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WHAT IS FINANCIAL FORECASTING?
It is a Part of Planning process.
They are inferences as to what the future may be.
One of the key aspects of organizational management and is critical to the success
of all businesses
i. Economic assumptions (interest rate, inflation rate, growth rate and so on).
ii. Sales forecast.
iii. Pro forma statements of Income account and Balance sheet.
iv. Asset requirements.
v. Financing plan.
vi. Cash Budget
TYPES OF FINANCIAL FORECASTING
There are a number of methods that can be used to develop a
These methods fall into two general categories
i. Qualitative Methods
ii. Quantitative Methods
1. Executive Opinion:
The expert opinions of key personnel of various departments are gathered to arrive at
The management team makes revisions in the resulting forecast, based on their
2. Sales force Polling:
Companies believe that salespersons have close contact with the consumers
They could provide significant insights regarding customer behavior.
The estimates are derived based on the average of sales force polling.
3. Delphi Method:
A series of questionnaires are prepared and answered by a group of experts, who are kept
separate from each other.
On the basis of result of first questionnaire, a second questionnaire is prepared
This second document is again presented to the experts, who are then asked to reevaluate
their responses to the first questionnaire
This process continues until the researchers have a narrow shortlist of opinions.
4. Scenario Writing:
In this method, the forecaster generates different outcomes based
on diverse starting criteria.
The management team decides on the most likely outcome from
the numerous scenarios presented
1. Regression Analysis
Regression analysis is widely used for prediction and forecasting.
It is analysis of average relationship between two or more variables.
In this method basically there are two type of variables
i. Dependent Variable
ii. Independent Variable
Basically it helps one understand how the typical value of the dependent variable
changes when any one of the independent variables is varied, while the other
independent variables are held fixed
Let ‘x’ be the independent variable, then the line of regression can be given by,
y = a+bx
Now we have to find the best possible value of a & b.
Line of Regression of x on y (by regression coefficient method):
𝑥 − 𝑥= 𝑟
(𝑦 − 𝑦)
Co-efficient of line of regression:
The slope of line of regression is called its ‘Co-efficient’, denoted by “b”
Since there ere two line of regression ‘y on x’ and ‘x on y’, there are two co-efficient,
𝑏 𝑥𝑦= 𝑟
2. Time series analysis:
It consist statistical data which are collected, recorded & observed over successive
interval of time.
More clearly it can be defined as successive observation of given phenomenon over a
period of time.
Components affect the result of time series are:
i. Secular Trend (T):
it shows the direction of the series in a long period of time. Effect of trend is gradual, but
extends more or less consistently throughout the entire period of time.
ii. Cyclic Fluctuation (C):
these are the fluctuations as a result of business cycles and are generally referred to as long
term movements that represent consistently recurring rises.
Components affecting time series….
iii. Seasonal Fluctuations (S):
• these are of short duration occurring in a regular sequence at specific intervals of
• These fluctuations are the result of changing season.
iv. Irregular Fluctuations (I):
• Also known as “Random Fluctuations”
• These variations are take place in a completely unpredictable fashion
Time series analysis…
• For analysis of the time series, we usually have two models,
i. Multiplicative Model:
ii. Additive Model:
Y*= Observed values of time series
3. Proforma financial analysis:
• Proforma statements use sales figures and costs from the previous two to
three years after excluding certain one-time costs.
• This method is mainly used in mergers and acquisitions.
• Also in cases where a new company is forming and statements are needed
to request capital from investors.
• Pro forma Income Statement. (Represents the operational plan for the
PREPARATION OF PRO FORMA INCOME STATEMENTS
Percent of Sales Method
• Assumes that future relationship between various elements of
cost to sales will be similar to their historical relationships.
• These cost ratios are generally based on the average of previous
two or three years.
• For example, Cost of Goods sold may be expressed as a
percentage of Sales.
2. BUDGETED EXPENSE METHOD.
• Estimate the value of each item on the basis of expected
developments in the future period for which the pro forma P&L
a/c is being prepared.
• Calls for greater effort on the part of Management, since they
have to define the likely happenings.
3. COMBINATION METHOD
• Neither the Percent of sales method nor the Budgeted expense
method should be used in isolation.
• A combination of both methods work best.
• Items which have stable relationship to sales can be forecasted using
the Percent of sales method.
• For items where the future is likely to be very different from the past,
budgeted expense method can be used.
Assumptions Proforma for
the qr ended
3.Cost of Goods
9. Ratio of CGS
10. Gross Profit
11. GP Margin
Sales decline 30%
due to low
No change in
20% of Cost of
22% of COG
4% of COG
54% of COG
Increase by 1.5%
Actuals Assumption Proforma
21. Tax @ 30%
25. Cash flow
A drop of Rs.
A drop of Rs.
Carried to B/s.