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CHAPTER 5 Financial Forecasting Explain how the “percent of sales” method is used to develop pro-forma financial statements, and how to construct such statements in Excel. Use the TREND function for forecasting sales or any other trending variables. | 5 Financial Forecasting After studying this chapter you should be able to 1. Explain how the percent of sales method is used to develop pro-forma financial statements and how to construct such statements in Excel. 2. Use the Trend function for forecasting sales or any other trending variables. 3. Perform a regression analysis with Excel s built-in regression tools. Forecasting is an important activity for a wide variety of business people. Nearly all of the decisions made by financial managers are made on the basis of forecasts of one kind or another. For example in Chapter 3 we ve seen how the cash budget can be used to forecast short-term borrowing and investing needs. Every item in the cash budget is itself a forecast. In this chapter we will examine several methods of forecasting. The first the percent of sales method is the simplest. We will also look at more advanced techniques such as regression analysis. 139 140 Financial Forecasting The Percent of Sales Method Forecasting financial statements is important for a number of reasons. Among these reasons are planning for the future and providing information to the company s investors. The simplest method of forecasting income statements and balance sheets is the percent of sales method. This method has the added advantage of requiring relatively little data to make a forecast. The fundamental premise of the percent of sales method is that many but not all income statement and balance sheet items maintain a constant relationship to the level of sales. For example if the cost of goods sold has averaged 65 of sales over the last several years we would assume that this relationship would hold for the next year. If sales were expected to be 10 million next year our cost of goods forecast would be 6.5 million 10 million x 0.65 6.5 million . Of course this method assumes that the forecasted level of sales is already known. Forecasting the Income Statement As an example of income statement forecasting consider the .
