Forecasting Financial Statements: formula sheet

Key formulas

Core idea of forecasting

Forecast = Past data + Expected changes in conditions + Management assumptions

This is a way to remember the method, not a mandatory formula. Say that forecasts rest on assumptions.

Forecast vs budget (key contrast)

Forecast = what is likely to happen; Budget = what management wants to happen and commits to

A forecast is an estimate and is flexible. A budget is a target and is used for control.

Funds need (link to later topics)

Additional funds needed = Forecast increase in assets − Forecast increase in liabilities and retained profit

Forecasting statements are used to find this. The detailed method is studied under External Funds Requirement.

Percentage of sales ratio

Item as % of sales = (Item ÷ Sales) × 100

Use for items that vary directly with sales, such as inventory, receivables and payables.

Forecast item (percentage of sales)

Forecast item = Forecast sales × (Item ÷ Current sales)

Fixed assets are scaled only if capacity is fully used.

Growth rate

Growth rate = (Current sales − Previous sales) ÷ Previous sales × 100

Trend method: forecast = latest figure × (1 + growth rate).

Regression line

Y = a + bX

Y is the forecast variable, X the driver, a the fixed part and b the change in Y per unit of X.

Slope of regression line

b = (nΣXY − ΣX·ΣY) ÷ (nΣX² − (ΣX)²)

Then a = (ΣY − bΣX) ÷ n.

Forecast sales

Forecast sales = Current sales × (1 + growth rate)

Use the growth rate given. If an absolute increase is given, add it to current sales.

Percentage of sales

Item as % of sales = (Base year item ÷ Base year sales) × 100

Apply only to items that vary directly with sales.

Projected item

Projected item = Forecast sales × Item % of sales

Use for cost of goods sold, expenses, debtors, stock, creditors when assumed proportionate.

Retained earnings addition

Addition to reserves = Projected PAT − Dividends

Equals PAT × (1 − payout ratio) when a payout ratio is given.

Projected PAT

PAT = PBT − Tax = PBT × (1 − tax rate)

Compute interest on the loans stated in the question before PBT.

Debtors from days

Debtors = Credit sales × Debtor days ÷ 365

Use 360 days if the question says so. Stock and creditors use cost-based figures: Inventory = COGS × days ÷ 365.

External funds required

EFR = Projected total assets − (Projected liabilities + Projected equity before EFR)

A positive result is a funding need. A negative result is surplus.

External Funds Requirement (AFN)

EFR = (A/S) × ΔS − (L/S) × ΔS − [PM × S1 × (1 − d)]

A/S = spontaneous assets as a ratio of sales; L/S = spontaneous liabilities as a ratio of sales; ΔS = increase in sales; S1 = projected sales; PM = net profit margin on projected sales; d = dividend payout ratio.

Retained earnings for the year

Retained earnings = PM × S1 × (1 − d)

Use projected sales S1, not current sales, unless the question says otherwise.

Increase in sales

ΔS = S1 − S0

If growth is given as a percentage g, then ΔS = S0 × g.

Cash budget closing balance

Closing cash = Opening cash + Receipts − Payments

Opening cash of one period is the closing cash of the previous period.

Financing need in cash budget

Surplus or deficit = Closing cash before financing − Minimum cash balance

A negative figure means borrowing is needed; a positive figure means surplus.

Quick revision

• Forecasting is estimating future financial results and position from past data and expected conditions.
• Sales forecast is usually the starting point; most other items are linked to it.
• Qualitative methods rely on judgement and opinion; quantitative methods rely on data and statistics.
• Percent-of-sales method assumes selected items change in proportion to sales.
• Pro forma statements are projected statements, not actual results.
• Fixed assets may not rise with sales if there is spare capacity; state your assumption.
• Spontaneous liabilities such as trade creditors rise with sales; borrowings and share capital do not automatically.
• EFR = Increase in required assets − Increase in spontaneous liabilities − Increase in retained earnings.
• Retained earnings addition = Projected net profit × retention ratio.
• Cash budget shows cash receipts and payments by period, not profit.
• Non-cash items such as depreciation are excluded from a cash budget.
• Always write your assumptions at the start of the answer.

Common mistakes

• Treating forecasting and budgeting as the same thing Fix: Remember that a forecast predicts what is likely, while a budget sets what management aims for and uses as a yardstick for control.
• Writing that a forecast is a guaranteed result Fix: Always say forecasts are estimates based on assumptions and are revised when conditions change.
• Scaling every item with sales Fix: Scale only items that vary with sales. Keep share capital, long-term debt and often fixed assets unchanged unless told otherwise.
• Mixing up qualitative and quantitative methods Fix: Ask if the method uses past numbers. If it relies on opinion, it is qualitative.
• Growing fixed items such as share capital and long-term loans with sales. Fix: Mark each item as variable or fixed before calculating. Keep fixed items unchanged unless the question adds capital or repays loans.
• Forgetting to add retained earnings to reserves. Fix: After PAT and dividends, immediately write closing reserves = opening reserves + retained profit.
• Using current sales instead of projected sales to compute retained earnings. Fix: Profit for the coming year comes from projected sales. Write S1 beside the formula before substituting.
• Treating all liabilities as spontaneous. Fix: Only trade creditors and accruals normally rise with sales. Loans, debentures and share capital do not, unless stated.

Exam tips

• Expect short theory questions: meaning, objectives, and difference between forecasting, budgeting and planning. Prepare all three.
• Write the answer in points with one explanatory line each. Examiners reward structure.
• For any distinction question, give at least four bases and end with the relationship between the two terms.
• Use the words 'estimate', 'assumptions' and 'likely' when defining a forecast. They show you understand its nature.
• Link the topic to later chapters, such as forecasting statements and funds requirement, to show depth in longer answers.
• For theory, always split your answer into qualitative and quantitative methods and give two examples of each.
• Write the formula before substituting numbers; marks are given for method.
• State the assumption behind each method in one line.