Financial forecasting
Financial forecasting is a process of projecting future
financial requirements of a firm. Financial manager is concerned with the
futurity of financial performance. Financial forecasting, an integral part of
finance manager's job, is an act of deciding in advance the quantum of funds
requirements of the firm and the time pattern of
such requirements. In the process of financial forecasting, financial manager
is supposed to develop projected financial statements. Efficient financial
forecasting enables a financial manager to plan for future financing
requirements and to identify the appropriatesources of funds to satisfy
the financing needs. An efficient financial forecasting should consists of the
following activities:
1. Setting up projected income
statement and balance sheet so that the effect of operating plan on firm's
future profit and other indicator of financial performance can be analyzed.
2. Determining need of financing to
support firm's growth in sales and other investment opportunities.
3.
Forecasting appropriate sources of financing that can be generated
internally as well as externally.
4. Setting up proper mechanism of
control relating to allocation and utilization of funds.
Financial forecasting is concerned with the projection of
future financial performance, condition, flows, and requirements. It enables
the firm to protest the financial feasibility of various policies and actions,
it facilitates the raising of funds by enhancing the confidence of lenders in
the management of the firm, it provides a basis of control and improves the
utilization of resources.
Major
Components:
1)
Projected income statement
2) Cash
budget
3) Projected
balance sheet and
4)
Projected sources and uses of funds statement.
The
inter relationship among these components and their principal parts is shown in
the following figure.
1.
Projected Income statement: The projected income statement also referred to as the
profit plan or operating budget, shows the expected revenues and expenses for
the budget period, usually, one year, and the net financial results of the
operations.
The profit plan of the firm is based on several
budgets, Sales budget, production budget, materials and purchases budget, labor cost budget, manufacturing overhead budget, and budget for
non-manufacturing costs.
2. Cash budget: The cash budget
reflects the cash inflows and outflows expected In the future. The major
sources of cash Inflow are: Cash sales, collection of accounts receivable,
disposal of assets, short-term borrowing, long-term debt and equity capital.
The important cash outflows relate to: Cash
purchases, payment of accounts payable, wages, salaries, rent, interest, taxes,
dividends, capital expenditures and repayment of loans and debentures. The cash
budget should not include noncash expense items like depreciation.
The projected surpluses/deficits in the cash
budget provide the basis for investment (where there is a surplus beyond the
target cash balance the firm wishes to maintain) and financing (when the
projected cash balance falls below the target cash balance).
3. Projected Balance Sheet: The projected balance
sheet shows the projected assets, liabilities and owners equity at the end of
the period. The inputs required for its preparation are the initial balance
sheet, the profit plan, the capital expenditure budget, the cash budget, and
the investment and financing plan.
4. Projected sources and uses
of funds statement:
The projected sources and uses of funds statement shows the sources of funds
and uses of funds in the planning period (funds are usually defined as working
capital). The inputs required for its preparation are the initial balance
sheet, the projected balance sheet and the projected income statement.
The projected sources of funds
are:
i)
Operations (profit before tax plus depreciation),
ii)
issue of additional share capital
iii)
decrease in fixed assets, and
iv)
increase in long-term liabilities.
The projected uses of funds
are:
i) tax
payment,
ii)
dividend payment,
iii)
decrease in long-term liabilities
iv)
gross increase in fixed assets, and
v) net
change in working capital.
