Published on Nov 30, 2023
Financial Planning and Forecasting is the estimation of value of a variable or set of variables at some future point. A Forecasting exercise is usually carried out in order to provide an aid to decision – making and planning in the future.
Business Forecasting is an estimate or prediction of future developments in business such as Sales, Expenditures and profits. Given the wide swings in economic activity and the drastic effects these fluctuations can have on profit margins, business forecasting has emerged as one of the most important aspects of corporate planning. Forecasting has become an invaluable tool for business to anticipate economic trends and prepare themselves either to benefit from or to counteract them. Good business forecasts can help business owners and managers adapt to a changing economy.
Financial planning and forecasting represents a blueprint of what a firm proposes to do in the future. So, naturally planning over such horizon tends to be fairly in aggregative terms. While there are considerable variations in the scope, degree of formality and level of sophistication in financial planning across firms, we need to focus on common elements which include Economic assumptions, Sales forecast, Pro forma statements, Asset requirements and the mode of financing the investments.
In general usage, a financial plan can be a budget, a plan for spending and saving future income. This plan allocates future income to various types of expenses, such as rent or utilities, and also reserves some income for short-term and long-term savings. A financial plan can also be an investment plan, which allocates savings to various assets or projects expected to produce future income, such as a new business or product line, shares in an existing business, or real estate.
Financial forecast or financial plan can also refer to an annual projection of income and expenses for a company, division or department. A financial plan can also be an estimation of cash needs and a decision on how to raise the cash, such as through borrowing or issuing additional shares in a company.
The main objective of the study is to understand the financial position of the company, refers to the development of long-term strategic financial plans that guide the preparation of short-term operating plans and budgets, which focus on analyzing the pro forma statements and preparing the cash budget.
Financial forecast or financial plan can also refer to an annual projection of income and expenses for a company, division or department. A financial plan can also be an estimation of cash needs and a decision on how to raise the cash, such as through borrowing or issuing additional shares in a company.
While a financial plan refers to estimating future income, expenses and assets, a financing plan or finance plan usually refers to the means by which cash will be acquired to cover future expenses, for instance through earning, borrowing or using saved cash.
Corporations use forecasting to do financial planning, which includes an assessment of their future financial needs. Forecasting is also used by outsiders to value companies and their securities. This is the aggregative perspective of the whole firm, rather than looking at individual projects. Growth is a key theme behind financial forecasting, so growth should not be the underlying goal of corporation – creating shareholder value is enabled through corporate growth.
The benefits of financial planning for the organization are
Identifies advance actions to be taken in various areas.
Seeks to develop number of options in various areas that can be exercised under different conditions.
Facilitates a systematic exploration of interaction between investment and financing decisions.
Clarifies the links between present and future decisions.
Forecasts what is likely to happen in future and hence helps in avoiding surprises.
Ensures that the strategic plan of the firm is financially viable.
Provides benchmarks against which future performance may be measured.
There are three commonly used methods for preparing the pro forma financial statements. They are:
1. Percent of Sales Method
2. Budgeted Expense Method.
3. Variation Method.
4. Combination Method.
Percent of Sales Method
The percent of sales method for preparing pro forma financial statement are fairly simple. Basically this method assumes that the future relationship between various elements of costs to sales will be similar to their historical relationship. When using this method, a decision has to be taken about which historical cost ratios to be used.
Budgeted Expense Method
The percent of sales method, though simple, is too rigid and mechanistic. For deriving the pro forma financial statements, we assume that all elements of costs and expenses bore a strictly proportional relationship to sales. The budgeted expense method, on the other hand calls for estimating the value of each item on the basis of expected developments in the future period for which the pro forma financial statements are prepared. This method requires greater effort on the part of management because it calls for defining likely developments.
Variation Method
Variation method on the other hand, calls for estimating the items on the basis of percentage increase or decrease of comparing with the same item of base year. It is quite flexible throughout the future period. This method is not like budgeted method, the value estimating for an item under this method is entirely dependent on the historical data.
Combination Method
It appears that a combination of above explained three methods works best. For certain items, which have a fairly stable relationship with sales, the percent of sales method is quite adequate. For other items, where future is likely to be very different from the past, the budgeted expense method or variation method is eminently suitable. A combination method of this kind is neither overly simplistic as the percent of sales method nor unduly onerous as the budgeted expense method or variation method.
The method used for this study is combination method which eminently works best for an organization.The assumptions made for forecasting are as follows:
1. The sales are expected to increase by 20% every year.
2. All expenses are estimated under percentage of sales method.
3. Tax is estimated on the basis of profit.
4. Proposed Dividend to be increased by Rs. 5,000,000 every year.
5. Dividend tax is payable on the basis of proposed dividend.
6. Secured and unsecured loans to be decreased by 5% every year.
7. Tax liability on percentage of sales method.
8. Fixed assets are expected to increase by 2% every year.
9. Work-in-progress of capital is expected to decrease by 10% every year.
10. Investments are expected to increase by 5%.
11. Current assets like inventories and sundry debtors are expected to increase by 2% every year.
12. Cash and it equivalents on the basis of percentage of sales method.
13. Loans and advances are estimated to increase by 5% every year.
14. Current liabilities are expected to increase by 5% every year.
15. Provisions are expected to increase by 10% every year.
Financial Management – Prasanna Chandra
Management Accounting – M.Y. Khan and P.K. Jain
Advanced Accountancy – S.M. Shukla
Financial Statements – Royal Classic Group
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