chapter 11 - revised slidedeck in class Flashcards
why is forecasting important
managers use forecasts to set targets for future performance and also to make decision about and help plan future purchases of assets, sources of financing etc
creditors use forecasts to determine whether their debtors can repay
IB make forecasts pertaining to firms or divisions of firms which they think are potential takeover targets
Analysts make forecasts to communicate their view of a firm’s future prospects
what’s the valuation formula for forecasting using projected future payoffs
the sum of projected future payoffs divided by (1+discount rate)^t
what are the general principles of forecasting financial statements
product unbiased, reliable estimated of future earnings
future =/= looking like past
best forecasts = comprehensive + internally consistent forecasts
benchmark forecasts against other analysts, industry average past performance, etc (
what’s the point of a sensitivity analysis
to observe the effects of assumptions
why forecast annualy
too much forecasting frequency = overkill
how to adjust financial statements for forecasting
begin with retrospective analysis
identify + eliminate transitory items
why is revenue forecast most importantn
bc other income statement and balance sheet accounts derive from the revenue forecast
what are the two approaches to forecasting sales growth
top-down
bottom-up
what’s the top-down approach
forecast industry sales growth
- macroeconomic data –> industry data –> firm=specific data
reliable macroeconomic data + strong link between macro economy + industry
consider competitive landscape
works well for large players in the industry
what’s teh bottom-up apporach
start at product/segment level
- clear revenue driver, established business model
- small players
- less defined industry; lack of clear boundaries, overlapping/niche area, rapidly evolving market,
how to forecast sales growth for firm’s with relatively homogenous assets
sales growth = (1+growth rate in new assets)*(1+ growth in sales per asset) -1
what’s the overview for forecasting income statement
estimate sales growth rate (e.g 1% growth)
estimate expenses;
- COGS + SG&A = % of sales
- depreciation expense = beginning of year PP&E x estimated depreciation rate
- interest expenses = average interest-bearing dent x estimated interest rate
- nonoperating expenses = assume no change and adjust later
- for 1-time item, not expected to recur, thus forecast = $0
- other nonoperating expenses = use a 5 year average
- income tax = based on company’s guidance of pretax income
- noncontrolling interest = no change in historic ratio
what’s the overview to forecasting balance sheet
- working capital accounts = % of sales
- PP&E = increase by estimated CAPEX and reduce by forecasted depreciation expense
- intangible assets = subtract forecasted amortization expense
- current + long-term debt = assume company makes all contractual payments of long-term debt, assume total debt remains unchanged
- SE = no change for paid-in capital accounts except for planned treasury stock transactions
- retained earnings = increase by forecasted net income and reduced by estimated dividends
- estimated dividends = (current year dividends/current year net income) x forecasted net income
- no change in goodwill
- short term debt remains constant
- long-term debt reduced by current maturities and increase by new borrowing to yield _% cash target
how to forecast CAPEX without comapny guidance
forecasted CAPEX = (current year CAPEX/current year sales) x forecasted sales
how to forecast depreciation expense + Forecasted PP&E, net
find historic depreciation expense rate = current year depreciation expense/ prior year PP&E, gross
then use the historic depreciation expense for the forecasted depreciation expense
= current year PP&E, gross x forecasted depreciation rate
forecasted PP&E, net = current year PP&E, net + forecasted CAPEX - forecasted depreciation expense
what does it mean if the cash balance is much higher or lower than normal?
if higher than normal - assume excess liquidity can be; invested in marketable securities, used to pay down debt, repurchase stock or increase dividends payments
if much lower than normal, expect company would; borrow money, sell stock, and/or liquidate marketable securities
should we attempt to maintain the historic debt to equity ratio when forecasting?
yes, especially when forecasting additional borrowing, debt repayment, stock sales or stock repurchases
how to forecast cash flow statement
begin with net income, adds back or deduct any noncash expense or revenues
then determine the cash flow effect of changes in working capital and remaining asset, liability and equity items
compute changes in each line item on forecasted balance sheet + classify changes as operating, investing or financing
why would analysis and managers need or use multi-year forecasts
analysts use it to value a firm’s equity valuation, asses ability to repay debt, assign credit ratings
manager’s use it for cash flow budgets, capital expenditure plans, divesture decisions, mergers + acquisitions
how is the forecasted balance sheet typically balanced
using the cash account as a plug
What’s the parsimonious method
Needs 3 inputs;
1. Sales growth
2. Net operating profit margin (NOPM) = NOPAT/Sales
3. Net operating asset Turnover (NOAT) = sales/year-end NOA
We use year end NOA instead of average NOA because we want to forecast year end values.
Forecasted sales = prior year sales x (1+ sales growth rate)
Forecasted NOPAT = forecasted sales x NOPM
Forecasted NOA = forecasted sales/NOAT
