Valuation, 7th Edition

13Forecasting Performance

This chapter focuses on the mechanics of forecasting—specifically, how to develop an integrated set of financial forecasts. We’ll explore how to build a well-structured spreadsheet model: one that separates raw inputs from computations, flows from one worksheet to the next, and is flexible enough to handle multiple scenarios. Then we’ll discuss the process of forecasting.

To arrive at future cash flow, we forecast the income statement, balance sheet, and statement of changes in equity. The forecast financial statements provide the information necessary to compute net operating profit after taxes (NOPAT), invested capital, return on invested capital (ROIC), and, ultimately, free cash flow (FCF).

While you are building a forecast, it is easy to become engrossed in the details of individual line items. But we stress the importance of placing your aggregate results in the proper context. You can do much more to improve your valuation through a careful analysis of whether your forecast of future ROIC is consistent with the company’s ability to generate value than you can by precisely (but perhaps inaccurately) forecasting an immaterial line item ten years out.

Determine the Forecast’s Length and Detail

Before you begin forecasting individual line items on the financial statements, decide how many years to forecast and how detailed your forecast should be. The typical solution, described in Chapter 10, is to develop an explicit year-by-year forecast for ...