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.
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, labour 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 non¬cash 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.