Question

How will a financial projection be developed?

What is the percentage of sales method?

What is its utility in corporate finance?

Answer 1

For developing a financial projection we begin with the sales forecast and create an expense budget. Cash flow statement needs to be projected along with income projections. For this the annual report for the current year needs to be obtained and a common size statement needs to be prepared. Finally the sales and assets for the next year need to be projected based on expected sales of the next year. The projection can be customised as per own assumptions.

The percentage of sales method is used to calculate the amount of Financing needed to increase sales. For this purpose the forecasting sales is computed as current sales X 1 + growth percentage. Firstly a historical correlation between sales and the forecasted item has to be established on the basis of which sales for the forecasted period is estimated. There after the applicable percentage of sales is applied to the item to arrive at the forecasting amount.

In corporate finance this method is the most useful and common for forecasting future amounts. This method give almost accurate forecast and it is useful to apply it to those expenses and balance sheet items that are closely correlated with sales. Forecasting in turn helps the management to better plan and budget their activities.