Forecasting Process of Financial Statement - Essay Example

Identifying the need for forecasting: The purpose of forecasting may be different in different scenarios. For example, the purpose of sales forecasting is different from the purpose of forecasting for new facility planning.

Therefore it is important to first identify the general need. 2. Selecting the period of forecasting: “A forecast is usually classified by the future time horizon that it covers.” (Heizer et. al., 2008) There are three basic time horizons which are short-term, medium-term, and long-term. A short-term forecast is usually for a period of up to one year. Medium-term is for a period ranging from one year to three years. Anything above three years is a long-term forecast. 3. Selecting the technique of forecasting: There are two basic techniques of forecasting namely Qualitative and Quantitative.

The qualitative method includes the Delphi method, Market Research, Survey of customers, etc. whereas linear Regression, Moving Average, and Exponential Smoothening are some of the Quantitative methods. 4. Collecting the actual results for a past period. It is always better to have historical data relating to a larger time frame as it helps to generate more accurate forecasting results. 5. Preparing the forecast: This step involves applying the technique using the data collected and calculating the value of the forecast. 6. Evaluating the forecasted result: It is not wise to blindly believe in the forecasted result.

One needs to apply his logic to check the feasibility of the result. Also, it can be evaluated based on confidence intervals on a more scientific basis. Comparing the Forecasting process with the Budgeting process While forecasting is a prediction of what is expected to happen, a budget is a target that the company aims to achieve. The budget is based on planned events. It is used by companies to plan and control the business in the future. The main purpose of budgeting is to allocate capital for any future activity and use it in a proper way to achieve the target.

The steps involved in the budgeting process are listed below. 1. Identifying the future business targets by the senior management. 2. Determining the deadline for completing the budget. 3. Accumulating historical financial data. 4. Extending the business templates to departmental or cost center levels. 5. Preparing business plans and strategies at different departmental levels by the respective managers. 6. Compiling all the departmental budgets to form one master budget. 7. Presenting the master budget to the senior management.

(Budgeting & Forecasting Process, 2011) The senior management will then accept the budget and plan their day-to-day activities and finances based on the budget. It is always advisable to perform a periodic check of the activities by comparing them with the budget. It will aid the management to achieve the goals without much variance. Role of Projected or Forecasted Financial Statements in the Budgeting Process The process of budgeting begins with forecasted income and expense statements. It is from the forecasted expense statement that a manager estimates a firm’s need for cash and anticipates the periods of probable cash shortage.

Since the cyclical nature of cash inflows and outflows are not always conveniently timed, it is very important in projecting the financial statement in a budgeting process. Companies prepare cash budgets by using forecasted financial statements. The cash budgets will tell a finance manager about the cash requirement at each stage of the business. Also, cash requirements for capital expenditure and debt servicing can be included in the forecasted financial statements to get a clear picture of the assets and liabilities the firm is going to deal with.

The projected income statement is developed by using the following steps Establish a sales projection Set up a production schedule Calculate other expenses and determine estimated profits (Peavler, 2011) The pro forma balance sheet will show the cumulative changes in the firm over time. If there is an increase in the assets in the current year compared to the previous year, there is a need to adjust it with the increase in liability. Thus these projected financial statements help forecast future levels of balance sheet accounts as well as profits and anticipated borrowing. This will allow a finance manager to track the actual events against the financial plan and make adjustments wherever necessary.