. Through them, we make the forecast workable, and through them, we begin to develop an understanding of how things interrelate in our company.

When we prepare our first-pass forecast, we generally make very basic assumptions. The most common basic assumption is that we want the current or existing financial relationships to be maintained. (Remember, this is just our starting point. We can and should reevaluate these assumptions in later forecasting passes during our planning process.)

The most common way to operationalize these basic assumptions is to link various values to sales. This should make some sense to you because the company's sales level is probably one of the biggest, if not the biggest, determinant of its future.

The basic model we use is called the percent of sales method. To prepare our first-pass forecast, we determine how each asset, liability, and expense should behave as sales change. Sometimes the changes in the assets, liabilities, ...