week 7 (module 11) - cash flow statement forecasting

Question 1

what is forecasting and why is it significant?

Answer 1

preparing future financial statements

• managers can use them to set targets for future performance, make decisions purchases of assets, sources of financing
• creidtors determine if debtors can pay
• investment bankers make forecasts pertaining to firms/dividions of firms they think are potential takeover targets
• analysts

vo = sigma(n, t = 1) projected future payoff(t)/ (1+discount rate) ^t

Question 2

what are the general principles of forecasting financial statements

Answer 2

produce unbiased, reliable estimates of future earnings

best forecasts are comprehensive and internally consistent

forecasts should pass common sense test (benchmark against other analysts, industry average, etc)

Question 3

how frequently are f/s forecasted?

Answer 3

• annually (seasonal effect, costs of details overweights benefits)

Question 4

what is the first process of forecasting financial statements

Answer 4

adjusting f/s

make sure f/s accruately reflect comp core, econ financila conditional and performance

identify and eliminate transitory items

Question 5

what is the importance of the revenue forecast?

Answer 5

other income statement and balance sheet accounts derive directly or indirectly from revenues forecast

both i/s and b/s grow wiht incr of revenues

Question 6

what are approaches to forecasting sales growth

Answer 6

top down:
- forecasting industry sales growth
- macroecon, industry data, firm-specific data
- comeptitive landscape
- works well for large players

bottom up:
- start at product/segment level
- clear rev driver, established business model
- better for small players
- less defined industry (no clear boundaries, niche, rapidly evolving markets)
- ex. ai based diagnotics, augmented reality, chatgpt, blockchain

for firms with rleatively homogenous assets:
sales growth = (1 + growth rate in new assets) * (1+ growth in sales per asset) - 1

ex. retail stores
- sales growth = (1 + growth rate in new assets) * (1+ growth in sales per asset) - 1
- 10-k may have info on opening/closing stores and comments on same store sales
- assume one retail firm has 1000 stores at the end of 2023. plans to open 20 new stores with no closures. same store sales is same. so sales growth for 2024 = (1+20/1000)*(1+0%)-1 = 2%

Question 7

how is the income statement forecasted?

Answer 7

• estimate of sales growth rate
• expense estimates:
  
  • cogs and sg&a: % of sales
  • depreciation: beginning of year ppe * estimated depreciation rate
  • interest: avg interest bearing debt * estimated interest rate
  • nonoperating expenses: assume no change
• other non operating expenses - use 5 year average
• income tax - based on guidance
• non controlling interest - no change in historic ratio

Question 8

how is interest expense calculated?

Answer 8

interest expense = avg debt balance * estimated interest rate

Question 9

how to forecast balance sheet?

Answer 9

• estimates for all assets other than cash (plug amnt), all liabilities and all equity accounts
• working capital accounts: % of sales
• ppe: increase by estimated capex and reduce by forecasted depreciation
• intangible assets: subtract forecasted amort. expense
• current/LT debt: assume comp makes all contractual payments of LT debt, total debt remainds unchanged
• SE: assume no change for paid-in capital accs except for planned treasury stock transactions
• retained earnings: incr by forecasted net income and reduce by estimated dividends

Question 10

how to calculated forecasted capex?

Answer 10

forecasted capex = (curr year capex/curr year sales) * forecasted sales

Question 11

how to calculate historic depreciation expense rate and forecasted dep expense?

Answer 11

historic dep expense rate = curr year depreciation expense/prior year ppe, gross

forecasted dep exp = curr year ppe, gross * forecasted dep rate

Question 12

how to calculate forecasted ppe, net?

Answer 12

forecasted ppe net = curr year ppe net + forecasted capex - forecasted dep exp

Question 13

how to forecast intangible assets?

Answer 13

decrease by expected amortization expense

Question 14

how to forecast LT debt

Answer 14

assume ST debt, other than curr maturities of LT debt will remain at current levels

reclassify current maturities from long to short term and forecast LT debt
prev year LT debt
less: current maturities of LTD
forecasted following year LTD = prev LTD - curr maturities

Question 15

how to forecast dividends and retained earnings?

Answer 15

forecasted RE = curr year RE + forecasted net income - forecasted dividends

forecasted dividends = (curr year div/curr year net income) * forecasted net income

exclude one time items in payout ratio calc

Question 16

how to forecast treasury stock?

Answer 16

comp provide guidance

if not, look at historic data

Question 17

how to forecast cash?

Answer 17

compute cash needed to balance b/s

total assets (total liabilities and equity) - all other asset balances

assess forecasted cash balance and determine if it deviates from historical norm

Question 18

what can you assume if cash balance is forecasted to be much lower/higher than normal?

Answer 18

higher: assume excess liquidity:
- invested in marketable securities
- used to pay down debt, repurchase stock or increase div payments

lower:
- expect company to:
- borrow money, sell stock, and/or liquidate marketable securities

attempt to maintain historic debt to equity ratio when forecasting additional borrowing, debt repayment, stock sales, stock repurchases

Question 19

how to forecast the statement of cash flows?

Answer 19

use forecasted i/s and b/s

• begin with net income, add back/deduct noncash expenses or revenues
• determine cash flow effect of changes in working capital and remaining asset/liability/equity items
• compute changes in each line item forecasted b/s and classify changes as operating, investing or financing

Question 20

how is forecasting for multiple years used?

Answer 20

analysts:
- value firm equity valuation
- assess ability to repay debt
- credit ratings

managers:
- cash flow budgets
- capex plans
- divestiture decisions
- mergers and acquisitions