Question

Financial Forecasting:

To determine potential future financial needs, one must generate a plan based not only on past relationships but also on reasonable future projections. Using ratios to help formulate a forecast where sales drive results is an important step in the planning process.

The financial planning models generated by forecasting activities help synthesize the financial manager's thinking about financial, as well as operational, relationships. To generate an estimate of future funding needs, financial planning models use the traditional financial statements you know and love the balance sheet, the income statement, and the statement of cash flows. There are some slight differences, however, between an accounting approach and a financial approach to planning. Specifically, from a current assets and current liabilities perspective, the focus is on firm operations, and not the financial instruments that represent short-term balance entries.

For example, accounts receivable and inventories are used from the current assets section, but cash and marketable securities are not. Accounts payable, taxes payable, and wages payable are used from the current liabilities section, but short-term debt and current portion of long-term debt are not used in the planning process. Remember the focus... Generating a financial plan helps determine future financing needs, incorporates operational plans into financial plans, and provides bases for firm valuation. All those factors should be driven by operations, and not access to short-term financial instruments. Although the outcome of a plan may be a need or estimated need for access for "what-to-do," e.g. how much short-term borrowing should we do in the short-term, the starting point excludes those factors.

Required:

When planning an acquisition, financial forecasts often provide guidance for future activities.

1. How long in the future do you think is an appropriate length of time to formulate a financial plan? Write 50 words.

2. What financial forecasting experience do you have? Write 100 words.

3. Why do you think financial forecasting might be problematic? Write 100 words.

Please write in your own words. Please don't copy from anywhere and give the link which is used for writing.

Answer 1

1. Financial Planning can be done at any stage of the ongoing business depending on the goals you want to achieve. It is done for a specified period of time to estimate the financial requirements of the next year. It will be difficult to forecast for a longer period than to short duration like next year. Financial planning can be related to short-term goals or long-term goals. To achieve the short and long term goals, we need to prepare a financial plan for current period as well as for future. The amount required to buy a fixed assets or to estimate the fund required for the working capital are all part of the financial planning. The estimations must be based on the sound financial principles to avoid the excess or inadequacy of funds.

An acquisition means when one company offers a cash or equity to another company with the intention of acquiring it. Making forecast in the acquisition process is similar to the Discounting Cash Flaw (DCF) model where assumptions are made for the fixed cost, revenue cost, capital expenditures, profit margin and revenue growth. To formulate the financial plan three statement model is required to be made that is income statement, balance sheet statement and cash flow statement.

2. Financial forecasting requires experience in terms of financial knowledge and it's principles. As I have a handful knowledge of finance related to building a financial models that is income statement, balance sheet and cash flow statement in accordance with the principles associated with it, I think I am ready to do the financial forecast. Also having the knowledge of the financial ratios used in forecasting like turnover ratios, debt- equity ratios, inventory ratio, account recievable/payable ratios etc. are an important basics for the financial forecast.

3. Financial forecasting might be problematic in terms of the accuracy, time frame and contingent issues.

Time frame means the duration for which we are doing forecast. Accurate financial forecast can be done for the next year in comparison to the forecast for a decade.

Sources of data that has been included in the forecast must be accurate, otherwise the data will mislead the forecasting goals. As linear analysis is used for forecast which is based on the dependent variables aligning with the financial figures, it must be reliable as there is chance of occurrence of human error.

Contingent issues are related to unforeseeable  events that are likely to occur in future. Like changes in government policies, risk related to external market shocks and economy can form a hurdle in financial financial forecasting.